Tax avoidance and evasion, together with legal exemptions from paying tax, can unfairly shift the tax burden onto other people
A government can grant legal exemptions to allow specific individuals or activities not to pay some taxes. This is one of the ways in which politicians can use their economic powers for political purposes, as discussed later (3.3.7); it complicates the tax code and increases administration costs.
People don’t like paying tax. The term 'tax evasion' is used to describe illegal withholding of tax payments, for example by failing to declare income or assets. The authorities can use the law to prosecute tax evaders.
Individuals may wish to opt out of an element of tax payment because they disagree with the use to which the money is being put. This may seem to be a principled stance for someone to take, but it is both illegal and undemocratic. The government cannot usually compensate by reducing its spend: if pacifists withhold the amount of tax they think that they are contributing to the defence budget, for example, the government cannot cut defence spending accordingly without reducing the protection offered to the rest of the population.
There are several legal ways for people and organisations to reduce the amount of tax they pay. The term 'tax avoidance' is used for aggressive, but legal, ways of dodging the payment – by exploiting loopholes in the tax codes, or by shifting money around to reduce the tax liability. There is a lot of evidence of such practices. According to one report, Offshore Shell Games 2015: The Use of Offshore Tax Havens by Fortune 500 Companies:
“Multinational corporations’ use of tax havens allows them to avoid an estimated $90 billion in federal income taxes each year.” [p. 1]
The report identifies companies and their tax havens, noting that:
“At least 358 companies, nearly 72 percent of the Fortune 500, operate subsidiaries in tax haven jurisdictions as of the end of 2014.” [p. 1]
“Apple …would owe $59.2 billion in U.S. taxes if these profits were not officially held offshore for tax purposes”. [p. 2]
Ugland House, in the Cayman Islands, is a modest-sized building that “serves as the registered address for 18,857 companies” which pay no tax on profits claimed there and which do not need any physical presence there other than the postbox [p.4].
The report highlighted the financial sector: “The 30 companies with the most money held offshore… — all large financial institutions that received taxpayer bailouts in 2008 — disclose a combined 412 subsidiaries in tax havens” [p. 7].
The Panama Papers are an unprecedented leak of 11.5m files from the database of the world’s fourth biggest offshore law firm, Mossack Fonseca. The Guardian report, What are the Panama Papers?, revealed that several national leaders, including Russia’s President Putin, had hidden wealth overseas.
The impact of all these mechanisms of tax avoidance and evasion, whether illegal or not, is that everybody else has to pay more. Corporations which reduce their tax liabilities by aggressive (but legal) tax avoidance can reasonably argue that they have an obligation to act in their shareholders' interests. The onus therefore falls on politicians to close these tax loopholes in the interests of society as a whole.
Some solutions have been proposed, including a paper by Joseph Stiglitz and Mark Pieth: Overcoming the Shadow Economy. It recommended increased transparency and international cooperation.