Tax, moral obligation and the rule of law

This issue – or confusion of issues – has been troubling me for some time. Let me start with three declarations. First, I used to be a tax lawyer. Second, for me, the obligation to pay tax can ultimately only be a legal one, and not a matter of morals. Third, I’m not in favour of complex, elaborate, or artificial, tax avoidance schemes.

“If we truly believe in the rule of law, there can be no residual notion of a moral obligation to pay tax.”

Legalised confiscation

First, some basics. The purpose of taxation is to finance the State. Indeed, the origins of tax lie in raising money to finance wars. (As an aside, because of the unwillingness of earlier generations to contemplate a permanent state of war, even today income tax is only an annual measure which has to be confirmed and reimposed by Parliament every year, hence the need for an annual Finance Act. So what irony, then, that although we raise more than enough money each year through taxation to finance our defence, governments of all persuasions in recent years have so cut back on defence funding in their allocation of tax revenues raised that our ability to defend ourselves effectively must now be questionable.)

So, taxation is in effect legalised confiscation of citizens’ money in order to pay for State activities. This means that in a modern democracy that subscribes to the rule of law, the State’s power to confiscate must be clearly and unambiguously set out before our money can legally be taken from us. The obligation to pay tax must, therefore, be a legal issue because the State’s ‘right’ to take it from us must be set out in law. How unfortunate, then, that the political and media rhetoric about taxation is so often today framed in terms of some citizens engaging in tax avoidance and ‘wrongly’ keeping money due to the State.  If it is legally due, the citizen is evading tax and is indeed wrong to keep it – and the law has processes for collecting it.  If it is not legally due, it is not and never was the State’s money, whatever anyone else might have thought ought to have happened.

The places for setting out the legal obligation to pay tax are (a) in the legislation defining the scope and amount of charge, as well as of any allowable deductions, and (b) in the judgements of the courts when the scope of any charge, amount or allowance is challenged. If we truly believe in the rule of law, these define the limit of the obligation to pay tax: there is and can be no further or residual notion of a moral obligation to pay. Indeed, for anyone to suggest that, notwithstanding the terms of a tax statute and any judicial determination on its meaning and extent, there remains a “moral obligation to pay one’s fair share” is to undermine the rule of law. It seeks to substitute a subjective judgement and moral ‘duty’ in circumstances where the law says there is no legal duty.

If those who draft statutes, and the Parliamentarians who enact them, are found not to have expressed their intentions clearly enough to impose a legal obligation, then seeking to impose moral censure on those who have otherwise complied with their legal obligations does not serve society well.

Moral obligation and fair share

When we talk about a ‘moral obligation’ to pay one’s ‘fair share’ of tax, we confuse a number of issues. First, there is the State’s decision about how much money to raise through taxation and what to spend that money on. That is the fundamental purpose of the Chancellor of the Exchequer’s annual budget. This is, inevitably and rightly, a political process. At a personal level, we might well disagree with the Chancellor about the amount and the intended purposes. But it is the outcome of a legitimate democratic process. In part, we elect Members of Parliament to make such decisions on behalf of society.

I am therefore entirely comfortable with the notion that this process is used to express on our collective, democratic behalf what we as a fair and decent society should pay for and support through the institutions of the State (it is, in my terms, the expression of ‘the public interest’). This can equally be said to identify what our ‘fair share’ of tax contribution should be. If we don’t like it, we have a collective, democratic process to change those who make such decisions on our behalf. I’m not therefore denying that there is such a notion as our ‘fair share’ of tax.

This political determination of the amount of money the State needs, and how it should be raised and applied, is just that – a political process carried out by Parliamentarians on our behalf. Their intentions should therefore be expressed and clear; and in expressing the wishes of a fair and decent society, there might well be said to be ‘moral’ underpinnings to those intentions and decisions. I am comfortable with that.

Second, however, the authority to collect money from citizens through a system of taxation to raise the money to be applied by the State for those ‘moral’ purposes can only be expressed in legislation. If the Parliamentarians do not fully or effectively convert their good intentions into statutory language that confers legal authority to collect, there can be no legal obligation to pay tax. But more than this: however fair, decent, moral, or noble the Parliamentary intentions, there can be no residual obligation to pay tax as originally conceived merely on the basis of a moral obligation. Taxation is a compulsory levy, not a voluntary one: without law, there is no compulsion. Any further voluntary or ‘moral obligation’ payment would simply be an expression of charity or good citizenship. It has nothing to do with taxation and cannot be compelled.

