Articles / 10.19.2016
I was honored to join a SOCAP panel, in which Transform Finance’s co-founder Andrea Armeni posed the following question:
“A lot of the need for impact investment arises out of the government’s lack of provision of those basic goods and services, from sanitation to education. This is due in large part to the erosion of the tax base through tax avoidance. As such, shouldn’t impact investors try not to contribute to the problem via the pursuit of tax avoidance strategies?”
I disagreed, diplomatically, but firmly. My three-part reasoning was that 1) a core responsibility of my job is to help our clients maximize their after-tax rate of return, so they can 2) continue to invest in high-impact strategies that 3) generate social and environmental benefits in a more efficient, targeted manner than the government is typically able to do.
Yet the recent controversy surrounding U.S. presidential candidate Donald Trump’s tax returns has compelled me to revisit the question, repeatedly. Why? Because U.S. citizens are surprisingly unified regarding the importance of paying taxes. Research reveals that on this matter, voters display a consensus not often seen in politics: nine out of 10 agree that “it is every American’s civic duty to pay their fair share of taxes.”
Where this consensus begins to break down is around the definition of “fair share.” One of the reasons Trump’s tax avoidance has provoked such heated debate is because the notion of a billionaire (possibly) not paying any federal income taxes for over a decade just feels, deep down, somehow…wrong. Lest anyone accuse me of taking a partisan stance in what I intend to be an apolitical post, I must also acknowledge the unequivocal legality of what is known1 about Trump’s tax strategy. So if he’s abiding by the tax code, can we blame him for operating opportunistically within the law?
Warren Buffett might do precisely that. After he was accused by Trump of taking “massive deductions” in the second presidential debate, Buffett quickly set the record straight. Not only did he demonstrate that he pays federal income taxes, but more intriguingly, he claimed that he has paid them every year since 1944 – and that he has never used a carryforward (the core element of Trump’s strategy). The Oracle of Omaha is obviously a savvy investor. But it seems likely that even over his sterling career, he would have incurred some losses, which he, too, could have legally employed to reduce his taxable income. So by choosing to pay taxes higher than the minimal amount permitted by law, he seems to stand at one end of the taxpayer spectrum.
At the other end of the spectrum, there are clearly other wealthy individuals, who will stop at nothing to shelter income – through aggressive, questionable, and/or nefarious means. Without going into detail, I’ll point out that we once fired a client who asked us to pursue a tax strategy clearly designed to skirt tax law. To be abundantly clear, we do not support illegal tax evasion in any way.
Looping back to Andrea’s question: should I, as an impact investor, hold every client we serve to this sort of standard? Should I seek to pay a rate higher than minimally required? Is that reasonable? Or should I seek to optimize my tax burden within the limits of the law, so that I have more investable capital to pursue targeted impact investments? It has long been our stance that it is every American’s obligation to pay taxes, and every American’s right to pay as little tax as is required by law. The problem comes when that law can be bent so as to possibly avoid paying taxes altogether.
But it is a cop-out, a cheap rhetorical device, to orient this argument around the extremes, the black and white. So let’s focus on something a little more gray, and likely consistent with the spirit of Andrea’s question: tax loss harvesting.
For those unfamiliar, this is a practice where an investor sells a security that has dropped in value during the holding period. By realizing this loss, the investor can offset taxes associated with capital gains triggered elsewhere in her portfolio, as well as some ordinary income. To sharpen the point, we work with an impact asset manager – Aperio Group – who specializes in this strategy. Indeed, it is a core component of their value proposition. Mechanically, the practice is not much different than the tax loss carryforward employed by Trump. I don’t think there is anything inappropriate about Aperio’s efforts, or our clients’ embrace of the strategy. Then again, thankfully, not one of our clients has harvested nearly $1billion of losses.
So is this just a question of scale? Or is there a fundamental moral component to the debate, as implied by Andrea’s question? Honestly, I’m not sure. I feel the gravitational pull of Andrea’s logic: government budgets are stretched, so tax avoidance places increased stress on social service funding. And yet…
In the end, we are asked to build portfolios in alignment with our clients’ values. In this pursuit, we also focus on our clients’ after-tax rate of return; to do otherwise might be perceived as an abdication of fiduciary responsibility, analogous to ignoring asset management or transaction fees. In cases where clients tell us not to worry about taxes, it may be because they, like Buffett, have a slightly more magnanimous mindset on the matter. But it might also be because they, like Trump, are working with shrewd tax advisors who know how to game the system. We don’t always know.
I believe it’s an intensely personal question, similar to asking how much one should give away. The query exposes one’s fundamental relationship to the meaning of money. I rest easy at night knowing that the foundations and families I serve are putting much, if not all, of their capital to good use by investing for impact. The question about whether they could be doing “more” is entirely subjective. But I still suggest – indeed, hope – that more impact can be accomplished through capitalistic solutions than bureaucratic programs.
1Indeed, most of the discussion has been highly speculative, particularly since questions surround how much of his own money was lost (versus those of other investors) and whether the loss was accentuated due to financial leverage. Rather than bore the reader with arcane discussions of tax treatment, I’ll simply assert that it is at these fringes of the discussion where questions about ethics really come into play.