Where next for tax and ethics in the 21st century?
There is a passage in the Christian bible where some ‘teachers of the law’ ask Jesus about his attitude to taxes, hoping to highlight some discrepancy between his moral teachings and the demands of civil law. ‘Render unto Caesar that which is due to Caesar’, replies Jesus, ‘and render to God that which is due to God’.
As a moral teaching for humans that seems clear enough: Roman taxes were levied in Roman coin, and what Jesus was saying can be broadly paraphrased as ‘meet the abstract obligations of tax law through the abstract medium of currency, but meet the real human obligations of God’s law by following the bible teachings about feeding the hungry, clothing the poor and caring for orphans and widows’.
But how could we translate those principles for corporate bodies with a separate legal personality? Comparatively few businesses have specific aims to consider anything but financial results in their constitution, and while in some jurisdictions the directors may be under an obligation to consider stakeholders beyond shareholders, that’s by no means universal.
Nevertheless, there are good arguments that a business’s ‘licence to operate’ is dependent on more than simply making money for shareholders. Moral outrage in the wake of the Global Financial Crisis of 2007–8 saw the tax affairs of multinational businesses held up for scrutiny, and public reaction was not kind. Many thousands of hours have been spent on trying to craft rules that respond to those concerns, but the huge political barriers to agreeing global rules for taxing profits have yet to be fully overcome.
But just because limited liability corporations are defined by their financial results doesn’t mean that has to be the only way of taxing them. There is good logic for taxing profits. Economic theory says you should try to avoid distortions in business decision making, and businesses will try to maximise profits regardless of whether they are taxed or not, so it may appear that taxing profits won’t distort those economic decisions.
Nonetheless, that logic is based on an assumption that maximising financial profits is the best outcome. While that may be true within the closed environment of one business, with its own rules and results, it only takes a moment’s thought to find examples where economic results should not be the only yardstick of success. Such ‘profits’ may be completely offset by social and environmental costs borne elsewhere, as outlined below.
Actions have consequences
Accountants often refer to ‘externalities’ – outcomes of business behaviour that are not reflected in measured results. These can be positive or negative. One of the most common examples of negative externality is pollution, where a business definitely harms the local environment without bearing any costs of clean-up or remediation. But there can also be negative externalities of tax.
Employment taxes can be a major cost for labour-intensive sectors, so keeping individuals’ earnings below the threshold at which employee and employer tax and social security contributions kick in makes economic sense – but it impoverishes the individual employees, and may result in higher costs to taxpayers when underpaid staff then rely on state benefits. Such practices often go hand in hand with significant uncertainty for them about their income levels, as employers look to manage individuals’ hours to optimise tax efficiency.
There is a simple cure for this practice, but it requires a structural change to the tax system: levy employer-based taxes on the aggregate of employee remuneration, rather than at an individual level. And this is far from the only area where a change in the balance of the tax system could have positive impacts on individuals and society without compromising the overall interests of business.
Taxing profits without considering how those profits are made inevitably favours those businesses that can take advantage of negative externalities to reduce their operating costs. Tackling externalities such as pollution or excessive resource consumption through the tax system often involves the use of proxies, such as carbon taxes. Critics often attack environmental taxes on the basis that, if effective, they will destroy their own base. However, we only need to consider labour, the single most heavily taxed input into most business models, to realise that if something is vital to a business then taxing it won’t destroy the base. If behaviours that can have negative impacts, such as profligate use of water, energy or carbon-intensive resources are taxed directly then there will be an incentive to find the models that consume the least of these assets. Business will adapt and survive, provided the taxes are properly designed and fair between competing businesses.
In practice, the adviser to a specific business needs to operate within the rules as they exist. ACCA’s Global Policy on Taxation, and the 2024 International Ethics Standards Board for Accountants (IESBA) Code of Ethics for Tax Advisers, emphasise the need for advisers to understand the limits of not only what is legal but also what is desirable for the business. As developments in digitalisation change what businesses do and how they do it, businesses, governments and tax systems will need to adapt. The role of the ethical tax adviser goes beyond avoiding the unlawful or undesirable, but must surely extend to identifying the necessary changes and advising those who need to make them on what to do.
How businesses make their profits affects everyone; how much profit they make affects only their shareholders and, given the shape of our current system, the government’s tax income. But in a country with a tax rate of 20%, a business with a typical profit margin of 10–20% must generate around $2.5k–$5k of economic activity to create $100 of tax income. If profit margins are lower, then even more underlying activity and related externalities are required to provide the exchequer with those funds.
Prevention is better than cure. If revenue could be raised by directly targeting the specific behaviour which gives rise to externalities, then society would face reduced remediation costs, and the government can freely spend the tax raised on something other than fixing the costs created by business in making its profits. Designing and creating a tax system for the future can and should address the wider concrete implications for society and the global environment as well as abstract economic indicators. Taxes and companies may be no more than legal constructs, but they have significant impacts on the lives of humans everywhere; recognising and dealing with those impacts is an ethical imperative for all involved in designing, paying and spending taxes. Like those first-century inhabitants of Jerusalem, businesses need to pay up in cash, but also take responsibility for the society in which they operate.
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