Tax avoidance is one of the disreputable activities that nevertheless have no victims and may have good consequences...
When I was studying philosophy in the late 1970s, the academy was regarded as a sanctuary away from the hustle and bustle of daily life, far removed from the relentless demand to produce tangible results. It was supposed to be a quiet forum for reflection where arguments were pursued to their logical conclusions, however inopportune they might seem. Philosophers were to seek truth, not popularity. I hope this is still the case. It is in this spirit that I have recently been discussing certain disreputable and sometimes illegal activities, such as prostitution, pornography, and insider trading. I have argued that these are all victimless activities and should therefore not be made crimes, even if some of us may personally disapprove of them (although I would make a distinction between vices like prostitution and pornography on the one hand and ungenerous but useful business practices like insider trading on the other hand). The scarce resources of the police and regulatory authorities should instead be spent on trying to suppress activities which are clearly harmful to others, such as fraud and violence.
Yet another disreputable activity is tax avoidance. One reason for its widespread condemnation may be that it is confused with tax evasion which is under normal circumstances both immoral and illegal. A person who intentionally tries to hide some of his income or who presents fraudulent expenses against his revenues, is guilty of tax evasion. Tax avoidance on the other hand is when you use all the legal means at your disposal to reduce your tax burden, such as diligently collecting and claiming expenses as deductions against your revenues or transferring assets from a high-tax country to a low-tax country. Tax avoidance in this sense is usually legal, and I see nothing morally wrong with it. When you plan trips abroad, you surf on the internet for the cheapest airline tickets in the class of your preference. Taxes are what government charges you for its services, and it is no less reasonable for you to try to lower this cost as it is to search for the best price elsewhere. You do not want to pay too much for what you get.
This view has been widely challenged, though. One argument against it is that tax avoidance will starve government of resources necessary for the adequate provision of public goods. These are goods which private companies cannot spontaneously provide on the free market because their consumption cannot be limited to those who pay for them. Thus, government has to provide them, financing their provision by taxes. Examples are the defence and police forces and the judiciary and perhaps education and poverty relief. Competition between different tax jurisdictions will lead to a ‘race to the bottom’, it is asserted. Another argument against tax avoidance is that it is unfair because only those citizens who command mobile resources (including themselves) can avoid taxes. They can easily transfer their resources from a high-tax activity to a low-tax activity or from a high-tax country to a low-tax country. Whereas they are moving targets, most people are like sitting ducks. We do not all operate private companies with the leverage it gives against the tax collectors. Nor can we all become tax exiles in Monaco, the Bahamas or the canton of Zug.
Both these arguments rest however on an implausible premise, as French Professor Pascal Salin points out. It is that in the tax jurisdiction under discussion the provision of public goods is optimal and that any departure from its present level will be harmful. An optimal provision of public goods would be where government is benevolent and well-informed and where the citizens get the amount of public goods unanimously, or almost unanimously, desired by them, paying taxes to finance their provision. There, no group would be imposing its will on others and transferring resources to itself from them, against their will. In such a place there would not be any incentive to move elsewhere. But in other places the provision of public goods is not optimal, for example because corrupt politicians and officials direct tax revenues to themselves (as in Brazil) or because demagogues extend public services beyond what is necessary (as in Belgium). In such places, tax avoidance becomes a corrective against public waste.
Tax competition between different jurisdictions is a means of revealing the real preferences of voters as to the acceptable level of taxation and the amount of public goods provided. You vote with your feet. This is what happened to some extent in Sweden in the late 1980s when the level of taxation had become quite high. Many of the most productive individuals moved abroad; stagnation set in; no new jobs were created in the private sector. The Swedes gradually realised that they had gone too far: they lowered taxes and tried anew to encourage the entrepreneurship for which they had become famous in early twentieth century. But the Swedish Social Democrats were moderate and reasonable compared to radical socialists and communists. An extreme case of tax avoidance was the exodus from East to West Germany in the 1950s which the communists tried to stop by building the Berlin Wall. Another extreme case was the massive emigration from Cuba after the communist takeover in 1959, with most of the best-educated and most-productive individuals leaving, about ten per cent of the population. They refused, like the refugees from East Germany in the 1950s, to be treated merely as government resources.
Tax exiles are not only the rich, taking pleasure in their private jets and yachts. They are also ordinary people who are willing to pay reasonable taxes but who prefer to keep the rest of their earnings for themselves and their families instead of watching them disappear into a dark, huge, impersonal, impenetrable bureaucracy. Moreover, those who seem captive because they are not mobile can vote not with their feet but with their activities. What they do if they find the level of taxation excessive is to switch as much as possible from taxed activities to non-taxed activities, which essentially means from work to leisure. They emigrate inwards, rather than to other countries. The inevitable consequence is that the tax base shrinks. This is the essence of the celebrated Laffer Curve which shows tax revenue increase with the tax rate up to a maximum and then decrease. This means that sometimes tax revenue actually decreases when the tax rate is increased: then the tax jurisdiction in question finds itself on the ‘wrong side’ of the Laffer Curve (as in Sweden in the 1980s). The research of Professor Edward C. Prescott, Nobel Laureate in Economics, amply demonstrates this. He points out that in the 1950s Americans and Europeans more or less worked as much, in terms of labour hours. But now, Europeans work much less than Americans. The reason is, Prescott submits, that their income is taxed at a much higher rate than in America.
