Powerful player, smaller bill: Risks of corruption in governments’ tax policies

Imagine you could play government for one day. Which taxes would you raise and which would you lower? What would your choices mean for a country’s treasury and development?

It’s a game that political leaders have been playing for a long time and their actions have not always served the common good. Around the world, their decisions have led to legal systems where those using considerable financial resources to exert big influence provide a significantly lower share to the tax base than regular citizens who pay taxes through their labour.

Tax breaks can sound like music to one’s ears – especially at a time of the economic recession caused by the COVID-19 pandemic. But tax incentives are measures provided to businesses, often with the overall aim of developing sectors of the economy, incentivising investment or boosting employment. When not well-assessed and justified, tax incentives can end up eroding the tax base and deprive governments of much-needed revenues. This is particularly concerning as companies operating in low and middle-income countries receive over US$2 billion in tax incentives every week.

Transparency International’s new report illustrates the risk of corruption driven by powerful interest groups in the process of designing and granting tax incentives. Through case studies and analysis, it demonstrates how tax incentives can be granted as a result of undue influence by powerful groups, rather than as the result of a proper assessment of the need for such incentives and of the socio-economic benefits they would bring.

For example, in December 2009, Brazil’s government granted tax incentives to the automotive industry in record time through a so-called Provisional Presidential Decree. To ensure that the government would publish the decree in the companies’ interests, lobbyists from consulting firms Marcondes & Mautoni and SGR allegedly contacted the president and his chief of staff on 24 June 2009. It appears that after successive discussions and an apparent negotiation of bribes, they agreed that the amount of R$6 million (US$1.04 million) in illegal financing would be paid for the 2010 electoral campaign of the Workers’ Party – at that time, the ruling party.

According to investigations, the draft text for the Provisional Presidential Decree was forwarded to the consulting firms before its enactment, demonstrating that public and private agents were apparently aligned. The terms of the published decree were in the companies’ interests and the president sent it to Congress on 23 November 2009. To ensure that the decree was passed, firms allegedly paid the Senate communications director to monitor and report on its progress.

Another case related to consulting firms and intense lobbying from the business community was the UK’s reform of its Controlled Foreign Company (CFC) legislation in 2012. This reform exempted some UK-based multinational companies from anti-tax avoidance rules.

When the CFC reform process started, the Treasury hired a secondee from KPMG called Robert Edwards. KPMG insisted that Mr Edwards was only there to provide technical advice, and industry insiders downplayed his role. However, he was listed as the primary contact for the Treasury’s new consultation on revisions to CFC rules. Following the adoption of the new rules and their implementation in legislation, Mr Edwards returned to KPMG where he would work on a team that advised people how to use the new rules to lower their tax bill.

As these examples show, undue influence in tax incentive granting processes can use various channels, from corporate lobbying to political finance and hiring professional service providers. Corporations – with the help of a major industry behind them – are able to exploit regulatory gaps to avoid public oversight and obtain privileged tax incentives.

This can blur the lines between meaningful participation of special interest groups in the political process and undue influence by those who exert control via these channels through connections and the necessary financial backing.

In severe cases, special interest groups can even capture the states themselves. State capture is one of the most pervasive forms of corruption, where powerful individuals, organisations or groups use corruption to shape a nation’s policies, legal environment and economy to benefit their own private interests. Governments that allow their tax policy to get unduly influenced are in danger of losing control of other aspects of their states.

Granting tax incentives to special interests is not just unfair and a corruption weak spot. It is often also a bad policy choice. Governments all over the world promote corporate tax incentives as a tool to attract domestic or foreign investments. However, there has been no clear evidence to determine whether this has worked. In many surveys, investors even consider tax incentives to be among the least important factors affecting decisions to invest.

What’s certain is that we are in a “race to the bottom” as countries compete to attract investment, prioritising the interests of big multinational companies, while ordinary people make up the shortfall by paying ever-higher taxes.

Tackling corruption in tax incentives requires a two-pronged approach that strengthens transparency and accountability of tax incentive regimes while limiting the space for different forms of undue influence.

This includes developing tax incentive regimes through transparent processes and regularly evaluating such incentives to assess their effectiveness, as well as building international cooperation on establishing a global minimum corporate tax rate.

At the same time, we need strong safeguards to ensure that political donations do not result in undue policy influence, and open, public registers of interactions between lobbyists and public officials. Governments should also create a “legislative footprint” for every regulatory proposal, among other measures against state capture.

Beyond these policy changes, we need sustained strategic cooperation between states to build a strong counterweight to those that influence the global tax system in their own interests. We should also closely follow the massive industry that is behind reinventing corrupt practices, finding new loopholes to exploit and influencing government decision making. As this industry evolves, our understanding of corruption has to evolve with that. We have to evaluate what a corrupt practice is not just inherently based on the principle, but in light of its social and economic outcomes – and those are especially severe with regards to tax policy.

Tax systems should provide the financial basis for achieving social and economic justice and other forms sustainable development. We need to act now and in unison to stop corruption undermining that.