But they should care. Because tax avoidance poses a larger threat to the integrity and functionality of a nation’s democracy than anyone stolen car or robbed purse ever could. Taxes fund roads, streetlights, buildings, schools, social welfare, fire departments, the military, and virtually every other integral element of modern society. Societies flourish with effective taxation and implode without it. If left unchecked, tax avoidance and tax fraud can lead to widescale corruption and severely weakened democracy.
Evasion, avoidance, and everything in between
The act of avoiding taxes goes by many names. As Warren Buffett said, “Bad terminology is the enemy of good thinking. When companies or investment professionals use terms people don’t understand, they want you to unthinkingly accept concepts that are dangerously flawed.”
Tax evasion is dominated primarily by two categories, income, and corporate. Income tax evasion is when an individual does not pay the required tax that they owe off their income, whereas corporate tax evasion is when a company fails to pay a required percentage of its revenue to the government. Where tax law gets hazy is in the difference between evasion and avoidance. Tax avoidance, albeit unethical, is legal. On the income side, it often consists of wealthy people hiring all-star teams of lawyers and accountants to exploit clever accounting tricks and loopholes. On the corporate side, it usually means shuttling money to tax havens and shell companies. Tax evasion, which is illegal, is when a person or corporation deliberately withholds the tax money they owe.
On paper, the difference may seem district, but it is anything but. Tax avoidance shouldn’t be legal, and most countries actively try to close the loopholes that allow for tax avoidance as soon as they can find them. The bottom line is that tax avoidance is really just tax evasion that hasn’t been made illegal yet, especially on the corporate scale. Then there is the final piece in the holy trinity of not paying proper taxes: tax fraud. Tax fraud is the act of falsifying tax documents to present the illusion a person or corporation has paid proper taxes, but really hasn’t. Although the three might have different consequences in the eyes of the law, they are all equally detrimental to democracy.
The detriment of tax avoidance
All forms of tax avoidance undermine the rule of law. Democratically elected governments develop strong tax law over months and years of tedious work, tweaking every clause and section to assure that each citizen is taxed in a way that best balances the needs of the individual and the needs of the government. Every nation does it differently based on the leaders elected by their citizens: some better than others, of course, but every tax law exists in an ecosystem of other tax laws that all serve to fund the luxuries of modern society in one way or another. Although many see tax as an arbitrary payment to a nameless, faceless government, that tax is your subscription to democracy. When wealthy people and corporations pool their resources, legally or illegally, to avoid paying that subscription, they are getting a paid service for free. Democracy is not free, at least from a monetary sense.
Just like Netflix needs your eight euro a month to fund and purchase and production of the hundreds of hours of entertainment it provides, your government needs your taxes to put a road under your feet and running water in your kitchen.
In a simulation, large-scale tax avoidance would result in the hollowing out of public services, and society would slowly wither into destitution as governments could not maintain the services they provide with the money they are getting from their citizens. Unfortunately, we do not live in a simulation. We like in the real world, which, when it comes to the realities of tax avoidance, is perhaps even worse. When wealthy people and corporations don’t fork up their end of the bargain, the government looks to get that missing money elsewhere. Usually, elsewhere is in the ordinary person’s pocket.
The hard-working, middle to lower-class, honest taxpaying citizen is the real casualty of tax avoidance. They are the ones left holding the bag when the rich scheme their way around the subscription fee. There is perhaps no greater illustration of this phenomenon than in the UK. Over 65,000 people in the UK are estimated to pay little to no income tax every year, according to The Guardian. As a result, the UK’s tax brackets are all ratcheted up.
People earning over £200,750 a year in the UK on average pay almost £3,000 more in tax than Europeans earning the same salary, with UK taxpayers forking up an average of £83,300 in tax, compared with an average of £80,600 for the rest of Europe, according to a study from London based accounting conglomerate UHY International.
As of 2019, The percentage of the UK’s national income made up by tax revenue is at its highest since the 1940s. Income tax avoidance costs the UK government an estimates £100 billion annually, according to the Guardian.
However, income tax avoidance is not the primary culprit of the UK’s high-income tax rates; corporate tax avoidance is. Of the 72 recognised tax havens globally, half are British territories, dependencies, or members of the commonwealth. Collectively, the International Monetary Fund (IMF) estimates the British government loses out on £500 to 600 billion annually due to companies exploiting these havens. In fact, about a fifth of the largest companies in the UK regularly avoid paying any tax whatsoever. According to the organisation Tax Watch UK, the nations heavyweight firms like Apple, Google, and Microsoft made over 30 billion in profit in the UK between 2012 and 2017, but shuttled most of it to British overseas territories like Bermuda to avoid paying corporate tax. The moves cost these companies just 933 million in total tax to the UK, the equivalent to a three per cent tax rate.