Tax avoidance is an entirely rational response to excessive taxation. More generally, it is the rational response to any kind of taxation. Consider a progressive income tax, as we have now in Iceland where there are three tax brackets, 31 per cent on income up to €2,336 a month, 38 per cent on income between that amount and €6,559, and 46 per cent on income higher than that. But even if you have a fixed salary, you face a choice when you retire and go on pension. In Iceland, there are three pension schemes. One is a government pension fund which pays out a basic pension to those who do not have any other arrangements, but which pays little or nothing to those who are adequately provided for otherwise. A second pension scheme is the most important one for most people. It is the professional pension fund into which you are obliged to pay a part of your income during your working career and which then provides you with a pension after retirement, usually 60–70 per cent of your previous income. The third pension scheme is a non-obligatory private pension account into which you can pay during your working career, and which becomes disposable when you have reached a certain age. After the obligatory retirement age at seventy, you have to rely on your pension from your professional pension fund and on additional payments out of your private pension account. The advice from your pension fund manager always is (like it was to me) that you should pay yourself monthly out of your private pension account no more than that amount of money which would bring your total income below the highest tax bracket of €6,559 a month. Thus, you could avoid the 46 per cent on income higher than that. This is a perfectly sensible advice, but it is about tax avoidance.
Similar considerations apply if you were a writer making a contract with your publisher on the payment of a large sum of money to you for a manuscript. You would then want to divide the total amount of money payable to you under the contract between two or three years, in order to avoid moving into the highest tax bracket for one year. Again, this would be quite sensible, but it would be a case of tax avoidance. A third example might be when you and your family are running a small business. Then you would want to divide the total income between you and your wife, and possibly your children as well, so that none of you would end up in the highest tax bracket. Yet again, this would be quite sensible, but it would be a case of tax avoidance. But I would be surprised if any reasonable person would morally fault these three examples of tax avoidance (which perhaps could better be described as tax planning). If you take care not to pay more than you need to, you are simply thrifty, and thriftiness is a virtue, not a vice. What is however perhaps most significant about these examples is that if the income tax would be a flat tax, as many economists recommend, then the need for such tax planning would disappear. It would make no difference how much you would augment your regular pension with payments from your private pension acount or in which year you would pay tax on a large sum of money stipulated in a contract.
The condemnation of tax avoidance is of course concentrated on the rich who, it is often said, do not shoulder their fair share of the total tax burden. But in fact, they already pay most of the taxes. The latest figures from Iceland are quite telling. The top 10 per cent contribute 50 per cent of the total revenue from the income tax, and the top 20 per cent contribute 72 per cent, whereas the bottom 50 per cent only contribute 1 per cent. The latest figures in the United States are even more interesting. There the notorious top 1 per cent contribute 40 per cent of total revenue, and the 10 per cent contribute 71 per cent, whereas the bottom 50 per cent only contribute 3 per cent. (The main reason for the difference between the two countries in the contribution by the richest 10 per cent is that income distribution is much more equal in Iceland in the sense that there are fewer super-rich people there.) It is really extraordinary when those figures are assessed that demagogues both in Iceland and the United States, including Bernie Sanders and Elizabeth Warren, propose heavier taxes on the rich. Perhaps they are trying to live up to Aristotle’s contemptuous definition of democracy as the exploitation of the rich by the poor. These figures also suggest the relevance of the question posed in Ayn Rand’s novel Atlas Shrugged: What would happen if the most productive individuals in society would leave? The examples not only of hardcore socialism as practised in East Germany and Cuba, but also of the much softer and more moderate democratic socialism of Sweden in the 1980s provide an answer.
It is often overlooked that even a flat income tax, say 30 per cent on all income, would in a sense be progressive. This would not only be for the obvious reason that a rich person would pay much more than a poor one: 30 per cent of a monthly income of €50,000 is €15,000, whereas the same proportion of an income of €2,000 is €600. This would also be for the reason that a distinction should be made between the gross and net tax burden, as Icelandic Professor Ragnar Arnason argues. The gross tax burden is simply the tax paid to government, in our example €15,000 a month on an income of €50,000 and €600 on an income of €2,000. But the net tax burden of an individual is the tax paid minus the benefit received. Both rich and poor receive benefits from government, the rich for example protection of their property and the poor some services they do not personally have to pay for, like education and possibly health care, and sometimes direct money transfers. It is not implausible to assume, as Arnason does, that the benefits received by different income groups are worth roughly the same to each taxpayer, although they may come in different forms. It only takes a moment’s reflection to see that on this assumption the net income tax is quite progressive, even if the gross income tax would be flat. I should add that I do not regard it as healthy that half the population pays no income tax but that it can easily be goaded into voting for a heavier burden on the other half.
