The social construction of multinational firms’ tax behaviour. Guest post by @MartinHearson

This week I am trying to help the undergraduate students that I teach to understand a range of scholarship that uses social constructivism to study the political economy. When you go back to first principles to teach something you often see some of your own work in a new light, and that is what I am going to write about today. I’m briefly going to sketch out some social constructivist thoughts about multinational firms’ tax behaviour.

For a side project I’ve been reading some of the academic literature on tax compliance. There’s a great summary of the different theoretical perspectives on tax compliance in this working paper by Odd-Helge Fjeldstad and colleagues. The authors divide them into five:

  1. Economic deterrance. This is the classic rational choice framework, in which taxpayers weigh up the incentives, essentially the tax rate versus the penalty and the probability of being caught.
  2. Fiscal exchange. This is where the notion of ‘quasi-voluntary compliance’ comes in. If taxpayers think they will receive something in return – public services, in other words – they are more likely to pay. Although the evidence for this, according to the ICTD paper, is weak.
  3. Social influences. The final three positions, which I am going to appropriate into the social constructivist field, have stronger evidence to support them than fiscal exchange. The first is that tax compliance relates to perceived social norms: if they think their neighbours are honest, people are more likely to be honest themselves.
  4. Comparative treatment. From this perspective, people are more likely to comply with tax rules if they think the system treats them fairly relative to their compatriots.
  5. Political legitimacy. The final constructivist view is that if people trust the government and the tax authority, they are more likely to comply.

There are loads of empirical studies looking into the determinants of tax compliance behaviour among individuals and small businesses. It’s fascinating, but I think I found a big gap: I didn’t find a single study explaining the attitude to compliance among large businesses (or, to clarify, I found studies about staff compliance with management decisions, but not about compliance with externally-derived rules and regulations).

What do I mean by compliance? Trying to define this could easily veer into a discussion about tax morality, but that’s not where I want to go. We know that multinational businesses have a degree of choice over how aggressive their tax position is, and I want to ask, empirically, “what determines this?” Most of the existing work examining multinational firms’ decisions about their tax affairs tends, I think, to be situated in the rational choice, economic deterrance framework. According to that view, the first theoretical position listed above just needs to be adjusted to reflect the additional risks faced by businesses, in particular the reputation risk attached to aggressive tax planning (here is a paper that tries to do this empirically). Current discourse suggests that this risk is increasing, andbusinesses are revising their positions in response.

John Maynard Keynes

It all starts with Keynes…

This is where my undergraduate class comes in. We could argue that large business decision-making is more likely to be rational than that by small companies and individuals, because a successful large organisation has to create systems that obtain the right information and use it effectively. But a growing trend of political economy work, especially since the financial crisis, has focused very much on the fact that behaviour in financial markets (often by actors who are part of very large companies) can’t be explained solely through rational choices. My students are reading Andre Broome’s excellent introduction to constructivist international political economy, which refers to work in this vein on capital account liberalisation, european monetary union, and behaviour within financial markets.

Economic constructivist thought is often traced back to John Maynard Keynes’ analysis of how actors in financial markets deal with their inherent uncertainty. According to another useful book chapter by Rawi Abdelal and colleagues [pdf]:

Keynes lists “three techniques” economic agents have devised for dealing with this situation, all of which are inherently constructivist. First, “we assume that the present is a much more serviceable guide to the future than a candid examination of the past would show it to have been hitherto.” Second, “we assume that the existing state of opinion … is based on a correct summing up of future prospects.” Third, “knowing that our own judgment is worthless, we endeavor to fall back on the judgment of the rest of the world … that is, we endeavor to conform with the behavior of the majority or average…to copy the others … [to follow] … a conventional judgment.” In short, Keynes’ macro-economy rests upon conventions, that is, shared ideas about how the economy should work.

As the works cited by Broome show, this insight has been applied beyond financial markets to many other processes involving decision-makers and market actors. So why not multinational taxation? If we decide to do so, we can come back round to the theoretical perspectives I set out at the start. Perhaps the calculation about how much uncertainty to build into a company’s tax position is subject to the kinds of conventions identified by Keynes. And perhaps, beyond just uncertainty, the social conventions that influence business decision-making about taxation incorporate perceptions of social norms among decision-makers’ peers, as well as notions of comparative treatment and political legitimacy.

Here is one example, a quote from a survey of corporate tax directors [pdf] conducted by Judith Freedman and colleagues back in 2007 (and which it would be interesting to repeat now). There are remarks here that might support the fiscal exchange, social influence and political legitimacy theories:

One respondent said that his firm’s CSR policy does not extend to paying more tax than is due under the law; they are not interested in ‘making donations to Government’. Others echoed this view, arguing that they could spend their tax savings more wisely than the Government could. At least two firms suggested that there would be a greater social aspect to taxpaying if the amounts collected were earmarked for particular public services, rather than going into general revenue.

