Corporate Responsibility: It’s the tax disclosure, stupid!
By Eric Israel, Skytop Contributor, March 9, 2021
Would you volunteer to pay more taxes if you could avoid it?
Avoiding taxes may be good for the individual, person or company, but if done on a massive scale what are the consequences for the country? It is likely to be inadequate funding for public services that are essential to having a prosperous economy and a fair society. The U.S. tax system and the role of corporations in that system have dramatic implications for corporate responsibility. Let’s explore that connection further. How to look at the U.S. tax system. It assumes that taxpayers will voluntarily comply with the tax laws by calculating and paying what they owe. Voluntary compliance applies to corporate responsibility as well. Corporations that report on their corporate responsibility do so voluntarily to explain their significant impacts on the economy, environment, and society. One major economic impact that deserves focus now is a corporation’s tax payments disclosure. Let’s explore the connection between the U.S. tax system and corporate responsibility further and its relevance under COVID-19.
How well has our federal tax system worked to cover the government’s expenditures?
According to the Center on Budget and Policy Priorities, in fiscal year 2018, the federal government collected $3.3 trillion and spent $4.1 trillion, resulting in a deficit of approximately $0.8 trillion – or $779 billion to be more precise – to be paid by future taxpayer’s money.
Half of all this federal revenue (51 percent) comes from individual income taxes, another 35 percent comes from individual payroll taxes, and corporate income taxes make up about 6 percent. The remaining 8 percent comes from excise taxes on products such as fuel, alcohol, and tobacco, estate taxes, and other revenue sources such as regulatory fees and custom duties.
Federal revenues were 16.5 percent of gross domestic product (GDP) in 2018. This was well below the prior 40-year average of 17.4 percent of GDP and was largely due to the enactment of the 2017 tax law. This was all pre COVID-19.
What impact will the pandemic have on our federal tax system?
The short answer: it is bad. But how bad? In fiscal year 2020, the federal government collected $3.4 trillion and spent $6.6 (!) trillion, resulting in a deficit of approximately $3.2 trillion, more than triple (!) the deficit for fiscal year 2018 or 2019. The deficit is almost the same as what the federal government collected for 2020 and is 16% of U.S. GDP, which is the largest it’s been since 1945. For fiscal year 2021 the deficit so far is $735 billion and that is before the $1.9 trillion Covid relief bill. Who will pay for this unprecedented deficit? Will it be individuals who already contribute 86 percent to the federal government, or will it be corporations that contribute a mere 6 percent? One may wonder why corporate income taxes are so low. Let’s explore this further.
According to a 2019 study conducted by the Institute on Taxation and Economic Policy (ITEP), 60 Fortune 500® companies avoided all federal income tax in 2018 under the new tax law. By employing a variety of legal tax breaks, many U.S. multinationals are shifting most of their profits offshore where they pay little or no tax at all. The study revealed that companies such as Amazon, Chevron, Delta Airlines, Eli Lilly, General Motors, among others do not pay federal taxes. Instead, the effective tax rate for these 60 companies that had profits in excess of $79 billion was minus 5 percent which means they got tax refunds. In terms of corporate responsibility, this indicates there is a big elephant in the room especially now with the COVID-19 situation.
An uncomfortable problem for policymakers and business that could be ignored for many years, but that has now become a glaring problem. So, what happened?
The financial crisis of 2008 spurred many fiscal requirements including bailouts to the financial sector but also revealed aggressive tax planning by many big companies. As a result, the public reacted to these bailouts and irresponsible corporate behavior by putting pressure on companies and demanding change. In its report to the G8 Summit of June 2013, the Organisation for Economic Co-operation and Development (OECD) concluded that vast amounts of money are kept offshore and go untaxed to the extent that taxpayers fail to comply with tax obligations in their home jurisdictions. Soon after the OECD issued it’s Base Erosion and Profit Shifting (BEPS) framework in 2015, multinational corporations were required to report on taxes paid in each jurisdiction in which they operate. However, these disclosures are made privately to tax authorities only, rather than publicly.
In 2016 the explosive ‘Panama Papers’ leak, including the assassination of a journalist leading the investigation in Malta, revealed that the scale of tax avoidance by global business was still massive and persistent. Although tax disclosure reforms were met with deep skepticism from corporations and policymakers, the Panama Papers scandal opened the door for more tax disclosure transparency. Because of these revelations, demands for change came from organizations rather than just the general public.
Is there pressure to provide more transparency around corporate approaches to tax included investment groups?
In 2016, signatories to the United Nations Principles for Responsible Investment (PRI) informed the Securities and Exchange Commission (SEC) that aggressive corporate tax planning should be a concern to investors as it can: (1) create earnings risk and lead to governance problems including fraud; (2) damage reputation and brand value pushing stakeholders into addressing honest tax disclosure; and (3) cause macroeconomic and societal distortions impairing economic growth due to lower levels of public investments. They also stated that the impact of tax-related risks can be severe and cover a large number of portfolio companies.
The need for better disclosure of tax such as the OECD’s country-by-country tax information is not new. The U.S. Internal Revenue Service (IRS) is already requesting this information, and over 135 countries including the U.S. are supporting the OECD Framework on BEPS. However, at the present time, this information is not publicly available. The Financial Accounting Standards Board (FASB) has issued a proposal to update accounting standards for income tax disclosures, but lawmakers feel the proposed rules are insufficient and should as a minimum require multinationals to publicly disclose the country-by-country tax information in mandatory financial reporting.
So, what about voluntary corporate responsibility reporting?
Many large publicly traded companies publicly report on corporate responsibility through sustainability reports. According to the Governance & Accountability Institute, 86 percent of the companies in the S&P 500 Index® and 60 percent of the companies included in the Russell 1000® published sustainability reports in the year 2018. Many multinational corporations are using the Global Reporting Initiative (GRI) Sustainability Reporting Standards developed by the Global Sustainability Standards Board (GSSB).
Last year, and coincidentally just before COVID-19, the GSSB released their ‘GRI 207; Tax 2019’ standard. The standard requires companies to publicly disclose financial, economic, and tax-related information for each jurisdiction in which the organization operates. It also requires disclosure of how the organization manages tax. To publish a sustainability report in accordance with the GRI Sustainability Reporting Standards companies will need to disclose all material issues. So, how material is tax in a COVID-19 world with monumental federal tax deficits? Corporations have a responsibility to pay some of this. Therefore tax avoidance will be a risky approach and can damage a company’s reputation and brand value.
In light of these developments, companies will need to prepare for greater tax transparency and scrutiny. To repeat a good phrase – Corporate Responsibility: It’s the tax disclosure, stupid!
In my next piece, I will further explore the impact of the GRI tax standard and why corporations should prepare for this.
Financial and ESG Executive
NWIC USA LLC