Tax and morality: Complicated laws make gaming the system inevitable

I RECENTLY spent a family holiday in a static caravan in northern France. As we sat outside with a glass of wine, my wife and I wondered why the caravan had wheels – it seemed unlikely that they would need to be moved, and I doubted they would carry its weight. Perhaps it has something to do with how permanent residences are treated in the tax code. In many countries, structures that are “mobile” (in theory, if not in practice) are taxed at lower rates and have weaker regulatory requirements.

This isn’t the only example of how tax law can lead to odd outcomes. When I lived in America, I was amazed that houses often had large basements at the rear of the property, until I learnt that historically taxes were based on the number of stories at the front of the house. My American friends are amazed at how gloomy my English cottage is until I tell them that historically property taxes were based on the number of windows.

The tax code is never neutral and can alter behaviour in ways that legislators never intended. Indeed, I believe this is at the heart of the debate about tax avoidance.

We commonly hear a distinction between tax avoidance (which is legal), and tax evasion (which isn’t). Those who are guilty of tax avoidance tend to defend themselves on the grounds that they were within the law. But we shouldn’t equate legality with morality. In Soviet Russia, Stalin raised taxes to exorbitant levels to deliberately crush the peasant farmers. Under such extreme circumstances, tax evasion can be morally justified.

There are actually three ways in which people reduce their tax bills. The first is tax evasion, which is simple to define because it is illegal and refers to actions outside the tax code. The second is tax planning, which is using the tax code as it is intended. The third is tax gaming, which is exploiting loopholes within the tax code in ways that policymakers had not intended.

This helps clarify that there is an important difference between, for example, married couples that receive tax credits and comedians who set up offshore companies to transfer income into loans. At the moment they would both be referred to as tax avoiders.

Some people may view tax gaming as morally equivalent to tax evasion, and they have a point. But note that tax gaming is the inevitable consequence of too much tax planning. Loopholes are a sure sign that the tax system is too complex. If you want to reduce gaming, you need to accept less planning.

Or to put it another way, one of the costs of tax changes is that you increase the chances of unintended consequences. Treasury minister David Gauke has proposed to “name and shame” those who engage in tax gaming, but additional regulations may well be counterproductive. The best type of tax system is neutral, and then HMRC resources can be focused on catching evasion.

Anthony J. Evans is associate professor of economics at ESCP Europe Business School. Twitter: @anthonyjevans

Correction: An earlier version of this article incorrectly said that tax avoidance is illegal and tax evasion is legal. This has subsequently been corrected.