When Is Tax Dodging Dodgy?

Like most of our fellow Americans, we here at the Drucker Exchange will be handing over a sizable share of our earnings this tax season to Uncle Sam.

If we look to the corporate world, though, many won’t feel any such pinch. A new report from Citizens For Tax Justice spotlights several companies that managed to avoid taxes altogether in 2012.

Southwest Airlines, for example, paid zero by using “accelerated depreciation” and other maneuvers. “The scope of corporate tax avoidance goes well beyond these few companies, and spans a wide variety of economic sectors,” the report asserts. “Moreover, the tax breaks that have allowed these companies to be so successful in their tax avoidance are, by and large, perfectly legal, and often have been on the books for decades.”

As we’ve noted, Peter Drucker favored a simpler tax system with no breaks or exemptions. But Drucker also recognized that cash is what keeps an enterprise afloat—especially a fledgling firm.

“During the first five or six years of the life of a new, and particularly of a growing, business, ‘profits’ are an accounting fiction,” Drucker wrote in Innovation and Entrepreneurship. “A new and growing venture always has to invest every penny of operating surplus to stay alive.” For this problem, Drucker recommended a fix that we’ve highlighted previously: Exempt these young businesses from any income tax.

With more established businesses, meanwhile, Drucker seemed to regard tax avoidance as a result of policy sins more than corporate sins. Create poor incentives, he believed, and people will do the wrong things. Specifically, Drucker said that when tax rates approach 40% (and in the United States the top corporate tax rate is 35%), they start to produce a “grey economy” of evasion and off-the-books work.

“While everyone loudly condemns the grey economy, most people not only participate in it but consider it morally justified and, in fact, ‘clever,’” Drucker observed in The New Realities. “But this undermines the moral cohesion of society.  It produces a dangerous political poison, cynicism.”

So if Drucker were to have seen a moral failing on the part of corporations, it would most likely be for failing to try to reform the system. As he urged in Management: Tasks, Responsibilities, Practices, managers must accept their “social responsibility” to “work for a rational system of taxation, which eliminates the temptation of ‘tax gimmicks’ and the need for them.”

What is your view on the morality of tax avoidance by corporations?