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Tax Avoidance: Between Temptation and Trouble

February 14, 2017 • FINANCE & BANKING, Global Capital Markets, Governance & Regulation, Personal Finance

By Matthias Kasper and Erich Kirchler

Fostering tax compliance is a key challenge for global politics. Public revenues need to be protected, and confidence needs to be restored in a system that is deemed ineffective.

 

Conservative estimations indicate that the revenue loss from profit-shifting, a form of corporate tax planning, amounts to USD 100 to 240 billion annually. This is 4 to 10% of global corporate income tax (CIT) revenues (OECD, 2015).1 For developing countries, which rely strongly on revenues from CIT, this ratio is even higher. Consequently, fostering tax compliance is a key challenge for global politics in order to protect public revenues and to restore confidence in the system. But as compliance behaviour is a complex, multi-faceted phenomenon, this is not an easy task.

Multinational corporations have several opportunities to reduce their tax burden. One common and highly effective practice is to shift profits to low tax jurisdictions. Dyreng et al. (2008)2 show that more than a quarter of US multinationals pays less than 20% in corporate income taxes and Oxfam, a UK based not for profit organisation, estimates that the 50 largest US companies hold USD 1.4 trillion in cash offshore to avoid paying taxes in the US (Oxfam, 2016).3 In theory, the law distinguishes between legal tax avoidance and illegal tax evasion, but in practice this distinction is often blurred. Global firm structures and complexity in tax law make the allocation of profits an extremely difficult task and many countries lack capacity to protect their tax bases from profit shifting. But moreover, corporate tax avoidance weakens the payment morale of non-corporate taxpayers who perceive that multinationals are not paying their fair share.

With their reputation at stake, firms become increasingly careful around the pitfalls of international tax planning. Graham et al. (2014),4 for instance, analyse the effects of reputational concerns and the risk of adverse media attention on corporate tax planning. 70% of the executives in their sample state that reputation is an “important” or “very important” factor in their decision not to engage in aggressive tax planning strategies. Their findings indicate that particularly large, profitable public firms are concerned about the reputational effects of tax planning. This is in line with findings from Hanlon and Slemrod (2009)5 who find that stock prices of multinational firms respond negatively to revelations about their involvement in tax shelters. But as corporations are still struggling to find the “optimal” level of tax avoidance, the fight against aggressive tax planning is gaining momentum and clearly, tax transparency is on the rise. To establish a framework for the allocation of corporate income, the G20 have joined forces with the OECD and developed an action plan to reduce base erosion and profit shifting (BEPS, OECD 2013).6 Likewise, the European commission is urging for a common consolidated corporate tax base (CCCTB) based on formula apportionment, which would limit multinationals’ opportunities to artificially reduce their tax payments. But while research indicates that documentation requirements successfully mitigate profit shifting (Beer & Loeprick, 2015)7 and the CCCTB might further impede corporate tax planning, the revenue effects of tax harmonisation within the EU remain to be seen (Devereux & Loretz, 2008).8

 
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About the Author

Matthias Kasper is Assistant Professor at the University of Vienna, Austria. His research analyses financial decision-making and the determinants of tax compliance behaviour.

 

Erich Kirchler is Professor of applied psycology at the University of Vienna, Austria. His research focuses on tax behaviour and money management in households.

 

References
1. OECD (2015). Measuring and Monitoring BEPS, Action 11 – 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris.
2. Dyreng, S. D., Hanlon, M., & Maydew, E. L. (2008). Long-Run Corporate Tax Avoidance. The Accounting Review, 83 (1), 61-82.
3. Oxfam (2016). Oxfam Media Briefing April 14, 2016. https://www.oxfamamerica.org/static/media/files/Broken_at_the_Top_FINAL_EMBARGOED_4.12.2016.pdf
4. Graham, J. R., Hanlon, M., Shevlin, T., and Shroff, N. (2014). Incentives for Tax Planning and Avoidance: Evidence from the Field. The Accounting Review, 89 (3), 991-1023.
5. Hanlon, M., and Slemrod, J. (2009). What does tax aggressiveness signal? Evidence from stock price reactions to news about tax shelter involvement. Journal of Public Economics, 93, 126 – 141.
6. OECD (2013). Action Plan on Base Erosion and Profit Shifting, OECD Publishing, Paris.
7. Beer, S., & Loeprick, J. (2015). Profit shifting: drivers of transfer (mis)pricing and the potential of countermeasures. International Tax and Public Finance, 22 (3), 426-451.
8. Devereux, M., & Loretz, S. (2008). The Effects of EU Formula Apportionment on Corporate Tax Revenues. Fiscal Studies, 29 (1), 1-33.
9. Fehr, E., Fischbacher, U., and Gaechter, S. (2002). Strong reciprocity, human cooperation, and the enforcement of social norms. Human Nature, 13 (1), 1-25.
10. Alm, J., Bloomquist, K. M, McKee, M. (in press). When You Know Your Neighbor Pays Taxes: Information, Peer Effects, and Tax Compliance. Fiscal Studies, in press.
11. Sussman, A. B., & Olivola, C. Y. (2011). Axe the Tax: Taxes Are Disliked More than Equivalent Costs. Journal of Marketing Research, 48 (SPL), 91-101.
12. Frecknell-Hughes, J. & Kirchler, E. (2015). Towards a general theory of tax practice. Social and Legal Studies, 24 (2), 289-312.
13. Owens, J., and Hamilton S. (2004). Experience and innovations in other countries. In H. J. Aaron and J. Slemrod (eds.), The Crisis in Tax Administration (pp. 347-388). Washington, DC: Brookings Institution Press.
14. Taxpayer Advocate Service (2012). Annual Report to Congress 2012, Volume 1, v.
15. Kirchler, E. (1998). Differential representations of taxes: analysis of free associations and judgments of five employment groups. Journal of Socio Economics, 27, 117-131.
16. Kasper, M., Olsen, J., Kogler, C., Stark, J., & Kirchler, E. (in press). Attitudes and social representations about taxation, tax avoidance and tax evasion. In N. Hashimzade & Y. Epifantseva (Eds.), Routledge Companion to Tax Avoidance. London: Routledge.
17. Forschungsstelle für empirische Sozialökonomik (2014). Steuerkultur und Steuermoral in Deutschland 2014. Bund der Steuerzahler Nordrhein-Westfalen e.V. http://deutsche-wirtschafts-nachrichten.de/wp-content/uploads/2014/07/Statement_2014_Folien1.pdf
18. Beer, S., Kasper, M., Kirchler, E., and Erard, B. (2015). Audit Impact Study. Taxpayer Advocate Service Annual Report to Congress 2015, Volume 2. http://www.taxpayeradvocate.irs.gov/Media/Default/Documents/2015ARC/ARC15_Volume2_3-AuditImpact.pdf
19. Mendoza, J. P., J. L. Wielhouwer, and Kirchler, E. (2015). The backfiring effect of auditing on tax compliance. http://ssrn.com/abstract=2597479
20. Rousseau, D. (1995). Psychological Contracts in Organizations: Understanding written and unwritten agreements. Newbury Park, CA: Sage.
21. Kirchler, E. (2007). The Economic Psychology of Tax Behaviour. Cambridge: Cambridge University Press.
22. Kogler, C., Muehlbacher, S., & Kirchler, E. (2015). Testing the “slippery slope framework” among self-employed taxpayers. Economics of Governance, 16(2), 125-142.

 

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