April 26, 2013
Morality, Taxation, and Morning Coffee
Is there a moral obligation to pay tax? The topic is not new. Our Google search of “Morality and Taxation” yields many millions of hits.
This is a special edition of the Arnold Report, jointly prepared by Brian Arnold and Larry Chapman
This issue has received a lot of attention recently with Starbucks’ decision to voluntarily pay income tax to the United Kingdom after it was revealed that despite operating there for over 10 years, it had not paid any income tax. The public and the politicians have reacted with outrage against the tax avoidance strategies of multinational corporations – even staunch defenders of corporate interests, such as conservative George Osborne, the U.K. Chancellor of the Exchequer, who calls tax avoidance “morally repugnant” Not surprisingly, the media reporting on the issue has been simplistic and uninformative. Nevertheless, the issue is important and this type of incident can trigger significant repercussions. For example, the OECD Base Erosion and Profit Shifting initiative has likely received a real shot in the arm from the Starbucks affair.
As tax professionals, we realize that there are many reasonable explanations for Starbucks not paying any tax in the United Kingdom. We know about tax, the boundary between tax evasion and tax avoidance, and the sometimes subtle differences between acceptable tax minimization and aggressive tax planning. Although we are not moral philosophers, what we want to do here is to try and provide a foundation for a thoughtful conversation about the issue of morality and taxation. After some considerable debate, we have managed to agree on a few basic principles at the outset.
First, we reject out of hand the outrageously nutty comments that taxation is legalized theft or illegitimate confiscation of private property or that taxation can be resisted on the ground that governments just waste the money. We are not libertarians and we fully subscribe to the Oliver Wendell Holmes Jr. quote that “Taxes are the price we pay for a civilized society.”
Second, we lament the widespread lack of acknowledgement of the link between taxation and government services. Too many people – the media, politicians and our citizens – seem to believe that there is a free lunch when it comes to government services – we can enjoy them but someone else will pay for them. (As Senator Russell Long so eloquently put it: “Don’t tax you, don’t tax me, tax that fellow behind the tree.”)
Third, we also acknowledge that an inevitable element of self-interest is at work here; it is difficult, both personally and professionally, for us to accept that by advising taxpayers on tax minimization strategies we are acting immoral. But it is important for us to ask ourselves whether what we do is acceptable.
If a moral obligation to pay tax is to mean anything, it must be different from a legal obligation to pay tax. Consider the following example, suppose you receive an amount that you know should be included in your income but you also know that the CRA will never find out about the amount. Should you report the amount on your tax return and pay tax on it? We would say the answer is unequivocally, yes – you have both a legal and a moral obligation to pay tax in this situation. The fact that your legal obligation to pay cannot be enforced does not make it non-existent. That is why this is an easy case. The obligation to pay is supported by both legal and moral considerations. Therefore, it can be argued that the moral obligation is irrelevant.
So let’s think about a situation in which you have no legal obligation to pay tax. Say you win the lottery or get some other type of windfall that isn’t taxable but obviously makes you better off. Do you have a moral obligation to pay tax on the amount? Does a person who wins the Nobel Prize or a similar cash prize have a moral obligation to pay tax on the prize despite the specific exclusion in the Act for such prizes? We would be very surprised if anyone would say yes. It would be like saying that someone who makes a capital gain has a moral obligation to pay tax on the exempt portion of the gain.
So maybe morality becomes relevant only when someone takes positive action to avoid paying tax. In other words, do you have a moral obligation not to try to reduce or avoid paying your fair share of tax? This seems like a more difficult issue.
The law is quite clear on this issue. The foundational principle established in the Duke of Westminster case is that taxpayers have the right to arrange their affairs to reduce tax. This principle is equally applicable in the United States, as Judge Learned Hand has memorably said: “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” (Gregory v. Helvering, 69 F2d 809 (2d Cir. 1934). And just in case you think he didn’t deal with whether or not there is a moral duty to pay tax, in Com’r v. Newman he said:
Over and over again the courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor, and all do right, for nobody owes any public duty to pay more tax than the law demands: taxes are enforced extractions, not voluntary contributions. To demand more in the name of morals is mere cant. (159 F 2d. 848 (2d Cir. 1942)).
In our view, most people would accept that there is a fundamental principle that persons who are members of a society have an obligation to pay taxes to finance public goods and services. Whether or not this obligation to pay one’s fair share of tax is a moral principle, we both agree it is impossible to operationalize such a fundamental principle without reference to the law. “Fair share” may a useful guidepost in setting up a tax system, but it is of little value when deciding how tax legislation should be applied to a particular taxpayer.
