Tax Evasion vs. Tax Planning

by Dr. Meir Tamari

There are very few business decisions at the corporate or at the privately owned level, which do not in one way or another involve the finding of the best way to minimize the tax burden. Individuals and families, too, make many decisions, bearing in mind the effect of the taxes levied by the government on their actions. These decisions, although they involve money and affect costs, are actually determined primarily by the religious, cultural or social philosophy both of the corporate directors and of the individual citizens.

These would seem to involve the following issues:

The taxes levied by the government are used to fund the activities of the public sector in providing welfare, security and infrastructure to the citizens. The degree to which the citizens approve of the purposes for which the funding is used will in a large measure determine their willingness to share in the costs of such services through the tax mechanism.

The tax base and the tax rates used are not the product of some blind economic mechanism, but rather are the product of an ideology. This ideology will exempt certain groups from the taxes, will introduce progressive taxation making other groups pay more or provide a variety of taxes based on benefits such as user taxes, etc. The knowledge of the citizen as to the fairness of the tax system, as well as the efficient use of the tax money collected will affect his or her decision as to participation in the tax payments. This too is not an economic decision but rather an ideological decision, namely the unwillingness to be a party to unfair distribution of taxes and an objection to public sector wastage..Taxes reduce the disposable income of the citizen, who now has less money to do what he would like.

So, egotistical considerations, greed and unwillingness to lose money are also important ingredients in the corporate or individual decisions regarding taxation. The tax related decisions take two broad forms: Tax evasion and tax planning, both of which are aimed at withholding the tax levied from the authorities:

Tax evasion usually involves withholding knowledge of the transactions or of the income from the tax collector. The methods of achieving this are limited only by the ingenuity of the citizen and his accountant on the one hand and the sophistication and efficiency of the tax collector on the other hand. Irrespective however of the sophistication or the ingenuity which makes tax evasion possible, it creates innumerable moral problems, which affect both the individual and, to the degree that tax evasion becomes a norm, the whole of society. In order to minimize one’s income and evade the tax, it is necessary to create a large number of subterfuges, to lie consistently, and to keep false records. As often as not, these require collaboration between workers and employees, between suppliers and consumers, indeed between all the factors in the economic world. At the same time, the tax payer has a problem of what to do with the money; any legitimate use will arouse the suspicion of the tax collector as to the source of this income. Here, too, immoral considerations come into play. Sometimes it is necessary to illegally extradite the money from the economy in which one is operating, and to retain it in secret numbered accounts in countries set up as tax havens. Sometimes, the money is used in wasteful consumption of articles and of services which the tax collector cannot reach. Usually this involves payment in cash and indulging in luxury articles, etc. In a society that has made tax evasion pervasive and acceptable, the citizen ultimately loses the ability to keep distinctions between right and wrong and between truth and falsehoods, separate and clear. This must inevitably spread to other forms of social behavior.

Tax planning also intends to reduce the cost to the firm or to the individual of sharing in the expenses of society. Here, however, nothing illegal is done, rather the ingenuity of the tax payer and his financial associates is geared to finding loopholes in the law or methods of minimizing income within the limits of the fiscal legislation. It would seem that tax planning does not have moral implications similar to those of tax evasion. However, unfortunately, closer examination will show that here too moral decisions really lie at the basis of the tax planning. Tax planning, like tax evasion, enables the citizens to escape their moral obligations of paying for the social costs of the community. In addition, the moral border between legal possibilities of minimizing the tax burden and some form of cheating, are not all that clear. For example, in the non-listed corporation or in those corporations, even if they are listed on the stock exchange, where control is held by a small number of shareholders who are also actively involved in the conduct of the corporation, gray areas multiply. In a non-listed corporation when active directors withdraw the return on capital in the form of inflated salaries and purportedly business expenses which are in effect personal ones, they are not planning to minimize their fiscal obligations, they are evading them. In passing, it should be noted that they also are defrauding the non-active shareholders who are not able to share in this division of profits since they are not eligible for the expenses or salaries, etc. Even salaried directors in the listed corporation, who enjoy perks which appear in the financial statements as legitimate business expenses but are in actual fact salaries in a different form, could also be involved in tax evasion rather than in tax planning. Offering stock options instead of salaries, which affect the tax liability of the corporation or of the directors may also be closer to tax evasion. There is a further moral issue regarding such options. As often as not, they are aimed at improving directors’ performance, something for which they were already paid a salary.

