The free-riders

by Catriona Heyworth, GLOBUS Correspondent

Tax evasion, while prevalent in today’s society, is hugely unpopular among the general public (Scott 2014). The ethics of tax evasion is not particularly controversial, as most would agree that tax evasion is economically regressive, contributes to inequality by pulling needed funds out of government coffers, and creates other adverse externalities. But the effect of tax evasion on the economy and society is unclear. Taxation revenue is a ‘fundamental underpinning of a functioning society’ and is now more important than ever with government debt being driven up hugely by the costs of COVID-19 and continuing to rise as governments try to speed up economic recovery. The IMF estimates that $500 – $600 billion of corporate tax revenue has been lost from governments, but figures vary greatly.

Some argue that tax evasion is not a massive problem because the corporations which avoid taxes (like Starbucks) contribute to society anyway (as they are the largest employers and the largest spenders). This is a flawed argument which lacks empirical evidence and ignores the fact that those who avoid taxes would not be able to function without publicly funded services. For example, a firm’s employees may have been educated in government-funded schools and travel on government-funded infrastructure. Since these firms benefit from these services and cannot be excluded from using them, to avoid contributing to these serviceswhich they benefit from is undoubtably free riding.

Tax avoidance evasion also has a large impact on sustainability. Sustainability encompasses social justice and fairness, as well as resource management. The most fundamental principle of economics is that resources are scarce, which means that decisions must be made about where to allocate those resources. This raises some important questions about how we approach the COVID-19 recovery, as many countries have pledged to pursue ‘green recoveries’ by prioritising funds to sustainable projects. If large quantities of resources are being hoarded away in tax havens instead of being invested in these projects, it limits our ability to continue progressing towards a greener future.

The link between tax evasion and sustainability also calls into question other actions of firms. Those that are more likely to evade taxes also have weaker corporate social responsibility practices, which will have knock-on effects into other areas of sustainability. For example, firms with stronger CSR are more likely to engage with the local community or in efforts to reduce inequality. There has been plenty of literature showing that tax evasion can decrease the longevity of the firm in question by reducing its integrity. Firms with better CSR practices are rewarded by consumers more than those who do not, provided there is transparency about the firms’ actions. Thus, it is within a firm’s best interest to engage in socially responsible actions, which include paying taxes. Avoiding taxes also threatens the social norms of our society, weakening the incentive for others to be tax compliant and creating harmful multiplier effects. This is a problem which can damage the social fabric in a country by reducing mutual trust within the society.

Trying to tackle tax evasion is an age-old problem that has no easy solution. While hard law is necessary, it is very difficult for a government to successfully accomplish change unilaterally, as this is certainly an international problem. Soft law might be more successful, by changing norms and making corporate social responsibility higher on the agendas of less ethical firms. It is clear that international cooperation will be required in the long run to increase the sustainability of our tax system. A task of this magnitude always brings challenges, one being that regions which are considered tax havens will lose from more aggressive targeting of tax evasion. Major steps forward are being made through soft law, for example the Global Reporting Initative, through which firms report their most important impacts on society, including tax reporting. One of the best sustainability measures, the Dow Jones Sustainability Index, rates the largest firms in the world based on a number of sustainability measures including tax policies, and does positively affect firms’ sustainability. There is great progress being made here and it is rising on government’s agendas, but hard international law has a long way to go, and soft law will still need to be established more significantly.

Cover image: Christine Roy