Taxation, death and democracy
Many myths are constructed to justify not paying taxes. David Hutt explores some of them and their effects on the majority world.
When Benjamin Franklin uttered his memorable bon mots, ‘nothing in this world is certain except death and taxes’, still resonating was the echo of another aphorism, ‘no taxation without representation’, a cry so eloquently put by James Otis that it motivated many to risk their lives for the foundation of the American Republic and one of the world’s most enviable democracies. These two dualities, the parity of death and taxation, and the causality between taxation and democracy, would be unwise to overlook in our present era, especially by those in the developing world.
It is often said that taxation is something wished upon others but rarely upon oneself. Perhaps a universal sentiment, though one can only hope that so too is the desire for equality. And in our present day, few issues irk those who aspire for equality more than tax evasion. The Guardian reported last year that tax revenues for most developing countries lie between 10 and 15 per cent, compared to an average of 35 per cent for the developed world. Around the same time, a report by Global Financial Integrity showed that, between 2004 and 2013, developing and emerging economies lost $7.8 trillion because of illicit tax flows. Cambodia – the country where I now live – was ranked 61st, losing $1.5 billion.
One might assume, and not unfairly, that transnational corporations are the worst offenders. Last year, the UN Conference on Trade and Development estimated that at least $100 billion is lost each year by the developing world because of tax avoidance by these firms. Still, one must also dump blame at the feet of the local companies, many of which have become well heeled in the art of financial trickery.
Tax evasion, however, is only one side of a sharpened coin used by companies to avoid paying what they should. The other is tax holidays, which the IMF argues are the ‘most popular’ form of tax incentives among developing countries, and used to attract foreign investment in return for offering the foreign firms a temporary or permanent reduction in certain taxes.
The justification for tax holidays, as I sense its claqueurs primed to claim, goes thus: if tax rates reduce potential profits, companies will not invest in the developing world, and, by extension, these countries would be wise not to rebuff foreign investment since it is the prerequisite for the growth of their economies. I take issue with this ‘pious’ and ‘noble’ logic.
First, several studies have demonstrated the correlation between tax holidays and foreign investment is flimsy at best. Even the IMF in a 2009 report stated that issues such as good infrastructure, education and good governance ‘matter more than taxation’ for foreign investment – and which cannot be adequately funded without taxation. Second, it starts the developing world on a ‘race to the bottom’, in which governments compete with one another to offer the lowest taxation for foreign firms. Third, tax holidays ‘provide a strong incentive for tax avoidance, as taxed enterprises can enter into economic relationships with exempt ones to shift their profits through transfer pricing,’ claimed an IMF report. Fourth, tax holidays also force governments to spend money on administrative costs, necessary to make sure time-restrictions or other such conditions are not being taken advantage of. Fifth, the logic is often followed by another charge that if taxation was paid, it would just end up in the hands of corrupt politicians. Pure casuistry: ‘We accept the wisdom of governments to give us tax breaks, but not the wisdom of the same governments to provide for their own citizens,’ and it should be left to perish with corresponding paternalistic statements that seek to disparage sovereignty for the sake of profit.
An overarching question must be asked at this juncture: if the justifications for tax holidays are not what they claim, is the practice not just a variation of tax avoidance? Arguably, yes. And if so, are the affects the same as pure tax evasion? Most likely.
In a 2008 study, Christian Aid found, or predicted, that tax evasion would cause the deaths of 5.6 million children in the developing world between 2000 and 2015. Almost 1,000 per day. (This says nothing for the effects on adults or the generational afflictions that come with underfunded healthcare, education and so on.)
The report went on to suggest that ‘UK taxpayers are effectively subsidizing company profits through the aid budget’ – an insinuation could be made that taxpayers are also funding these deaths. This is not to be overlooked. In 2014, a report called the State of Finance for Developing Countries showed that since 2008, for every $1 gained by the world’s poorest countries through aid, they have lost $2 through tax evasion, profits by foreign corporations and debt repayments to wealthier nations.
Few would deny the importance foreign aid in the developing world, though some have suggested its importance is not necessarily positive.
Sophal Ear, an associate professor of Diplomacy and World Affairs at Occidental College, Los Angeles, and author of the book Aid Dependence in Cambodia, believes that foreign aid has hurt Cambodian democracy, ‘because the more the authorities rely on outside resources, the less they are incentivized to collect taxes, which are needed for holding the authorities accountable.’ As he told me rather succinctly: ‘Accountability is missing when the people aren’t paying the taxes that would cause them to say: Stop, you have to listen to us, the people.’
This echos Otis’s coinage of ‘no taxation without representation’, which, in the present era, can be inversed to read: no representation without taxation. This is not a new concept, and has been expounded by numerous academics and economists who have dubbed it the ‘taxation leads to representation hypothesis’ (a detailed study of it can be read here).
A brief outline of Cambodia offers a case study: the proto-democracy has been ruled, effectively since 1985, by Prime Minister Hun Sen and his Cambodian People’s Party. Elections have been held, in which the opposition polled well, despite claims of vote-rigging. And it is a country of NGOs and charities, where many of the essential services needed by the country’s poor are provided by them, and not the government.
In February, I posed the question: will increased tax collection in Cambodia strengthen democracy? The answer appeared to be yes. Cambodia has long gone cup in hand to foreign donors to bolster its state budget, yet in the coming years it is expected to transition from being a ‘least-developed country’ to a ‘lower-middle income country’. While these might sound like fatuous terms, they mean a great deal because a move up the appellative ladder means that foreign aid and preferable loans are scaled back. Because of this, the Cambodian government has realized that it will have to provide for itself in the future. And this discovery has come at the same time as its national budget is rising: $4.3 billion for 2016, up 12 per cent from last year.
In 2015, Cambodia collected almost 22 per cent more tax than the previous year and, early this year, set about overhauling its collection system. However, taxation remains at a paltry $1.3 billion – less than a third of the state budget. If foreign aid and loans are not to augment this deficit, then it is only logical that greater efforts must be made to ensure taxation can.
This could lead to two outcomes. The first, and arguably the more optimistic, is that as the Cambodian government is forced to swell its state budget through increased taxation, taxpayers will not only demand greater accountability in how it is spent, heightening the people’s democratic voice, but this might be successful in making the government spend more on essential services. (Of course, it is not to be expected that citizens welcome greater taxation with open arms or would be conscious of its democratizing affect; these are mere side effects.) The alternative outcome, however, is that if the Cambodian government does increase taxation without providing accountability or the delivery of essential services, this could lead to increased conflict between taxpayers and their government, which may not necessarily be a bad thing.
Only time will tell which of these two outcomes will take place. But what does appear clear today is that if a country like Cambodia is to develop as its people deserve, then alongside increasing taxation on citizens must also be a greater demand on taxing foreign businesses. While the first may have the side effect of strengthening democracy, the latter will almost certainly provide the necessary funds to combat poverty, underfunded education and poor healthcare that inflict much of the Global South. Should the two happen at the time same; all the better.
(Disclosure: I should declare that I have not paid one cent in income tax in Cambodia, nor have many of my fellow migrants, since the government has yet to enforce this on most foreign workers. Acquaintances have suggested that if they were to be taxed, they would go elsewhere, which I doubt very much.)
New Internationalist will be delving into the intricacies of corporate tax evasion in our December 2016 issue.
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