Recent comments by politicians that taxpayers who structure their affairs to legally minimize their taxes are somehow engaged in morally questionable behaviour are disingenuous and motivated by political considerations. The quantum of tax legally paid or legally avoided by a taxpayer is not a moral issue; it is not immoral to legally minimize your taxes. Taxation must be imposed in accordance with explicit rules that can be enforced.
So perhaps the question becomes, how far can you go in reducing your tax or in advising others to do so? Taxpayers, tax professionals, tax collectors and people in general will inevitably make different judgments about the acceptable boundaries of tax-avoidance strategies; and moral and reputational considerations may be important factors in those judgments for some people.
It makes no sense to discuss moral issues with respect to corporations, despite U.K. politicians’ calls for corporations to pay their fair share. Although corporations are persons under the law (for many, but not all purposes: a U.S. court recently rejected a commuter’s argument that he was entitled to use a traffic lane dedicated for vehicles with multiple passengers because his company’s constating documents were with him in the car), they are legal fictions; they don’t really exist. As a result, standards of morality can’t be applied to corporations in any meaningful way. They can be applied only to real persons – directors, officers, shareholders, and employees.
With this background, let’s look at the Starbucks affair. Starbucks, along with Google and Amazon, have been sharply criticized by U.K. politicians for not paying any (or enough) U.K. tax. This generated a consumer protest that could have had a devastating impact on Starbucks’ business in the United Kingdom. So Starbucks tried to do damage control – without perhaps talking to their tax advisers – by offering voluntarily to pay tax of 10 million GBP in each of the next 2 years, even if it doesn’t have any profit. It says this result will be achieved by not claiming deductions for intercompany royalties. Google and Amazon have refused to follow Starbucks’ lead.
The voluntary payment of tax by Starbucks is extraordinary. As tax people, we note that a voluntary payment of tax is not a tax; it’s a gift to the state. From a practical perspective, Starbucks is paying the tax to protect its reputation and its business. Other payments that it might have made to achieve the same purpose – charitable donations, advertising campaigns, carbon offsets – would be deductible for tax purposes. A voluntary payment of tax will not be. It is somewhat unclear to us how a voluntary payment of tax could be made. In practice, of course, taxpayers can voluntarily decline to claim the deduction of amounts to which they are entitled and often the tax authorities will have no reason to challenge such strange behaviour. That said, it is worth noting that the tax authorities are under an obligation to collect the proper amount of tax owing in accordance with the law – no more and no less.
Starbuck’s so-called voluntary payment of tax is a public relations gesture in response to public outrage about corporate tax avoidance. This is not a sensible method of extracting corporate tax. Starbucks is susceptible because of the nature of its business, but Google and Amazon are not retail businesses in the same sense as Starbucks, so they can decline to pay one penny more than they legally owe. That doesn’t seem fair, especially when we know that Starbucks, Amazon and Google are not special cases. Many other multinational corporations – and it isn’t limited to U.S. multinationals – are not paying any tax in many countries in which they do business, not just the United Kingdom.
We are nervous when companies like Starbucks volunteer to pay tax. How do we know that 10 million GBP per year is the right number – Starbucks’ fair share? – maybe it should be twice as much. A voluntary payment like this is not objective! It cannot be evaluated on legal or moral grounds but simply as a public relations gesture.
Starbucks is a commercial enterprise in a capitalist society. Its purpose is to maximize its profits within the law. The purpose of government is to regulate companies doing business and to tax them. So perhaps the United Kingdom should stop whining about foreign-based multinationals not paying their share – if Starbucks isn’t paying any U.K. tax that might be a clue that the U.K. tax system isn’t working properly. The United Kingdom could change the tax rules to make Starbucks pay more U.K. tax; however, that would run counter to the recent U.K. tax reforms to make the United Kingdom the jurisdiction of choice for multinational companies doing business in Europe. This may turn the issue into a political argument, but it certainly isn’t a moral one.
The role of tax professionals in assisting multinationals to avoid tax may require some serious soul-searching. Without our “creative” talents in manipulating legal relationships, complex legislation and tax treaties, this type of international tax avoidance would not be possible. We can, often do say, in our own defence – that if the law allows something or, more precisely, if it doesn’t prohibit something, then we are not only free, but have a professional duty, to advise our clients that they can do it. As noted above, the difficulty arises where the law is unclear or where the intent of the law is reasonably clear but the words of the law do not fully capture that intent. What is our responsibility then? As professionals, are we or should we be held to a higher standard of behaviour than other business people? If not, then what does it mean to be members of a profession?