How to Stop Tax Avoidance

by Benjamin Studebaker

Recently, as countries have sought to shrink deficits, the question of tax avoidance has come up, and how to put a stop to it. In Britain, Google, Amazon, and Starbucks are being questioned by parliament as to why they pay such small amounts of tax on their UK incomes. Much of the public is in uproar over the fact that Google, Amazon, and Starbucks paid effective tax rates of 0.4%, 2.5%, and 0% on their respective 2011 earnings. All of this begs one very important question, one that no one seems to be attempting to answer seriously–what do we do about this? How do we stop it?

A brief point of clarification–we are discussing tax avoidance, not tax evasion. Avoidance is the use of legal means to avoid paying tax, evasion is the use the illegal means. Before I offer serious answers to the question I have set, I must first point out the few answers on offer and why they’re not serious:

  1. Guilt Trip: Shame corporations and rich people into choosing not to avoid tax.
  2. Grass roots Boycotts: organise boycotts of companies that choose to avoid tax to deter them from so doing.
  3. Lower Rates: the rich wouldn’t bother tax avoidance if rates were lower, so a lower rate would produce higher revenue.

Let’s take each in turn.

Guilt Trip:

We can collectively scold the rich through the press and put the blame on them for the lack of revenue, but it will have absolutely no significant impact. Why? The rich respond by pointing out that everything they are doing is legal and that, consequently, their behaviour has been tacitly endorsed by the state. Whether you agree with the reasoning or not, it will rationalise the continuation of avoidance on the part of the rich regardless of what the rest of us write about its moral value. The state created the loopholes and the tax structure that make tax avoidance possible; it is only by fixing that structure that the state can recoup the lost revenue. People who have money want to keep it, and will if we allow them to do so. It is the fault of the state for failing to recognise that and legislating accordingly, not the rich for acting as human beings always act when permitted–with selfishness and conceit. The state must correct for human nature, not the other way around.

Grass Roots Boycotts:

Perhaps, some argue, if we punish the rich by boycotting their businesses, they will change their behaviour to prevent the loss of sales. This sounds very nice in theory–indeed, if no one bought anything from Amazon in the UK, Amazon probably would behave differently. The trouble is that the reason people buy things from Amazon in the first place is that Amazon is, relative to its competition, both quite convenient and quite a good deal. Most ordinary citizens are going to take the most efficient commercial option, and they just don’t care enough about tax avoidance to bother with a boycott even in the short term, let alone sustain it in the long term with the vigilance to act as a permanent regulatory force that keeps companies paying tax. Once again, people calling for boycotts are unrealistically expecting people to behave contrary to human nature, though in this case it’s consumers rather than the companies themselves. Again, society must correct for human nature, not the other way around.

Lower Rates:

Just dropping the rates is, unlike the previous two options, one that does take into consideration the nature of the actors with which we are dealing. It is, however, guilty of being deeply unimaginative. On the one hand, it assumes that there is nothing the state can do to make people pay the rates it’s seeking, a rather bold claim unsupported empirically or theoretically. On the other hand, it assumes that the rich will take this concession and stop avoiding tax rather than do what is in my view far more likely–take this as a sign of weakness from the state, a form of appeasement, and press their demands further. Lowering rates only serves to create an incentive for further future avoidance.

With that out of the way, what would work? Taken on their own or, more ideally, in combination, the following would actually contribute to solving this problem:

  1. Closing Loopholes: the state can identify common avoidance behaviours and make them illegal, turning avoidance into evasion, something the state can enforce and prosecute.
  2. Property Taxes: companies can move their income offshore, but they cannot move their stores, so tax the stores.
  3. International Tax Trust: an international agreement among states setting minimum tax rates, eliminating the downward tax pressure produced by international competition for business.

Let’s add a little more detail into the how and the why of each of these suggestions.

Closing Loopholes:

These companies can only avoid tax in the first place because the specific behaviours the engage in are permitted by law. For instance, the UK branch of Starbucks pays a royalty on the use of the Starbucks logo to the Dutch branch of Starbucks so as to transfer revenue to the branch in the lower-tax Netherlands. Amazon is allowed to define its UK branch as a “service company” by sending most of its income to a branch in Luxembourg. The UK (and all other states that find themselves in similar situations) could identify these behaviours and others like them and simply make them illegal. If you want to do business in a given country, you have to abide by its laws. Countries like the UK are simply too large of economies for other states to give up on the opportunity to profit from doing business there. There is too much money to be made. A similar scenario exists in the United States, where California leads the country on environmental regulations. California sets tougher standards than other states, but because California is such a large economy, companies comply with California’s standards rather than surrender their market share to competitors. This strategy is an excellent one for big economies that have more leverage over their companies, like the United States and the other major economic powers.

Property Taxes:

Property taxes do not entail all the regulating and enforcing that closing loopholes in the income tax system entail. They’re even more progressive than income taxes, and they punish companies and individuals for possessing land that is not being put to good economic use, meaning that they create an incentive for efficient use of land. With the exception of certain predominately web-based firms like Amazon or Google, a strong, powerful property tax could recoup quite a bit of avoided income tax from say, Starbucks, which possesses many individual stores and shops. The primary concern with this option is that it also places an increased burden on elderly pensioners who are sometimes forced to leave their homes in the face of high rates, or small businessmen who struggle to bear the cost of paying the tax for their shops, but this could be worked around with a more targeted property tax, say one that only comes into effect on individuals or corporations with incomes above certain thresholds or with certain numbers of employees.

International Tax Trust:

Closing loopholes is often not really an option for small countries and property taxes don’t hit web-based firms. So what would top all of this off and sew the whole thing up? A tax trust. The idea comes from the old business trusts from the early 20th century, prior to anti-trust legislation. These trusts involved many businesses coming together and colluding to fix prices so that they could all sell their goods at higher prices without having to worry about being undercut. This created an artificial monopoly and reduced market efficiency. It also created a hardship for consumers. However, in this context, a trust is precisely what is needed. Right now, there are a group of economies that are using low tax rates to poach businesses and revenue from other countries–Ireland, Luxembourg, there are many such “tax havens”. Their gain comes at the expense of states like Britain, France, and the United States. However, this latter group is by far the more economically and politically powerful. If the big high tax rate economies were to use their power and influence to coerce the small low tax rate economies into acceding to a tax trust that placed minimum effective rates of tax to which all member states had to adhere, avoidance would quite literally be impossible. There would be nowhere for corporations and the rich to run with their money to escape tax, so the tax money would end up going to the countries in which the business was done–our goal all along. Some on the right might worry that this would free states to raise their tax rates as high as they liked, but let’s remember that states have other reasons for not setting 100% tax rates besides avoidance–economic efficiency due to loss of incentive to work hard, for one.

If governments used these three policies, they could absolutely crush tax avoidance. So why don’t they do it? Because their campaigns are funded by the very people avoiding tax, and consequently their display of anger is political pageantry. The politicians encourage the ineffective policies to demonstrate to the public their commitment to stopping avoidance all the while declining to implement any policies that would be effective. The public foolishly buys what the politicians are selling, and the problem goes on, year after year, unsolved.