Tax Transparency Fights Tax Avoidance

Justice Brandeis once famously said that “sunlight is the best disinfectant.”  It is a quote advocates for government and corporate transparency have repeated each time we are asked if any of “this stuff” makes a difference.  For the record, it does.

The latest evidence comes from a recent report produced by two German academics looking at whether a European Union (EU) tax transparency initiative had any measurable impact on corporate behavior.

Starting in 2014, the EU required large banking institutions to publicly report profits earned, taxes paid and several other pieces of financial information country by country as a way to crack down on aggressive tax avoidance and the abuse of tax havens.  The financial services industry has been one of several sectors called out for its tax planning practices and use of tax havens.

Globalization has made it easier for multinational corporations to shift profits and book revenues in offshore jurisdictions as a method of minimizing their tax liability.  Coutts, Rothschild, UBS and Credit Suisse were all listed in the Panama Papers.  Duetsche Bank and UBS recently lost court challenges to their tax avoidance schemes.

These schemes now involve enormous amounts of money.  They drain national treasuries, shift tax burdens to smaller businesses and individuals, create additional market risk and more.  The report, Financial Transparency to the Rescue: Effects of Country-by-Country Reporting in the EU Banking Sector on Tax Avoidance, looked at the impact of the EU tax transparency initiative and found an intriguing and significant impact.

The study found that when comparing multinational banks with ties to tax havens to wholly domestic banks, the formers’ effective tax rates were 3.7 % higher after disclosure. Additionally, for the banks using tax havens, taxes paid as a percentage of annual profits rose almost 3% when compared to pre-disclosure.

This substantial increase came at a time when no tax rates were raised.  No banks were boycotted, blacklisted or protested.  No trade secrets were divulged that altered any bank’s competitive advantage.  In fact, it is hard to identify any other factors to explain the rise in tax payments other than internal company decisions to clean up their most egregious and questionable tax practices.

These findings are significant because it means, with transparency, there is more integrity in the EU member nation tax systems, more reliability in their revenue streams and greater ability to fund public services. There is more stability in the financial markets and more assurance to investors that profits are based on solid earnings rather than questionable and ever changing tax policies.

Now that we have specific evidence on the benefits of tax transparency policies, the US should implement similar policies here at home.  There are bills in Congress to require companies to report this information at a country by country level. The Securities and Exchange Commission could require publicly traded companies to do so.  And the Financial Accounting Standards Board could promulgate new accounting standards for companies to include country by country information in financial statements.

Any of the above policy changes would provide enormous benefits. They would create a more honest tax system in which there is better alignment between effective and statutory tax rates and less opportunity to game the system.  We might even reduce some of the bizarre incentives for companies to spend enormous sums in the never-ending quest to find offshore loopholes. We would see a more stable and progressive tax base that hues closer to the intent of the tax law and stronger, more reliable markets for investors.

This is an important report that deserves greater scrutiny. It strongly suggests that transparency is a critical reform.  We urge those responsible for the rules around financial reporting to seriously consider the findings and move forward on adopting country by country reporting for all companies.

Gary Kalman, is the Executive Director at The FACT Coalition