Tax Evasion vs. Tax Avoidance

Tax evasion and tax avoidance are often used interchangeably. However, there is a huge difference between the two terms. Tax evasion is a criminal activity. In most countries, tax evasion would attract a jail term.

Evasion is usually done by not reporting income or overstating expenses. However, tax avoidance is not a criminal activity. Tax laws tend to be complex and lengthy. Hence, people with knowledge of these laws can end up paying significantly less tax than others. It is for this reason that the big four accounting firms hire tax experts. These tax experts help multinational corporations legally minimize their tax bill. However, over a period of time, the thin line between legal and illegal is being blurred. Several policies suggested by these tax experts are downright unethical and bordering on illegal.

The Problem with Tax Avoidance

Tax avoidance may be legal. However, it has a negative impact on the economy of the nation. Firstly, it creates public anger. People tend to realize that companies are paying significantly fewer taxes than they should. This leads to a culture of tax avoidance wherein everybody tried to avoid paying any tax at all. Also, companies that can lower their tax bills using these loopholes have significant cost advantages. They are able to simply price the competition out of the market. Hence, tax avoidance ends up skewing the entire industrial structure in an economy.

Steps To Overcome Tax Avoidance

There are many countries that are facing this problem of tax avoidance. Although it feels like they are helpless, this is not the case. Here are some of the steps that can be taken to solve the problem of tax avoidance.

• Lower Tax Rates: It is important for the countries to realize that a higher tax rate does not mean more tax collection. In fact, it may mean the exact opposite. People tend to hide their incomes when tax rates increase. A very high tax rate may discourage people from undertaking productive economic activity.

  The Laffer curve explains that beyond a certain point an increased tax rate leads to lower collections. The government needs to find out the optimal tax rate and implement it. President Donald Trump of the United States has realized this problem and as a result, has lowered tax rates significantly to increase tax compliance.

• Forcing Errant Sovereign Nations to Act: There are a handful of errant jurisdictions which do not provide information about tax avoidance. These countries are typically known as tax havens. These countries include Monaco, Luxemburg, Switzerland, and Bahamas, etc.

  Countries like the United States and the United Kingdom must blacklist these nations. This means that if a company is incorporated in these locations, they will not be allowed to trade in the local markets. The idea is not to infringe on the sovereignty of other nations. However, at the same time, these nations and associated multinational corporations should not be allowed to steal tax revenue with impunity.

• Exit Taxes: Countries like the United States and the United Kingdom can set up exit taxes. This means that if a company wants to move their business overseas, they should pay a tax to the government. The objective is to induce companies to produce locally. However, this model should only be implemented if the tax rates are already reasonably low. Otherwise, companies will simply shut down their operations in the country.

• Territorial Taxation: A lot of tax avoidance occurs because taxation is not territorial. This means that if Amazon sells goods in the United Kingdom, they can avoid paying taxes. They can do so by incorporating in Ireland and ensuring that the goods move across national borders. This strange tax regime has encouraged companies to incorporate in countries with low tax rates.

  Also, countries like Ireland and Luxemburg are involved in a tax war wherein they are lowering the tax rates and causing losses to their respective exchequers. At the same time, multinational companies are playing them off and reaping the benefits. New laws must be introduced which ensure that if the good or service is being delivered in the United Kingdom, it must be taxed as per local laws.

• Limit Intercompany Charges: Countries like the United States and the United Kingdom should ensure that they have strict laws which regulate transfer pricing.

  Many companies have been using transfer pricing as a mechanism to move profits to subsidiaries abroad which have lower tax rates. Instead of letting companies decide, what the appropriate price for a product or service is, countries must have strict transfer pricing laws which apply evenly to all companies.

• Dutiful Declaration: The United States should pass a law which makes it mandatory for every company to disclose all the offshore accounts belonging to them or their related parties. The auditors must be given the responsibility to guarantee compliance with this law. If the auditors are found to be working in connivance with corrupt multinational corporations, their licenses must be canceled.

To sum it up, tax avoidance has become a menace. Countries have lost a total of $3.4 trillion in 2017 due to tax avoidance. It is high time that the seriousness of this situation is understood and measures are taken to stop this menace once and for all.