Wednesday, May 28, 2014

When the bottom line is the only line, it's a problem

Last year Apple was being widely criticized in the press for its practise of funneling billions of dollars to Ireland to minimize the taxes it paid. During the height of the controversy, an MBA classmate of mine (and current Apple employee) wrote, "Avoidance is not evasion. One is legal, the other isn't. If you want corporations to pay more tax, close the loopholes."

This led to an interesting discussion about the differences between legality and morality, and what role (if any) corporations play in the latter.

His first rationalization for Apple's behaviour was pointing out, quite accurately, that most global corporations minimize and defer their taxes through numerous tricks and schemes. If governments would just "close the loopholes", he proposed, corporations would pay more.

Doing so, however, is not so simple. Businesses routinely threaten, browbeat, cajole, and blackmail jurisdictions to create precisely the legal conditions that allow tax avoidance on a massive scale. Companies such as Apple are in no way passive entities, merely following the rules laid out for them. To say otherwise is inaccurate and perhaps dishonest. Furthermore, while "Everyone else is doing it!" is an accurate observation, it is not a moral justification.

But why, he then asked, should there be a moral component to any corporate calculation? After all, "US corporations exist with basically a singular purpose, to increase shareholder wealth/value."

This was covered in our MBA - Milton Friedman believed that anything a corporation did beyond maximizing profits was a deviation from its sole true purpose and supremely unethical. This included donations to charities, supporting basic scientific research, or contributing to general education at any level. Only if the expected return from such activities (for example, the favourable publicity resulting from sponsoring some worthy cause) exceeded other potential investments should a company consider doing so.

While presented in class as one perspective of many (and an extreme one at that), apparently it has been taken to heart by some. 

This leads to a larger issue - when one fully optimizes on a single variable, everything else falls by the wayside. Optimization is a powerful mathematical tool, but there can be disastrous effects if it turns out that more than one factor is significant. Maximizing farming biomass output per hectare in isolation will ignore (for example) potential massive increases in water and fertilizer inputs, leading to water table depletion and downstream pollution. Factories to this day tend to pollute air, land and water when doing so is cheaper than paying a fine if they are caught - despite the fact it is orders of magnitude cheaper to contain toxic waste at its source than to clean it up once it has diffused into the wider environs. (The weakness of environmental regulations and their lax enforcement are often significant factors for a company determining where it will build a large manufacturing facility.) This principle was brilliantly illustrated by Edward Norton's character in Fight Club:
A new car built by my company leaves somewhere travelling at 60 mph. The rear differential locks up. The car crashes and burns with everyone trapped inside. Now, should we initiate a recall? Take the number of vehicles in the field, A, multiply by the probable rate of failure, B, multiply by the average out-of-court settlement, C. A times B times C equals X. If X is less than the cost of a recall, we don't do one.  
Perfect corporate logic. Horrific moral consequences.

Forbes magazine calls Friedman's call to maximize shareholder value to the exclusion of all other considerations "The world's dumbest idea", and notes its all too real results:
The corporate world is plagued by continuing scandals, such as the accounting scandals in 2001-2002 with Enron, WorldCom, Tyco International, Global Crossing, and Adelphia, the options backdating scandals of 2005-2006, and the subprime meltdown of 2007-2008. Banks and others have been gaming the system, both with practices that were shady but not strictly illegal and then with practices that were criminal. They include widespread insider trading, price fixing of LIBOR, abuses in foreclosure, money laundering for drug dealers and terrorists, assisting tax evasion and misleading clients with worthless securities.
Corporations do not exist in a vacuum. One cannot discard all considerations unrelated to maximizing profits merely because doing so may complicate a calculation. There is a social dimension because corporations (including Apple) derive enormous benefits from government expenditures:
  • Transportation infrastructure (airports, harbours, rail lines and roads) is generally built and maintained with tax dollars. Among other things, this allows corporations to ship products and move people around the globe cheaply. 
  • Functional governments enforce the rule of law, including an independent judiciary to maintain consistent application and oversee the enforcement of contracts if necessary.
  • Municipal, regional, and national police forces create and maintain safe(r) environments for factories, workplaces, and security of employees and tangible assets during and outside the working day.
  • Emergency response, such as fire and ambulance, are almost universally government funded and run services.
  • Most American Apple employees were educated in the US, in government funded primary, elementary, secondary, and post-secondary institutions.
One can see corporate influence on US tax policy by corporate taxes collected over time as a percentage of GDP. In the United States, corporations and individuals paid roughly the same amount in 1939 (actually, corporations paid slightly more - the last time this was the case). Ten years later, individuals paid 39% more. In 1959, individuals paid more than twice the taxes (2.14x) of corporations. This trend continues over the years - by 1979, individuals contributed more than three times what corporations did to government revenues; in 1999, it was nearly five times as much. 

In 2009, over 86% of the tax burden came from individuals. This trend cannot continue much further.

Corporations should include ethical considerations into their calculus - if for no other reason than enlightened self-interest. If a sufficient number of large companies and wealthy individuals become as successful as Apple in manipulating then exploiting the tax codes of various countries, our entire economic system will collapse into itself.

People in the developed world depend on corporations for so many crucial aspects of life - food, communication, drugs, equipments, products, and much else - that elements of corporate behaviour that jeopardize the stability, health, or longevity of societies in which they participate should be viewed as immoral.  The problem is not just that corporations behave unethically (though many do); it is that we (society) have created a system where harmful, detrimental corporate behaviour is implicitly (and in some cases explicitly) rewarded. The system must change if we are to avoid a catastrophic implosion; corporations are a single (major) player in a large, complex game. 

Perhaps we need to broaden the corporate mandate to include more than making money for shareholders; perhaps enforceable and genuinely global agreements on taxation and regulation would minimize the "loopholes" so expertly exploited by multinationals. 

At a minimum, we need to start having the conversation.