Social constructivists devote a lot of time to identifying and analysing the different groups among which social conventions form. There will be overlapping communities within and across companies, including for example the Davos elite, the tax function, social classes, nationality, and so on. I’ve written previously about a paper that touches on transfer pricing practitioners as a social group.

Corporate decisionmakers will have different information depending on their membership of different communities, but they may also be influenced by different social norms within their communities. This morning, for example, Chris Lenon suggests that corporate tax advisers are frustrated by what they see as a lack of rationality on the part of their boards, reporting “a gap between [tax advisers’] perception of the direction of travel in this debate and the denial of this at Board level because of the impact on earnings.”

I understand the normative case against using social norms to make up for deficiencies in the law, as well as the populist argument to the contrary. But I wonder if that debate might be seen in a different light if we begin from a constructivist ontology, in which, like it or not, social norms of one kind or another have always conditioned corporate tax behaviour.

[Ed’s note. Martin published this on his own blog yesterday. I am a big fan of Martin’s: he brings some academic rigour and by golly, I need it. You might do too.]

7 thoughts on “The social construction of multinational firms’ tax behaviour. Guest post by @MartinHearson

  1. Very interesting. I’d like to be one of Martin’s UGs! I think is interesting to think of the potential impact of professional intermediaries on his 5 influences. There’s a piece of work by Parker, Rosen and Nielsen on compliance in Australia (food regulation I think, not tax) which suggests that sometimes lawyers act to encourage what we might call Loopholing for shorthand and McBarnet’s work on creative compliance tells us this too. You could,see them pushing 1, 3, 4 and 5 in a particular direction. Rostain and Regan’s Confidence Games book suggests a set of essentially commercial factors (greater measurement and incentivisation of money making within accountancy and law firms) combined with a political climate which diminished the legitimacy of tax and the tax authority to push a particular view of the ethics of tax law which shifted more towards aggression. This may well have contributed 3, 4 and 5 in particular.

  2. All sounds very plausible to me, although suspect economic deterence interacts strongly w social norms. A hefty fine could work wonders for the moral fibre. All this stuff no doubt has a bearing on the behaviour of those doing the fining too.

  3. I’ve done some work on legal risk (which we’ll be publishing shortly and launching on 31/03 in London) and my sense is that generally legal risk is assessed by corporates very much in cost benefit terms. Reputational costs are part of that calculation and this opens the door to social norms, up to a point, but the approach is pretty much a utlilitarian one. The calculations of costs and benefits is though pretty subjective and I suspect this is influenced by social norms

  4. Thanks Richard. Would be delighted if you’d write something on its implications for businesses whose tax affairs extend beyond the plain vanilla?

  5. I’m a bit nervous of straying too far into the tax field, as a tax virgin, but I’ll have a think. I’d like to have a look at some of the references in this blog too – that might help…

  6. An interesting contribution. Thank you, Martin.

    I have heard people working in the tax function at large corporate groups saying there are two main points: first, hitting the predicted effective tax number in the accounts (the number that was assumed in the economic forecasting: overestimating tax payable can need just as much explanation as underestimating); and second, making sure that the effective tax number is broadly comparable to the competitors.

    From a corporate perspective, tax is essentially a cost of business to be managed, like any other cost, with the added frisson of increased downside risk (penalties and interest) and reputational damage of getting it wrong. Few taxpayers voluntarily pay more tax than they think is due, but we have to recognise that tax is often as much a matter of judgement rather than calculation, an art not a science (just what is the arm’s length price? is this situation investment or trading? is this expenditure capital or revenue? at what precisely which point does a business activity constitute a PE or residence in the UK?).

    Different people will take different views in reaching those judgements, and appetite for risk varies. There are some businesses where the culture involves accepting some tax risks on the basis that some will pay off and others won’t, but with some luck and good judgement the wins are likely to outweigh the losses. Even so, I suspect you would get very different answers to a survey of tax directors now, than Judith et al did in 2007. The culture has shifted considerably, and much for the better.

    I am not convinced that it is the advisers who push clients towards the so-called “loopholes”, as opposed to trying to help clients out when they get themselves into a pickle. Perhaps we should be more robust in telling clients: no, there is nothing you can do; you have lots of tax to pay.

    Perhaps I am an optimist, but I think most people want to comply, and there is a lot to be said for “nudging” them to do so, rather than reaching immediately for the stick to beat evil “tax avoiders”.

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