Why the big four auditing firms need to choose between tax schemes or government funding

Tax authorities, at least in Australia, are getting better at responding to each round of tax leaks, with the Australian Tax Office saying it would investigate hundreds of people named in the Pandora Papers and freezing the assets last week of a Gold Coast developer named in the papers.

But tax avoidance by large corporations and high-wealth individuals continues to place trillions of dollars of profits and wealth beyond the reach of governments, meaning poorer services and a greater burden on ordinary taxpayers and small businesses.

At the heart of the infinitely complex world of tax avoidance and evasion are the enablers — the accountants, tax lawyers and auditors that dream up and create the structures that siphon away and hide money. It’s a massive global industry led by some of the world’s biggest firms.

The industry is led by the big four audit and consulting firms — KPMG, Deloitte, PwC and EY. A 2013 inquiry by a House of Commons committee found that “providing tax services to companies and wealthy individuals is a huge industry, worth almost £2 billion to the four firms each year in the UK, and almost US$25 billion globally”.

More than a fifth of the turnover of the big four in the UK was from tax advice.

The big four insisted to the inquiry that they were no longer involved in marketing and selling tax avoidance schemes of the kind they had been involved in in previous decades. But the Luxembourg Leaks emerged in from the International Consortium of Investigative Journalists (ICIJ) in late 2014 and showed that was a lie. A follow-up inquiry by the House of Commons committee in 2015 reported that:

“In January 2013 PwC had told us ‘we do not mass-market tax products, we do not produce tax products, we do not promote tax products’ and ‘we are not just producing a clever idea and distributing it out’. The number of letters subsequently disclosed under the ‘Luxembourg leaks’, all on PwC headed paper, clearly cast doubt on those statements. When we asked PwC to explain these statements in light of the Luxembourg leaks, it argued that rather than mass-marketed schemes, these are in fact individual arrangements, each tailored to the needs of individual clients.”

The names of the big four firms recur constantly in the database of offshore leaks about tax avoidance and the use of tax havens.

It’s not merely the big four, of course. One of the biggest names in the Pandora Papers is the US multinational law firm Baker McKenzie. ICIJ has released a massive and forensic account of how: “Baker McKenzie has helped multinationals and the wealthy avoid taxes and scrutiny through the use of shell companies, trusts and complex structures in tax havens. These vehicles, shrouded in secrecy, hold vast riches — homes, yachts, stock and money that is sometimes of murky origin. Among the clients: people and companies connected to political corruption, fraudulent business practices and authoritarian regimes.”

The enabling of tax avoidance isn’t limited to tax advice. The big four help shape tax law. The New York Times recently outlined how employees of the big four shuttle back and forth between companies like PwC and the US Treasury, where they play a direct role in drafting tax law, before returning to much higher pay in their old firms.

It’s easy to find any number of Treasury officials here who have, according to their LinkedIn profiles, done stints at the big four — and not internships or vacation stints either. That’s on top of the massive outsourcing of advisory work to the big four, who have received $130 million in contracts from the Australian Tax Office since 2018, and about $19 million in contracts from Treasury, mostly for management advisory services. As Crikey has repeatedly noted, the big four are all major political donors as well.

Baker McKenzie also enjoys considerable government funding: it has obtained more than $6 million in Australian government contracts since 2018, mostly from the Australian Competition and Consumer Commission.

But this generosity to the big firms that enable global tax avoidance potentially has an upside. We now know that forcing corporations to sever links with the big four reduces tax avoidance. After a series of corporate failures, the UK government imposed requirements to rotate audit firms for large corporations. The result, according to a recent study:

“… companies generally increase their effective tax rates (ETRs) after audit partner’s mandatory rotation, and the increase is specifically driven by companies hiring non-big four auditors … Companies engaging in less tax avoidance before and simultaneously purchasing tax services from their auditors have less increase in ETRs after an audit partner’s rotation.”

Compelling companies to rotate auditors and move away from using the big four and their tax services would increase tax rates from companies.

But better yet, what if the big four were compelled to stop offering tax services, either on a mass-marketed or individual scale? And law firms as well?

A straightforward way to improve tax compliance and reduce of the abuse of complex tax laws would be for governments to present the big four, and firms like Baker McKenzie, with a simple choice: either you stop offering tax services that lead to the government receiving less tax revenue, or you’re no longer eligible for government contracts.

Given the big four earn hundreds of millions of dollars a year from major government contracts, it would be a powerful incentive that would undermine the sector at the heart of global tax avoidance.

This article was first published by Crikey.