As consumers and activists have increased their focus on the impact of corporate behaviours on society, companies have responded by upping their emphasis on their corporate social responsibility (CSR) initiatives. This is an undoubtedly positive trend and should be applauded.
However, at the same time headlines relating to corporate tax avoidance have become increasingly frequent. Household names including Google, Starbucks and Vodafone have sparked concern over their “tax planning” practices, despite some of their commitments to improve their environmental and social impacts.
Are CSR initiatives effectively being funded by tax avoidance? Does this actually matter to firms’ stakeholders? In this blog post, I will take a closer look at this relationship, consistent with the findings from research published by academics at the University of Oregon’s Lundquist College of Business. A holistic triple bottom line approach to corporate strategy has become embedded in the minds of many mangers. The concern is that tax avoidance is an equally ingrained logic.
Giving with one hand…
The Economist recently pointed to an interesting finding published by researchers at the University of Oregon’s Lundquist College of Business: companies who place greater emphasis on their CSR efforts tend to also pay lower levels of tax. An earlier version of the paper can be found here. Before looking into the implications of these findings, I’ve done some simple analysis which looks at the top “socially responsible” companies in the US and UK, as defined by MSCI, compared with other large companies in each country.
MSCI, an investment index provider, has developed a range of socially responsible investment (SRI) indices which track companies deemed to perform strongly in terms of their impact on the broader society. To be included in their SRI index, companies need to be the “best in class” with respect to their environmental, social and governance behaviours. Essentially, MSCI’s approach aims to identify the companies which focus on having a positive impact on the world, rather than purely trying to be the most profitable. This is an invaluable starting point for investors who are concerned about more than the traditional financial bottom line.
In developing Figure 1, I’ve taken the top 20 stocks from MSCI’s SRI index, as well as the top 20 stocks in MSCI’s regular index. The analysis looks at both the US and UK indices and their constituents at any point in time can be found here. Next, I’ve calculated the total tax paid by these companies and compared this to their before tax income, using the Google Finance and Yahoo Finance websites (eg Apple’s income statement here and GlaxoSmithKline’s here). This enables a combined tax rate for each group of 20 stocks to be calculated. In other words the tax rate is simply the sum of the taxes paid divided by the sum of the income earned. A detailed breakdown by country of the analysis is provided in Figures 2 and 3. Stocks which have generated a loss or have a negative tax rate are excluded from the total.
So what do we find? My analysis is consistent with that highlighted by the University of Oregon. In the US, the top 20 stocks in the MSCI SRI index have a combined tax rate which is 2.8% lower than for the “regular” index. The difference is even more stark in the UK where socially responsible companies have a combined tax rate which is 6.2% lower.
Figure 1: Combined tax rate of top 20 stocks in MSCI SRI index versus MSCI Regular index
Sources: Google Finance, Yahoo Finance, CURRENTLY UNDER DEVELOPMENT. Based on data as at 24 January 2016.
These percentages may seem to be relatively small, so it’s worthwhile looking at the more detailed analysis presented below. For the US case as shown in Figure 2, the top 20 stocks in the MSCI SRI index collectively had a tax rate of 24.8% of income before tax in 2015, roughly $34bn (ie 24.8% of $137bn). Meanwhile, the top 20 firms in the MSCI Regular index paid a collective rate of 27.7%. If the firms in the socially responsible index paid tax at the same rate as those in the regular index, the US Inland Revenue Service could have collected an additional $967mn.
Figure 2: Detailed breakdown of income before and after tax – USA
* Amazon is excluded from the total and average as the firm generated a negative before tax income in 2015. Sources: Google Finance, CURRENTLY UNDER DEVELOPMENT. Based on data as at 24 January 2016.
To be sure, this analysis isn’t very scientific as there are differences between the companies in each index so there are specific reasons for differences in tax rates. There is also some overlap between the two lists and stocks which are included in both indices have been highlighted in blue.
