By: Darshinee Nadarajan, Dr. Mohd Istajib Mokhtar
Here we are living in the era of ESG where, Environmental, Social and Governance principles shape almost every corner of our lives, influencing from the products we purchase to deciding on which companies to pursue our careers. Corporate companies trumpet their sustainability initiatives and goals, investors pour billions into ESG funds, and governments champion ESG focused policies to ensure businesses stay marketable in the global stage. ESG has become our modern-day dictionary guiding us to define frameworks for what it is like to be ethical and sustainable in the present world. It is no more a nice-to-have thing but more of a transformation, integrating itself into our daily lifestyle, reshaping industries, and redefining what it means to succeed in the 21st century. Without realizing ESG is silently becoming the lens through which the future is being created.
Companies with ESG policies, proudly stress on their decarbonation strategies, decent work, and compliance in where they operate. But one puzzle piece is always remained neglected – tax. Yes, indeed! Taxes which are the mandatory payments to government to cover the cost of public services. This may not be so favorable for many corporations, but if they aim to be an ESG champion, then tax inclusion is integral. Lisa Chen in her most recent analysis iterated how tax transparency in ESG landscape could revolutionize sustainability practices and U.S. companies should not tout their ESG policies without taking stock of how they manage their tax practices. Meanwhile, a research team led by Heriantonius Silalahi recently articulated that integration of tax in ESG principles is a progressive step that can courage companies to further adopt sustainable and responsible business practices. This should explain that taxes are beyond than just business expense, rather they reflect a business commitment on corporate social responsibility to reduce unequal distribution of wealth, which eventually relates back to the S aspect of the ESG. Then why taxation has been at the periphery of ESG discussions and U.S companies continue to neglect tax inclusion in their sustainability initiatives?
Well, one of the main issues here is that the readily available ESG ratings often put greater emphasis on most common elements on environmental impacts, sweeping taxes portion under the governance factors which do not provide a clear view of how tax strategies and practices are being measured or quantified. We have may have seen and read some ESG rating methodologies from the major ESG rating providers but not all providers grant that kind of visibility for us to evaluate the extend tax factors into the ESG ratings. While, published methodologies to measure tax factors are not comprehensive and meaningful.
One example provided by Lisa Chen from the University of California in her recent article which, MSCI (ESG rating provider) includes “Tax Transparency” under governance aspect as a corporate behavior, however the scoring for this indicator is based on company’s involvement in ongoing tax controversies and estimated tax gap. This is insufficient to distinguish U.S. companies with responsible tax behavior from those who are engaging in aggressive tax planning as they can easily justify that they are still abiding by the law despite the increasingly disfavored by society and deteriorates voluntary tax compliance. To deal with this gray area, Lisa Chen and Elamer with his research team recently argued that adequate integration is ESG evaluation and ratings could differentiate companies questionable tax practices and encourage fairer contributions to society. After all, what’s the point of funding a green project if it is undermined by tax avoidance that cripples public infrastructure?
Additionally, if you’re an investor looking at ESG ratings, brace yourself for confusion. The ESG ratings are perceived as inaccurate, often inconsistent and with lack of comparability. Why? Simply two reasons. First, ESG rating providers are unregulated who adopt multiple methodology-settings to assess and calculate ESG scores. This stems from not having a universally accepted approach to measuring non-financial indicators. Second, many rating providers rely on unregulated, unaudited, outdated, or even self-reported data from companies which potentially lead to “greenwashing or worse “ESG-washing” making companies appear more ethical than they really are as stated by Candelon and his research team in 2021. Hence, the verification and quality of data used for rating calculation by the rating providers, would be a question mark here mainly for stakeholders like investors to understand companies true ESG reflection.
Several scholars from the global north very recently suggested to using established frameworks such as Global Reporting Initiative (GRI) published the GRI 207- Tax (2019) which requires annual tax disclosures comprising tax strategy, governance, and risk management to increase transparency and accountability in corporate tax practices. Such transparency could allow ESG ratings to better reflect a company’s true sustainability impact and provide assurance of investor protection, allowing them to assess portfolio risks and opportunities better. Imagine being able to compare two companies’ tax contributions to society as easily as you compare their carbon emissions.
In a summary, ESG is not only about building a greener and safer planet but also building a sustainable and equitable society. Because tax is an essential ingredient in the component of ESG to reflect companies’ real sustainability commitments and impacts, any ESG policy or rating that does not meaningfully consider tax is incomplete. Hence, expecting corporations to play fair game with their tax is a win – win situation for many stakeholders including policymakers, investors, and common citizen. So, the next time you hear about a company’s shiny new ESG initiative, ask yourself: are they paying their fair share of taxes? Because in the world of ESG, every penny counts.
The authors are from the Department of Science and Technology Studies, Faculty of Science, Universiti Malaya.
Leave a comment