CSR-Friendly Tax Policy: Unlocking Value and Aligning Interests

By Wayne Dunn

The best thing I ever learned about tax policy came from one of Professor Howell’s economics classes I took at Stanford Business School: “What you tax, you get less of – and what you reward, you get more of.”

It makes good sense to me, so why is it so difficult for governments to see it this way? Tax is usually regarded as punitive, and someone always loses out. But with Professor Howell’s piece of simple wisdom, everyone can be a winner. And isn’t that the whole point of corporate social responsibility (CSR)?

We are seeing some governments making CSR policy into a tax, setting minimum amounts that companies must spend on CSR, often with little thought for value and impact.

So, in case any government is considering taxing CSR, this article puts forward the case for replacing that with its polar opposite – using tax breaks to incentivize and enhance CSR to everyone’s benefit.

Now, why would any cash-strapped government give this notion any serious attention?

Well the answer’s simple. CSR searches out the synergies between different stakeholder interests – and those include government’s developmental priorities and investment attraction objectives.

So, it is in government’s interests to incentivize private-sector investments and activities that create benefits and value for them, as well as for communities and corporations.

And there are two definite candidates for this incentivization model – tax credits, and co-investment. Each offers a real carrot for CSR work, and can be implemented separately or combined to suit government policy.

And as I’ll show, each saves the government money in the long run by helping deliver more successful CSR projects and avoid money-draining loopholes, while at the same time making the country more attractive for foreign investment.

So, let’s see what exactly how these two tax breaks might look, and how they benefit not just the community projects but the governments that implement them.

Tax credits: What are they? How could they work?

In its most common form, this involves the state providing companies with a credit against tax (or royalties) owed, based on the company’s investment in local communities.

Carefully-targeted tax credits have proven to be very efficient at creating local value and benefits and, simultaneously, developing local capacity and infrastructure.

Acceptable spending areas and processes are defined by the state and normally include local infrastructure projects and a requirement for local governments to be involved in setting priorities.  Some also have a requirement for local involvement in planning and execution, as well as a local content provision.

In some cases the model can be expanded to include more than one local government and/or regional governments.  Some, such as Peru, provide mechanisms to involve national government departments and agencies as well.

The model can also be adapted to also include company support to health, education, local government capacity and other government priorities.

The level of tax credit can be 100 percent of what the company invests or less and is determined by government.  Companies simply deduct the appropriate amounts from their taxes and/or royalties owed to the state.

Example: The Porgera Market

In 2002, Placer Dome was operating the Porgera mine in the highlands of Papua New Guinea. The government had a tax-credit policy that allowed the company and the local government to undertake local infrastructure and capital projects worth up to 35 percent of a company’s tax bill.

The local government set the priorities, including identifying and prioritizing the projects and setting local procurement requirements.

A number of projects were identified and developed including a community sports field and a local market.

They were developed with support and guidance from the company, which brought project management expertise and financing, and under the leadership of the local government.  Local contractors and labor did the majority of the work.

The end result was two valuable community assets: a high-quality sports field for local teams and youth and a community market that fostered local commerce, small-scale agriculture and local entrepreneurship.

The project met a community need and priority.  Financing was much more efficient than if the money had been routed through the national government and then sent back to the community for the projects.

Think of the transaction friction, potential for leakage and transaction costs if the same money had been sent from the company to the national treasury, allocated to the Local Government Ministry, and the community had to develop proposal and secure the funds back from the state to complete the project.

Anecdotal evidence at the time suggested that as much 50 to 75 percent of the funds would have been consumed/leaked/etc. before getting back to the local government and local project.

Project execution had the benefit of using the mine sites’ world-class project management expertise. The mine had teams that were accustomed to managing projects such as this and the associated contracting and equipment.

Contrast that with a situation where the project would be managed by either a local government with limited project management expertise and experience, or a national government that would have to send in project management capacity from the capitol.

The end result is: Community priorities were met, and the financing and execution efficiencies enabled much more to be done and much greater impact than if the same projects had been attempted through traditional tax, allocate, finance, executive models.

Benefits

Strategic integration of corporate social responsibility into tax policy can produce benefits across a range of stakeholder interests.

Perhaps the ultimate benefit is simply a tighter alignment between government, community and corporate interests and a more efficient application of government and corporate resources to support development priorities.

Other benefits include:

Benefits to Government:

  • Improved investment attractiveness because of more efficient CSR/social license process and better national and community support for key industries;
  • Enhanced developmental and community/infrastructure impact from tax revenues;
  • Improves local governance and capacity;
  • Increased synergy and alignment between corporate CSR spending and local and national government priorities creates finance and development efficiencies.

Benefits to Community:

  • Structured and constructive relationships with participating companies (this can often lead to additional partnerships, collaboration and value)
  • Streamlined and integrated process results in enhanced community level impacts;
  • Direct participation in project identification ensure local priorities are targeted, enhances local ownership and facilitates improved local project development and management capacity;
  • Improved ability to optimize local content (suppliers, labor, etc.) and improved alignment with other stakeholders.