The outcome of this corporate money moving falls once again on the average joe, who must fork up the difference of over 700 billion annually that the UK loses over income and corporate tax avoidance to maintain the nation’s tax income balance.
Populism
When society’s subscription price goes up for the honest payers, tax evasion sinks its most lethal venom into democracy: the rise in populism.
As a population of taxpaying citizens experience rising income tax and witness their leaders fail to curb the financial crime that causes it, they lose faith in the government’s ability to properly protect them. This leads to a wave of populism, where voters flock toward right-wing “for the people” political parties that challenge standing governments.
The Yellow Vest movement in France was a manifestation of this exact principle, where hundreds took to the streets of Paris in 2018. The populist activists took part in destructive riots triggered by frustration with tax reforms that seemed to benefit the rich and punish an increasingly insecure middle class.
According to a 2019 study from the Journal of Corporate Accounting and Finance (JCAF), nations with weaker and underdeveloped tax law see higher voter turnouts from populist parties. Likewise, the study found that, on average, the higher the percentage of government income that comes from corporate tax, the smaller the populist presence is in that country.
This is because the higher the percentage of government income made up of corporate tax, the less prevalent tax avoidance is. A nation that achieves sufficient income from corporate tax likely means it does not deal with an abundance of tax avoidance, therefore saving its citizens from raised income tax and avoiding a wave of populism.
This phenomenon of tax-fueled populism is detrimental to democracy for two salient reasons. The first is the sheer manipulative effect that tax avoidance has on swaying elections. The JCAF study proves how rampant tax avoidance, especially on the corporate scale, can force citizens’ hands into voting for populist parties and politicians. The state of any democracy is inherently threatened when the abundance of a single crime, left unaddressed by the elected leaders, can galvanise a large scale shift in political idealogy among citizens in order to avoid being hard done by a government punishing the rule followers for the wrongdoing of the rule-breakers.
The second catastrophic impact that tax-avoidance-inspired populism has on democracy is the long-term effect populism has on a democratic structure. It is no secret that populist leaders have a track record of working to break down democratic checks and balances to leave themselves more power and fuel their agenda. Look no further than Donald Trump’s handling of the 2020 US election. These leaders are also infamous for undermining the complexities of financial law and their shortcomings by funnelling public mistrust into innocent parties like immigrants, minorities, and asylum seeker. This issue was exemplified in the 2008 global financial crisis. While understanding complex terms like “mortgage-backed securities” and “synthetic collateralised debt obligations” were key to understanding the disaster, many chose instead to blame it on things they understand. As Steve Carell’s character Mark Baum said at the end of The Big Short, “I have a feeling that in a few years people are going to be doing what they always do when the economy tanks, they will be blaming immigrants and poor people.”
Solutions - do we really need taxes?
The necessity of tax causes a list of problems for both governments and citizens. After all, people and companies would not pour millions of euro into avoiding them if they didn’t stand to make massive net gains by doing so. Traditionally, the solution to tax avoidance, and therefore all of its long-term consequences to democracy, surrounds the strength of tax law. Most envision the responsibility falling on the democratic lawmakers to not only implement strong tax laws, but properly enforce them to mitigate wealthy companies and individuals scamming the government, and therefore the people, out of billions each year. This is indeed the best bet for nations that need income and corporate taxation, but not every nation does.
The United Arab Emirates, Qatar, Monaco, and Brunei are all examples of “tax-free” nations. That is not to say these countries do not receive tax money, but they do not collect income tax from their citizens. These governments still receive income from sales and corporate tax. An income-tax-free monetary scheme is not a feat any nation can pull off, as virtually every “tax-free” nation on earth has one thing in common: natural resources.
Resource-rich countries like the UAE can afford to replace tax revenue with oil revenue, and still offer the same amenities that an income taxing nation can. Many financial theorists may argue that this process is still taxation, just done vicariously through the government taking away assets from its citizens instead of money. In theory, a country’s natural resources belong to its citizens, so whether a nation collects income tax or subsidises it with natural resources, they are still taking away an asset of the population to pay for public expenditure.
The key difference, though, is that individuals are not able to stop the government from selling these natural resources to pay for public expenditure, as they would be able to through avoiding income tax.
This means that nations that can afford to substitute income tax with natural resources can save their democracy a lot of trouble. It also means they might be able to save as much as 100 billion euro annually, if the UK’s track record is any indication.
For those countries that don’t have an abundance of oil wealth, which is most in Europe, protecting tax law is integral to safeguarding their democracy. Without rock-solid tax law and effective enforcement, widescale income and corporate tax avoidance can inflict long and harsh consequences on democracy.
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