USA tax form 1040 for year 2012 and calculatorBackyardProduction/Getty Images/iStockphoto
When we talk about tax, the debate tends to focus on the billions hiding in palm-fringed tax havens, money that cascades down a daisy chain of companies until it reaches an obscure letterbox in the British Virgin Islands. In response, finance ministers threaten retaliation, the OECD calls for global rules and the populist media demands the scalps of offenders. These are not human miscreants but corporate bodies so it's easy politics to blame the bloated corporations when the government is struggling to balance the books and pay the nations' bills. However, we may be missing the real point. It's not corporates who are hiding the big money. It's somebody else.
The latest big number to emerge is $82-billion (U.S.). The figure is calculated by MSCI, the stock index provider, which has assessed the gap between what was paid on average by the 1,505 top multinationals in its MSCI World Index compared with what those companies ought to have paid, based on the average corporate tax rates in the countries where they earn revenue.
It is a lot of money, but MSCI's theoretical calculation is probably a conservative stab at what is owed by the world's richest companies. The U.S. Congress has its eye on Apple's colossal offshore cash pile, now reported to total $158-billion, money that the tech company won't repatriate for fear that it becomes subject to U.S. tax at the rate of 35 per cent.
It sounds like a dragon's hoard, ready for the taking, but consider some different numbers. America's Internal Revenue Service calculated that the nation's net tax gap – the difference between the amount owed and the amount collected by the IRS, after late payments and enforcement action – was $385-billion. The most recent period to be properly assessed is 2006 and if that year is typical, 15 per cent of the $2.7-trillion owed to Uncle Sam vanishes, due to error, avoidance, underdeclaring, evasion and downright fraud. Of that amount, the biggest component was individual income tax, amounting to $267-billion unpaid, while the corporation tax shortfall was a much smaller $67-billion.
Britain's tax inspectors have conducted the same exercise, the latest assessment being the 2012-2013 tax year when HMRC (the UK's tax authority) suffered a £34-billion shortfall between what was owed and what was collected. The British are doing a bit better than the IRS in chasing taxes owed, with only 6.8 per cent of the estimated total tax owed missing for that year. Still, the same story holds true, with the lion's share of the total unpaid bill accounted for by tax owed by individuals, some £14-billion, or 41 per cent of the total. Unpaid corporation tax was only £3.9 billion and it is clear that the big problem facing tax authorities is the self-employed who, according to British estimates are failing to declare and pay almost 17 per cent of the tax they owe to the government.
Unfortunately, Canada is not investigating these numbers, for reasons which are not entirely clear. However, it would seem unlikely that Canadian statistics will show hugely different trends because the IRS and HMRC are telling us what we already know. The biggest problem facing tax authorities is not the multinationals and their armies of overpaid accountants and lawyers. It's not the Caribbean tax havens or the Luxembourg holding companies that are squirrelling away the billions that could wipe out the national debt. Sure, transfer pricing and profit shifting by multinationals is a problem but for the really big bucks, it's your neighbour and his weekend business activity, conducted in a shed. It's that guy in IT who will fix the software glitch in your personal laptop for $100, paid in cash. It's all those moonlighters and part-timers, the people who were laid off after the crash but carried on working for themselves, declaring some tax but not every penny, because if they did, they would not be able to keep up with the household bills.
It sounds like peanuts, a few thousand dollars owed by him or by her but we are talking about the hidden or underdeclared income of millions of people and their numbers are swelling as corporations shed staff and delayer their organizations. If you ever wondered why tax revenues have been sluggish to respond to economic recovery, look at the expansion in self-employment. It's a phenomenon that begs the question whether our tax systems can cope in a new world of short-term, casual or self-employed work.
Meanwhile, the tax sheltering behaviour of some U.S. multinationals has become notorious in Europe, where the European Commission is now investigating sweetheart tax deals with itinerant multinationals struck by several EU governments, notably Luxembourg, where the Commission believes the Grand Duchy entered into an agreement over the tax treatment of royalty payments to Amazon's Luxembourg holding company which may have been illegal state aid.
It is these arrangements, whereby global companies funnel cash from high tax to low tax jurisdictions by way of royalty payments, interest payments or management charges, that the OECD is investigating in its project on Base Erosion and Profit Sharing (BEPS). Hopefully, the OECD will come up with a set of rules that can satisfy both the U.S. Congress and the EU as well as myriad island tax havens. It will be a lengthy process. But if governments carry on trying to corral the huge corporations, it is because they know that the drafting of such complex rules and approval from dozens of nations is an easier task than getting more tax dollars out of millions of self-employed plumbers, builders, IT consultants and graphic designers.
Such a crack-down on Joe Public is a political bridge too far for any government, whatever the potential reward in terms of paying off the national debt. It would certainly lead to mass political protest and possibly social unrest. More importantly, it would stifle business creation and smother economic recovery as potential entrepreneurs abandon plans and small businesses cut back investment.
It is almost a pity that governments don't try to collect those missing billions from small businesses and the self-employed. Were they to do so, it would finally force governments to ask the big question, the one that no politician ever dares to pose: what level of tax is tolerable? How high can taxes go before the average person decides it is not worth sacrificing the weekend to earn an extra buck? It's about the real economy, the nickels and dimes of economic incentives. But that's too big and hard a problem for the day-to-day business of government.
Carl Mortished is a Canadian financial journalist based in London.