Academic research has shown that there are reasons besides greed for attempts by the citizens to minimize their tax liability. It would seem that the moral issues involved here can only be solved if attention is paid to these reasons. Empirical evidence has shown that in countries with high tax rates, by and large, a large underground economy develops which is funded by the proceeds of tax evasion. It would seem, therefore, that to the degree that it is the high tax rates that produce the evasion, a tax cut should be made for moral reasons. The moral damage of not doing so may be greater than the social damage resulting from a decline in the public sector income. Also, when citizens feel that the tax burden is not distributed fairly and at the same time the public sector authorities waste the tax money through junkets, white elephants, catering to special interest groups, etc., the objection to paying taxes grows, as do the ways of tax planning and tax evasion. From a moral point of view it would seem beholden on us to link taxes to government economy and to as fair as possible tax base. Unfortunately, it has proven very difficult to reduce the size of the public sector employment and thereby reduce waste. However, the experience of Thatcherite England has shown that there are ways of reducing waste through privatization and through more efficient methods of operating government.

There is a further reason for large-scale tax evasion that is based on ideology. Anti-apartheid supporters in South Africa refused to pay their taxes for a government policy which was immoral and unethical. In Israel, there are voices that claim that as the government is a secular one, taxes should not be paid otherwise observant Jews are funding things which are contrary to Torah. The poll tax introduced by Margaret Thatcher failed because the vast majority of English citizens felt that the tax poll was so regressive, so that it was immoral. However, the justification for such an ideological argument does not have to mean approval of tax evasion as a method of objection. It would seem that a far better moral statement would be for those who believe that the action of the government or the use of the tax is immoral, to make their objection public even at the risk of imprisonment, The Reverend Michael Scott in South Africa did exactly that, when he donated his tax liability to a school for blacks and sent the receipt to the revenue officers, challenging them in effect to punish him.

Even before Reverend Scott, John Hamden in the War of Parliament against the British Crown did the same thing. In that case, the inspiration was drawn from the biblical story of the vineyard of Navot. Kings in Judaism have the right of eminent domain, which is a form of taxation. Nevertheless, Navot refused to sell his vineyard to King Ahab. Most biblical commentators find justification for this illegal act of Navot in the fact that Jezreel, the site of the vineyard, was the home of the king Ahab and not his capital. Here, the sale of the vineyard to the king as a private citizen through the abuse of eminent domain, would be an unjust tax. Navot, therefore, refused to pay this tax, for which he paid with his life.

Irrespective of the methods chosen or of the motivation prompting them, both tax evasion and planning require a constant awareness of their potential unethical effects. After all, only very fine lines often separate morality from outwardly justifiable and legal acts. Rabbinic rulings and moral teachings are replete with such awareness. Non-payment of communal taxes is viewed as theft, either from the other tax payers, who now have a greater tax liability or from the recipients of the education, charity or services paid for by the communal budget. This applies to taxes levied by non-Jewish governments, as well. The law of the land applies in fiscal matters in modern open societies that treat Jews equally and allow the practice of their religion. In the case of arbitrary or illegal governments, there may be justification for evasion, except in cases where there is danger to the community or where others will be forced to pay more or where desecration of God’s name is involved.

Dr. Tamari is the former chief economist of the Office of the Governor at the Bank of Israel, and the founder of the JCT Center for Business Ethics and Social Responsibility.