Benefits to Company:

  • Improved coordination enhances impact and value at the community level and strengthens social license;
  • Structured collaboration with community on key projects enhances relationship and improves understanding of community issues and concerns;
  • Enables coordination of CSR spending and community infrastructure/tax credit spending, facilitating stronger local impacts;
  • Provides an opportunity for increased local procurement and employment.

These are some of the general benefits to key stakeholders.  Individual projects often have broader and more specific types of value and benefit emerge

The downside is minimal and mostly the inverse of some of the benefits.  Some examples include:

  • The national government may see the increased priority setting control of local communities as a downside;
  • Risk of corporate-controlled government or companies imposing their will/priorities on weak local governments;
  • Overall resistance to corporate involvement in public arena;
  • National/regional/local government lack of capacity to effectively prioritize and partner with corporations.

Co-investment in development

Let’s start by understanding the synergies and where there is intersection and overlap between business, governments and the international community.

When these synergies are identified and understood governments can use tax policy and incentives to encourage corporations to target CSR budgets toward key priority areas.

The challenge is to clarify and make irresistible the opportunities for making this synergy happen.

So, where do governments see their own priority areas lying?

Governments, international organizations and others have almost universally subscribed to the eight Millennium Development Goals (MDGs) that were unanimously adopted by the member nations of the United Nations in a special Millennium session in 2000.  Similar uptake and adoption is anticipated for the 17 Sustainable Development Goals (SDGs) that will be adopted by the United Nations in a special session during Climate Week NYC later this month.

From the CSR perspective, corporate CSR/sustainability objectives and investments fall into seven categories: education, health, poverty alleviation, gender equality, environmental stewardship, partnership development and equity/justice.

Not all projects or companies invest in all of these, but I’ve not yet found a CSR project or activity that didn’t fit into one or more of these categories.

If you look at the eight MDGs and the 17 SDGs, you will see that they can fit into the same seven-point framework that corporate CSR/sustainability investments and activities fit into.

However, all too often the current practice is for industry’s CSR investments in these areas to be done independently of government efforts, or with limited levels of collaboration.  This is inefficient and produces a sub-optimal outcome for all concerned.

For example, education and health are often key issues for local communities and a priority spending areas for industry’s CSR budgets, especially when operating in remote areas of emerging economies where deficiencies of infrastructure and reach can be significant.

Without active coordination and collaboration with governments, the impact of social investments by industry can be reduced and often negative impacts created.

To illustrate this, industry may build schools or health centers without knowing government’s location prioritization and rationale, resulting in a disruption to government plans, challenges in staffing and ongoing operations, or worse yet – the perception of competition.

Economic development and poverty alleviation are also key community priorities and easily recognizable needs.  Closely linked to these are various training initiatives that seek to provide local residents with foundational skills and resources that facilitate options to improve livelihoods.

Now, all of these areas are often targeted with industry CSR budgets and regularly include collaboration with local communities and stakeholders in their development.

And they are also often targets of governmental programs as well as direct programming by NGOs and other development actors. But too often there is little coordination between the players and the ultimate losers are everyone.

When government and industry doesn’t take advantage of these synergies it means that communities receive less positive impact and fewer benefits while project funders (industry, government, NGOs and others) generate fewer benefits for greater financial outlay.

So, the solution is for governments to use tax incentives and co-investment to encourage corporate CSR investments to focus on priority areas. 

One of the key challenges to successfully implementing this sort of co-investment model is that the parties, government and industry, are often not able to consummate seemingly natural partnerships.

However, tax-based incentives can be the catalyst to creating these partnerships and making them work.

For example, if the education ministry had plans for school construction in areas near a mining project there could be tax incentives such as a partial tax credit and/or increased deduction allowance provided to encourage the mining company to target some of its CSR investment to co-invest with the education ministry on their priorities.

In this example there can sometimes be additional value realized through utilizing a company’s project management capacity, similar to that described in the tax credit section.

Other areas where a similar approach could apply include health, economic development, etc.

Natural partnerships, unnatural partnerships:  The industry-government partnership capacity gap

In my experiences throughout the world, the state’s ability to collaborate effectively with the private sector on CSR/co-investment in development is nearly always hindered by its lack of capacity to work with the private sector.

Departments like health, education, local government and others do not have a history of collaborating with the private sector to partner on projects.  Too often individuals within the departments simply lack the experience or training to enable them to work effectively with private sector partners to collaborate on these initiatives.

The private sector also has limited capacity for working with government departments, and this combination results in valuable opportunities being missed, or projects performing poorly.

Training and mentorship have proven to be helpful at bridging this partnership capacity gap.

Conclusion

The above examples should be seen as indicative rather than exhaustive.  The takeaways are:

  • Companies are investing in local development as part of their social license and CSR strategy.
  • These investments are often aligned with government development priorities;
  • Governments can use tax policy to target and increase the developmental impact of private sector investment and operations without adding to companies’ tax burden
  • This can be an efficient way of meeting developmental priorities and can produce a broad range of stakeholder benefits, including improving a country’s investment attractiveness.

Image credit: Flickr/Andrew Magill

Wayne Dunn is  President & Founder, CSR Training Institute and Professor of Practice in Corporate Social Responsibility, McGill University. You can sign up for the CSR Training Institute newsletter here and read more from him here.