Publicly listed companies with the highest ESG scores and substantial investments from ESG funds often pay the least in taxes. In many cases, they pay even less than required by law, and according to Professor Gideon Parchomovsky, institutional investors play a role in this.
A trend has emerged where companies with strong ESG ratings from agencies like MSCI tend to pay less tax. Companies with a CCC rating, the lowest ESG score, pay an average tax rate of 27 percent, which is nearly double the rate paid by the best-rated group, AAA.
Gideon Parchomovsky, law professor at the University of Pennsylvania, arguess that tax considerations should be included in ESG assessments. In his recent study, “The Missing ‘T’ in ESG,” he suggested that tax should be a significant factor in evaluating companies.
“Even if companies legally reduce their tax liability, that choice should be reflected in their ESG rating, just like their other decisions,” Parchomovsky said in an interview. He notes that unintentional loopholes in U.S. tax laws are often exploited intentionally.
‘Ethically questionable’
The tax strategies of many companies fall into a legal grey area because tax avoidance is not explicitly illegal. However, while lawful, it often involves exploiting loopholes that go against the “spirit” of the law, making it “ethically questionable,” according to Parchomovsky.
He highlighted Microsoft as an example, noting that the largest recipient of ESG investments generated over 276 billion dollars in cash flow between 2013 and 2020, while paying less than 50 billion in taxes during that period. According to a 2022 study by the Centre for Corporate Tax Accountability and Research, more than 80 percent of Microsoft’s foreign income was channelled to tax havens.
Other tech giants, such as Meta, Netflix, and AT&T, paid zero taxes or received money from tax authorities in at least one of the past 15 years.
While aggressive tax strategies are common in tech companies, Parchomovsky notes that other companies across various industries also engage in tax avoidance. “General Motors, Nike, FedEx, and T-Mobile, to name a few, didn’t pay federal income tax in at least one tax year between 2018 and 2020,” he said.
Asset managers share responsibility
It’s estimated that tax avoidance strategies by large multinationals cost the U.S. government hundreds of billions of dollars each year, with state coffers missing out on around 30% of U.S. corporate taxes. Parchomovsky attributed part of this situation to asset managers, particularly the “Big Three”, BlackRock, Vanguard, and State Street.
By staying silent on tax avoidance issues—or even distancing themselves from corporate tax practices—asset managers are “eating from both sides of the fence,” he said.
He asserted that the Big Three not only turn a blind eye to aggressive tax avoidance strategies but also seem to encourage such behavior. “On one hand, they claim to integrate ESG considerations into their investments to attract investors. On the other hand, they benefit from the high returns resulting from aggressive tax practices, which contradict their commitments to socially responsible investing,” Parchomovsky said.
Implicit support from investors
Parchomovsky interprets the passive stance of institutional investors toward tax avoidance as implicit support for such behavior. “To encourage a more proactive approach, institutional investors should divest from companies with poorer tax behavior than their sector peers.”
He finds it “extremely confusing” that BlackRock, despite its ESG-focused agenda, explicitly distances itself from any authority on corporate tax and tax transparency. “Seeing these issues solely as the domain of tax authorities overlooks the many challenges global tax authorities face in addressing corporate tax avoidance.”
Shareholders’ preferences for tax avoidance significantly impact corporate tax behavior. To foster fairer and more sustainable tax practices, it is crucial for large institutional shareholders to embrace, rather than shirk, their responsibility in this area, Parchomovsky argued.
Global ESG-related assets under management are expected to reach nearly 3,400 billion dollars by 2026.
Further reading on Investment Officer Luxembourg:
- UN tax convention seeks inclusive and more effective rules
- ‘It is time to establish a global tax on the very rich’
- Impact of OECD “structured formal garden” for tax rules