Another Gathering Storm

As the euro crisis threatens a second round of the Great Recession, the potential shockwaves are being analyzed in boardrooms, newsrooms, and government caucuses.

It is a foregone conclusion that governments will have to cut programs and raise taxes, timed so as not to kill an emerging recovery. But what isn’t taken into account is the public fallout of these actions. Greece, France, and England have provided clear examples of street protests, strikes and riots. In the U.S., the debate for two years has pitted “inept” politicians against “corrupt” bankers. But Occupy Wall Street and fledgling organizations such as US Uncut (“No Cuts Until Corporate Tax Cheats Pay Up!) have set the stage for all sectors to come under close scrutiny.

That scrutiny will parallel the levels of pain American citizens are asked to absorb. Cuts in key social programs and tax increases of various types will bring public discourse to a simple question: are American corporations paying their “fair share”?

What is a Corporation’s “Fair Share”?

In 2010, Corporate Income Tax generated just 8.9% of US Federal revenue compared to 41.6% from individuals. That’s a short, fast fuse for public anger. But the Tax Gap – the difference between the statutory rate a company should pay and what they actually do pay – adds extra explosive.

A well-known example is 2010 GE’s infamous 0% U.S. tax, a whopping tax gap of 35%, despite a global profit of $14.2 billion, $5.1 billion of which came from the U.S. Even worse, from a public relations view, the company actually claimed a $3.2 billion credit.

As with most “scandals,” personal or public, the story vanished in a few news cycles. This vanishing act is why, however concerned they may be about SEC violations, most companies are relatively unconcerned about public “misunderstandings.” While not desirable, the primary defense is the fact that the public will stop paying attention soon enough.

But short attention spans may not protect companies much longer, as the public experiences more pain in the form of reduced government programs. And counting on public cynicism that nothing will be done to stop “abuses” won’t provide much cover either. Voters will demand accountability; just what form of accountability isn’t yet clear.

Preparing for the Storm

Before the storm breaks, companies should make their approach to tax a part of their Corporate Social Responsibility program. Companies should get credit for paying taxes rather than just blame when they are seen to have paid too little. Here are four elements of the correct approach to managing public perceptions on corporate tax:

1. Define yourself before you get defined. Concentrate on state and local taxes as well as federal. Include all taxes, both paid and collected on behalf of various governments –. Be clear about your company’s tax policy and commitments.
2. Explain the “tax gap” in plain language - resulting from legal deductions and incentives just as individual taxes do. Be specific about how R&D credits drive new products and job creation: connect R&D deductions to actual products and actual jobs.
3. Focusing on “full compliance” begets a discussion of “loopholes.” If a company “fully complies” with existing law but consistently has a big tax gap, the law will be seen as riddled with unfair loopholes. Recent focus on deductions for executive stock options is an excellent example.
4. “Fair Share” judgments will directly influence how tax reform lobbying is viewed. Every company has the right to participate in the tax reform debate, but companies deemed to be paying too little already may pay a high price for their lobbying efforts. That’s the dangerous line P&G CEO Robert A. McDonald walked during Congressional testimony this year. He called for a sharp cut in the US corporate tax rate without removing current tax breaks and shelters, yet P&G paid an average 24% tax over the past three years.

This is not a call for companies to throw open the books and allow revenue authorities to take whatever they deem “fair.” It is, however, a call to create a strategy for communicating more fully and directly about company tax payments. It is time to build a shelter before the storm.

What CEB is Doing for its Members

• Incorporate Tax into CSR: Members of the Tax Director Roundtable (TDR) can create a Tax CSR approach that balances corporate citizenship with shareholder obligations in the patterns of Vodafone’s Sustainable Contribution Disclosure.
• Build a Tax Impact Disclosure: TDR Members can also determine what and how much tax information can be shared without compromising audits, building from the model presented by Rio Tinto’s Comprehensive Tax Impact Disclosure.
• TDR Research in 2012: TDR is currently researching best practice on how companies are managing the “fair share” challenge. We would love to hear your views. Please contact me if you want to take part in the research.

If you would like further information about this or related topics, please contact Eric Zook.