Tax avoidance

So, third, what of ‘aggressive’ tax avoidance? Well, let’s be clear that no form of tax avoidance – however socially reprehensible it might be regarded by some – is illegal. If the tax legislation is so interpreted, there is no legal obligation to pay. And let’s also be clear: if the legislation on allowances and deductions is properly interpreted and applied, those allowances and deductions are not somehow payment of the State’s money to the citizen (as some of the media and, sadly, some Parliamentarians, would have us believe): the State has not made a valid claim in those circumstances legally to take more money from the citizen by way of taxation. If the allowance is valid, it is not the State’s money retained or paid back to the citizen: it was and remains the citizen’s money.

Nor, surely, can we complain about all forms of tax avoidance. If I have a limited amount of money to invest, I might make a choice between a pension contribution or investing in an individual savings account (ISA). I might make that choice on the basis that my pension contributions would attract tax relief: I have chosen to ‘avoid’ tax on some of my income and have structured my decisions and actions accordingly. Is this morally reprehensible?

Where is the line between ‘acceptable’ and ‘aggressive’ tax avoidance? Who decides – and when? In most cases, it can only be determined after the event, when a court has said that a particular scheme has succeeded or failed. One could argue that, in marginal cases, that is exactly what courts are for: a decision made by judges in accordance with the rule of law, and with a consequent legal obligation on the person involved to pay the tax due as if the scheme had not been entered into.

To suggest that the dividing line is to be ‘determined’ (even after a court has said that a scheme succeeds) by sections of the media or by Parliamentarians who then take exception to it is ludicrous. Indeed, it is offensive when the objection is not to the scheme in the abstract but is a personal attack on a named individual or business whose tax affairs ought otherwise to remain a matter between themselves and the tax authorities. To appeal to a ‘moral’ higher ground is to arrogate the right of judgement, but worse in my view since it seeks to circumvent the rule of law.

How could any of us then plan our personal and business affairs if this form of after-the-event subjective, arbitrary and temporal moralising ‘decreed’ that we nevertheless had a duty to pay tax that the law has said is not due (or personal pressure is brought on us before the law has said whether or not it is due)? If, in the course of a judicial determination on the extent of a tax provision, a court has taken into account the degree of artificiality in the underlying arrangements, the subjective ‘motive’ of a taxpayer will have been assessed. If, on that basis, the scheme still succeeds, on what basis can anyone else seek to undermine that judgement on supposedly ‘moral’ grounds without undermining the rule of law itself? This is dangerous territory.

Complexity

It seems to me that the real argument on aggressive or artificial tax avoidance lies in the complex structures and arrangements that some taxpayers will adopt in arranging their affairs solely in order to achieve a tax advantage without any other associated underlying personal or commercial benefit. If I make a pension contribution, there is a personal benefit in having pension income the future (which will be taxable, I might add): my associated benefit is future income rather than current tax avoidance. My use of the tax relief is exactly in circumstances envisaged by the legislation, and I have not artificially rearranged my affairs to find a convoluted way of claiming that relief.

But for as long as the tax system is complex, the perceived tax burden is too great, or tax revenues squandered on expensive and ineffective government projects (all creating an incentive to avoid), there will always be a motive to arrange one’s affairs using complex, anti-avoidance structures. Complex legislation also requires complex drafting – with a consequent likelihood either that it will not in fact cover every intended objective or it will unintentionally suggest opportunities for complicated structural responses designed to exploit perceived loopholes. It is this systemic complexity that creates the perpetual supply of new opportunities and loopholes and closing down of others; it is this that sustains a tax avoidance advisory industry.  The solution lies in the legal framework of the tax system, not in an appeal to morals.

If we don’t want complex tax avoidance, make the system simpler and clearer.  If we don’t like particular types of tax avoidance, legislate against them or remove the ‘offending’ allowances and reliefs.  Alternatively, tax legislation can allow judicial discretion to strike down schemes determined by judges to be ‘artificial’ where there is no substantive personal or commercial benefit, and they are intended only to avoid tax. On both approaches (simpler, clearer legislative drafting, or judicial discretion), the answer to tax avoidance lies in the playing out of the rule of law. This must be better than after-the-event media or Parliamentary appeals to moral obligation and fair shares. Any resort to moral pressure on questions of tax avoidance is dangerous, unnecessary and inappropriate.

So perhaps we can stop confusing what tax revenues are intended to be spent on with the legal authority to collect them; stop confusing the associated notion of defining a ‘fair share’ with a legally enforceable obligation to pay it; stop confusing tax avoidance with tax evasion; and finally stop believing that a failure to express legislative intention effectively can be remedied by resort to morals.

One thought on “Tax, moral obligation and the rule of law

  1. Is there also a wider issue here Stephen – businesses and individuals will always try and save tax, but avoiding it is different. Should it be the case that lawyers or accountants who proffer advice on avoiding rather than mitigating tax should themselves face some kind of scrutiny or penalty? It’s a lucrative business, and tax avoiders surely rely heavily on clever advice form experts who spot the loopholes. Stop that and it may reduce the problem significantly?

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