In a recent column in Canada’s Globe & Mail, my colleague Loren Falkenberg discusses “unintentional” and “benevolent” cheating by employees and offers advice for reducing it. What Professor Falkenberg is really discussing is tax avoidance by companies, carried out by their employees by “invisibly gaming the system” and “exploiting regulatory loopholes” to benefit the company (and is therefore benevolent). (While Falkenberg may refer to other ways of companies and their employees “gaming the system,” she never identifies them explicitly, so I focus on tax avoidance here). She laments that tax avoidance leads to losses both for the company (because it drains resources and focus away from innovation and wealth creation) and the society (because of lower tax revenue) and argues that it should be reduced.
Professor Falkenberg explains that profit pressures (too ambitious margins) and too optimistic budgets make employees use tax avoidance tactics to cut costs, which are reinforced by collective rationalization that tax avoidance is acceptable and by silent dissenters who don’t challenge the consensus. However, is tax avoidance really a problem that needs to be reduced, and is it really caused by pressure for profit?
I argue that the kind of tax avoidance Falkenberg discusses is not a problem and does not qualify as cheating. Cheating means breaking a rule or law; legal tax avoidance merely exploits “regulatory loopholes” without breaking the law and is part of a legitimate profit maximization strategy. (Illegal tax avoidance is inadvisable because of the significant negative consequences for companies, as are those illegal activities that violate others’ individual rights, such as the manufacture and sale of defective products). But profits cannot be maximized merely by minimizing costs, such as taxes. Actual wealth creation is required, achieved by productiveness—by creating material values and trading them—and should be the primary focus of a business (as Falkenberg also implies). But cost reduction measures, such as tax minimization, also need to be employed.
The cause of companies’ emphasis on tax minimization is not really groupthink among company employees, as Falkenberg indicates, but punishing corporate tax regimes in many industrialized countries. Consider Italy, where people recently gathered in the streets of Rome to demonstrate against the high unemployment (the rate of unemployed among the youth is 45%). Italy’s high corporate tax rate (30.4% in 2014 according to KGPM) is a disincentive to hiring, growth, and profit making.
To truly encourage companies to focus on innovation and wealth creation as opposed to tax minimization, governments should unleash companies from the regulatory and tax burden and let them compete freely, to create innovative goods and services and more efficient processes for their own profit—and for the benefit for the rest of us. The lost tax revenue and government programs would be more than compensated for by the increased freedom, competition, innovation, and productiveness of companies—and the wealth generated that would increase everyone’s standard of living. For evidence, observe that the freest jurisdictions around the world—such as Hong Kong and America in the 1800s—are (and were) also the wealthiest.
Actual employee cheating or dishonesty—faking reality to gain a value—is a real problem when it happens. Faking is futile because it cannot lead to achieving values in the long term. Faking that involves fraudulent conduct also violates others’ individual rights and must be prevented or punished. Why then do some employees deceive customers, investors, suppliers, their co-workers, or employers? Why do they create fraudulent advertising, defective products, lie about their qualifications or performance, or embezzle money? They do it because they think, mistakenly, that it is in their or even in their employer’s self-interest. But values cannot be obtained and kept by faking and fraud, and therefore dishonesty is never a means to self-interest. Just ask Bernie Madoff
The best way to prevent employee dishonesty is to screen carefully before hiring and reject candidates with any evidence of dishonesty in their record and behavior. The second important means of preventing employee dishonesty is to enshrine the value of honesty in the company’s culture, by communicating what the principle of honesty means and how it applies to concrete business situations, by management modeling it in their own conduct and rewarding honest behavior by praise, recognition, and rewards. Of course dishonesty needs to be punished also, by withdrawing privileges, including termination of employment.
Productiveness and honesty are principles worth embracing and following for businesses (and their employees) that want to thrive and create value in the long-term. Minimizing (and eventually abolishing) taxes would contribute to such flourishing.