Regardless, a couple of points stand out. Firstly, the vast majority of companies in the sample pay less than the US corporate tax rate of 35%. That’s likely to be largely due to firms earning profits in foreign countries which have lower tax rates. However this does highlight an inconsistency in the US tax code for corporations compared to individuals. The latter are required to pay tax on their worldwide income, without the ability to benefit from foreign earnings in lower tax jurisdictions. Secondly, the observation that socially responsible firms pay a lower tax rate in aggregate seems incompatible with their labelling as beneficial to society. This is pointed out in the University of Oregon paper where the authors highlight that some of these firms argue that taxes are:
“… harmful to innovation, production, job creation, and economic development, i.e. tax payments detract from social welfare. Many of these firms go on to argue that they are being good corporate citizens by actively lobbying to lower corporate taxes, an action they argue will lead to increased economic development.”
I will return to this point later, especially with respect to developing countries.
Turning to the UK case, similar detailed data are presented in Figure 3. The socially responsible UK firms paid around £8bn in tax in the 2015 reporting year. Using a similar calculation of the tax shortfall, the socially responsible firms could have paid HMRC an additional £497mn if their collective tax rate matched that of the firms in the regular index. What is additionally interesting in this group is that Vodafone had a negative tax bill in 2015, to the degree of £4.7bn, largely attributed to interest payments through their Luxembourg subsidiary. Meanwhile, Land Securities paid no tax, as the firm is structured as a real estate investment trust which gives it a special tax exemption.
Figure 3: Detailed breakdown of income before and after tax – UK
* BG Group, Tesco and Anglo American are excluded from the totals and averages as the firms generated a negative before tax income. Vodafone is excluded as the firm had a negative tax rate in 2015. Sources: Yahoo Finance, CURRENTLY UNDER DEVELOPMENT. Based on data as at 24 January 2016.
Impact on investors – cause or effect?
These observations are relevant for investors for two reasons. The first relates to the increasingly accepted view that socially responsible stocks outperform other stocks which are less focused on their impact on society (eg Morgan Stanley’s analysis of mutual funds and CDP’s analysis of the S&P 500 index constituents). In both cases, the cause of the outperformance is attributed to firms’ emphasis on incorporating CSR measures into their operations. However the evidence here may point to these firms being more profitable due to their ability to avoid tax.
The second effect is slightly more nuanced and is highlighted by the UNPRI with respect to investors engaging firms on corporate tax responsibility. The issue is that if a firm’s profitability is dependent on their ability to avoid tax, a sudden change in the tax regulatory environment could be harmful to future earnings, which would have a negative impact on investors’ perceptions of the firm’s value (and subsequently their stock price). For example, a recent ruling by the European Commission has resulted in the closing of a tax loophole which has been used by beverage maker Anheuser-Busch InBev and energy giant BP. Further, Google’s tax dealings in the UK have come under increased scrutiny as have the techniques used by Apple and McDonald’s.
For the companies involved, a negative tax ruling, fines, evidence of illegal avoidance or a broader set of tax reforms, would have a meaningful impact on their stock prices. One only needs to look at the effect on the stock price of Volkswagen’s cheating on emissions tests to get an idea of the potential impact of these types of developments. This is over and above the effect of tax avoidance on consumer perceptions of a firm’s reputation, as Starbucks found out in 2013.
… Taking with the other?
The taxation of multinationals is a difficult matter, at least partly due to the uncoordinated nature of corporation tax regimes globally. Owen Barder points this out in this blog post, while also emphasising the importance of including developing countries in the drafting of new tax rules. This theme is echoed by Oxfam America who point to research estimating that firms’ use of tax havens results in $620bn in avoided tax and the role of financial firms in enabling such practices. An additional effect of these arrangements is the potential for illicit flows to be transferred out of developing countries which was estimated at over $1tn in 2013. These are staggering amounts, even a small fraction of which would significantly add to the revenue base of the world’s poorest countries to aid their economic development.
Tax avoidance practices are enabled by the regimes put in place by developed countries. Cillian Doyle puts this very clearly in his blog which highlights the role of Ireland as a tax haven. Doyle notes the complicit nature of countries like Ireland and I would further emphasise the potential negative effects on the Irish economy (and that of Luxembourg) if such arrangements were viewed as violating international law. If Ireland was ruled to be a tax haven, imagine the effect on employment and the likely capital flows out of the country.
As the focus on global inequality sharpens, tax arrangements are going become an increasingly important matter. This is true for both developed and developing countries, as well as individuals and corporates. Tax policy is enshrined by national governments, many of which are democratically elected by their constituents. Consequently, tax is a matter of social importance and I would argue that tax responsibility is a key component of corporate social responsibility.