Demagogues are probably impervious to such arguments. They go after the rich for a simple reason: that is where they think they can get money most easily. Their time horizon is just the next electoral term and not the economic long run. There is a famous law about redistribution, Director’s Law, that when goods are politically distributed, they end up in the hands of those politically most powerful, usually the middle class. Perhaps I should state a corresponding Gissurarson’s Law, that when tax burdens are politically distributed, the main targets will be those least popular with voters, usually the rich and large corporations (and in the past religious minorities). It is unsurprising that demagogues want higher taxes which mean more opportunities for them to buy votes. But what is surprising is that economists at international organisations such as the OECD—who themselves pay no taxes on their income—go along with them and lead a campaign for ‘tax harmonisation’ by which they really mean the establishment of a tax cartel, closing all ‘loopholes’ or exit options. They ought to know better. But perhaps the explanation is that these organisations are dominated by high-tax countries. He who pays the piper calls the tune.
Recently, encouraged by the OECD and other international organisations, finance ministers from the largest economies of the world announced their support for a 15 per cent global minimum on corporate income taxes. I would question, on the contrary, the very existence of the corporate income tax. One reason is the old principle on which the United States was founded: No taxation without representation. Corporations have no votes. They are not persons or independent agents. In fact, corporations can best be conceived as a bundle of contracts between shareholders, managers, employees, and customers (including lenders and suppliers). A tax imposed on a corporation therefore will eventually hit some of these groups although it is sometimes unclear which groups these would be and how hard they would be hit. Some might find it obvious that a corporate income tax would mainly hit the shareholders because it would reduce their dividends. The shareholders are more or less the rich, so we need not worry, it is said. But it should be noted that nowadays pension funds and retirement accounts hold a considerable amount of shares in corporations, not only in the United States but also in many European countries. Moreover, a reduction in the earnings of a corporation, as a result of the corporate income tax, may also harm its employees and customers.
Some consequences of making shareholders and other owners of capital special targets of taxation may be unintended and unforeseen. If you want to avoid taxes on the capital you own, then you can simply consume all your current income instead of saving some of it in order to accumulate capital or just for a rainy day. Taxes on capital are instances of double taxation because that part of the income which was used to accumulate capital had already been taxed as income. But to spend all your current income instead of saving some of it is the wrong kind of tax avoidance. It discriminates in favour of the present against the future. Instead, I would submit, the ownership of stock should be encouraged and facilitated. A further consideration is that if ownership of stock is discouraged by a high corporate income tax, it increases the tendency of corporations to finance their expansion by debt rather than equity, by borrowing money (the cost of which can be deduced against revenue) instead of issuing new stock. This means that corporations will become too indebted, over-leveraged, and this, in turn, may lead to credit crunches which is exactly what happened in 2007–2009. For these and many other reasons, Swiss economists Pierre Bessard and Fabio Capelletti propose the abolition of the corporate income tax. They point out that it is anyway not a significant source of revenue in most countries.
While tax avoidance as such is not objectionable, and in my opinion a virtue rather than a vice, what is really preposterous is the double standard of individuals who do their best to reduce their taxes at the same time as they support increasing the tax burden of others. The famous Icelandic singer Bjork (a relative of mine) paid her taxes in the Bahamas while she supported various left-wing causes in Iceland. An Icelandic venture capitalist (whom I used to know personally) moved to Barcelona when a wealth tax was temporarily imposed on the rich in Iceland, after the 2008 bank collapse, but he nevertheless financed a left-wing newspaper, Frettatiminn, which became ever more anti-capitalist until it went under after only one and a half years. Of course the best-known example is Jeff Bezos of Amazon who owns the left-wing Washington Post at the same time as his company uses all available means to avoid taxes (as it should). Another glaring case is that of the two social media giants Twitter and Facebook. While they try as hard as they can to avoid taxes, they had the audacity to close not only the account of a right-wing President of the United States but also to ban all mention, before the American presidential election, of a New York Post story about some compromising material found on a computer belonging to a son of the left-wing presidential candidate Joe Biden. Bezos and his likes are the real free riders in our society, insisting on capitalism for themselves and socialism for everybody else. It is still a relevant question which one of my teachers at Oxford, the Marxist Gerry Cohen, posed in the title of a book: If You're an Egalitarian, How Come You’re So Rich?
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