Taxing Income: Still Crazy After all These Years.

There’s been a lot in the news recently about appropriate responses to tax avoidance schemes. The OECD has just released a report on tax base erosion and profit shifting (February, 2013) which was endorsed by the G-20 Finance Ministers in a communiqué following their recent Moscow meeting (February 16, 2013). Ernst & Young has come out with their study of the use of the GAAR in various jurisdictions, “GAAR rising – Mapping tax enforcement’s evolution” (February, 2013), and The Economist in a recent issue (February 16-22, 2013) has a lead editorial on the subject and a 14 page special report on offshore financial centres, aka tax havens. These on top of the growing outcry in the popular press directed at large corporations and wealthy individuals accused of not paying their fair share of taxes that I have noted in recent postings. There’s definitely something blowing in the wind here. While the comments in the professional literature are rational, a lot of what appears in the popular media is, to my mind, uniformed rhetoric.

The more thoughtful pieces recognize the distinction between acceptable tax planning and abusive tax avoidance. Taking advantage of legitimate planning strategies is not morally, let alone legally, wrong. Taxpayers are entitled to plan their affairs within the confines of the rules as written. Otherwise, the rule of law that governs the relationship between citizens and their governments is meaningless. Governments concerned about the loss of tax revenues are not defenseless. They have the power to amend the tax code to restrict the unacceptable planning strategies and do so regularly. Increasingly, governments have also resorted to general anti-avoidance provisions if the specifically targeted amendments fail to protect the tax base. While such provisions may infringe somewhat on the rule of law, this danger is minimized if the tax administration’s use of them is subject to review in court.

Some tax planning schemes are designed to exploit the rules in a way that goes beyond the intent of the legislature in enacting them. Often, such schemes depend on a literal reading of the statutory language and technically are defensible on the basis that the legislature is presumed to mean what it said in enacting the words, even if the particular result under consideration was not contemplated. This is a distinctly foggy area, however, and we should not be surprised when courts render seemingly conflicting judgments in cases of this type.

An altogether different type of case is one in which the tax rules are exploited in favour of a wholly artificial result. Increasingly, the Canadian tax courts have upheld the Crown’s challenge of such arrangements. Under the modern approach to statutory interpretation, such schemes can be challenged on the basis that the provisions relied on do not support the artificial result, although it now usually the case that the Crown uses the general anti-avoidance rule as backup in case the court is tempted to apply a strict interpretation of the rules.

These distinctions are often lost on some of the popular media and populist politicians. Morality (or the lack of it) really has nothing to do with the question whether some corporation or wealthy individuals are paying their fair share of taxes. The only proper measure of what’s ‘fair’ is what the tax code requires. What some individual thinks is an appropriate share regardless of the tax code is, quite frankly, emotional prejudice. It seems to me that this sort of uninformed reaction is increasing, which is a worrisome thing for those of us concerned about the rule of law.

I have thought for some time that part of the problem here is the fact that most governments rely on an income-based tax for a significant part of their revenue. Certainly we do so in Canada. “Income” is a slippery concept. Hard to define, hard to pin down in one place, and easy to manipulate. All of which is exacerbated when the income is generated in a global environment. With hindsight, we might have been better off with some other tax base. But that’s history. The graduated income tax as we now know it was introduced in the UK in 1798. That’s 215 years ago and we’ve struggled with it ever since! Crazy, some would say, to go on doing so. Paul Simon wrote “Still Crazy after all These Years” a mere 38 years ago, and I don’t think he had income tax in mind. But his song title rather points to one of the reasons why governments that rely on the income tax have such difficulty in preserving their revenue bases – and why the problem of tax avoidance is not going away anytime soon.