There are some economic terms that are fixed and immutable. Marginal cost will always be the addition to cost from an incremental increase in output, and average cost will never be anything other than total cost divided by output. Other terms have greater fluidity and evolve over time with developments in theory and practice. For this reason, compilation of the Dictionary is never finished and definitions are never final.
The original notion of equilibrium in economics referred to the equality of supply and demand. It then expanded to include the Nash equilibrium, and now includes numerous concepts of equilibrium in dynamic situations, situations under uncertainty, in the strategic games with complete and incomplete information, and so on.
In the past it has been possible to define tax avoidance by explaining why it is different to tax evasion. Typical definitions would observe that both concern actions taken to reduce tax payments, but one – tax avoidance – is legal whereas the other – tax evasion – is illegal. The definitions would go on to observe that the division was not entirely clear until a method of tax avoidance had been tested for legality in the courts. This gave a “grey area” in which actions hovered on the margin of legality and illegality until examined.
The issue of tax avoidance has received considerable recent media coverage following revelations that many large multi-national corporations pay tiny amounts of tax – if any at all. There may be perfectly legitimate explanations for this situation, such as high levels of investment leading to losses despite large revenue flows. However, many commentators and public opinion have favoured the notion that the corporations are engaged in tax avoidance on a grand scale, and that this is unfair and unacceptable.
It is not only corporations that have been accused of engaging in tax avoidance. HM Revenue and Customs (HMRC) have been confronted by an industry devoted to the construction of tax avoidance schemes and the promotion of these schemes to wealthy individuals. Until recent changes in legislation, the only available response for HMRC was to test the permissibility of the avoidance schemes on a costly and time consuming case-by-case basis. In line with the definitions some of the schemes were ruled illegal and the participants faced substantial bills for unpaid tax.
The first step to controlling these schemes was the introduction of the Disclosure of Tax Avoidance Schemes legislation in 2004. This legislation requires promoters of avoidance schemes to disclose what they are doing so that HMRC can decide whether they can be legally used or whether they should be prohibited. This policy change did not impact on the definition of tax avoidance, but it did help to reduce the size of the grey area since it should prevent some illegal schemes from reaching the market.
The definition of an economic term can change with shifts in policy.
More recently, in 2013, a General Anti-Abuse Rule (GAAR) was introduced. This rule overturns the previous legal presumption that it was acceptable for a taxpayer to use any lawful method to reduce their tax liability. It aims at identifying ‘abusive tax arrangements’, and outlaws avoidance schemes that ’cannot reasonably be regarded as a reasonable course of action’. For obvious reasons, this test is now known as the ‘double reasonableness test’. In simpler terms, abusive tax avoidance occurs when the action involved has no commercial justification other than the reduction of tax liability. This could include, for example, the use of complex financial instruments that reduce tax liability but do not change the level of risk faced by a firm or an investor.
The consequence of this recent legislation is that the definition of tax avoidance has to evolve. The act of re-arranging one’s affairs to reduce tax liability is now defined as tax planning if it is encouraged by the government, tax avoidance if it is not encouraged but does have legitimate commercial justification, and abusive tax avoidance if it has no justification. Further, from the perspective of UK law abusive tax avoidance is not legal. Changing policy has shifted the boundary of illegality and made some acts of avoidance illegal. This example illustrates that the definition of an economic term can change with shifts in policy.
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