Why does the ATO pick on Soft Targets
Some commentators argue that the tax administration should focus on ‘taxes and taxpayers they can catch’. Such a comment reflects a common belief that the Australian Taxation Office (ATO) could raise sufficient taxes by focusing on enforcing taxes that are easy to collect and/or focussing on taxpayers that are easy to monitor, also known as ‘easy pickings’ or ‘soft targets’. Interestingly, the ATO has also been accused of having a ‘revenue bias’ in it’s decisions and activities and failing to attack the more challenging issues.1 This accusation insinuates that the ATO focuses too many resources on the ‘easy’ areas in an attempt to maximize revenue whilst reducing administration costs. Some examples of ‘soft targets’ are:
· Tax on dividend and interest income as these are electronically monitored, and
· PAYE tax as this is deducted by the employer from all salary and wages paid.
Some examples of the more challenging issues that face the ATO are:
· The Cash Economy, and
· Electronic Commerce.
The above comment suggests that the ATO would be able to raise adequate revenue by focusing it’s resources on the easy areas and ignoring the more challenging issues. This paper will discuss whether such an approach has efficacy.
“The essential criteria for assessing a tax system are equity, efficiency and simplicity. An equitable tax system is critical, not only to the attainment of economic and social objectives, but also to the maintenance of basic respect for the tax system from which a high degree of voluntary compliance derives.” 2
According to it’s latest plan3 the purpose of the Australian Taxation Office (ATO) is: “To collect the revenue, properly payable, so as to fund services and support for the people of Australia”. The ATO plan also states that it’s challenge is to have community support in all it does.
1.Carmody M. “The State of Play Five Years On”. Address to Taxation Institute of Australia. (Victorian Division.) 3 February 1998.
2.Aust, Reform in the Australian Tax System. (Draft White Paper.) (Canberra. AGPS, 1985)
3.Australian Taxation Office 1995-1998 Plan.
As the Australian Taxation System is a system of Self Assessment, voluntary compliance is essential. As outlined above, voluntary compliance relies on a basic respect for the tax system. To maintain a basic respect for the tax system the ATO needs to achieve it’s purpose of collecting the revenue ‘properly payable’. This paper will outline why the Australian Tax System would fail if the ATO focussed it’s resources on ‘soft targets’. Whilst perhaps being an efficient and simple approach, it would not be equitable as it would not collect the revenue properly payable, and would result in a loss of respect for the tax system and an overall decrease in voluntary compliance.
It has been found that there are two main ways of increasing compliance, namely by improving taxpayer attitudes towards taxation or by increasing a tax authority’s ability to deter evasion. 4. These two methods will now be elaborated upon.
Taxpayer Attitudes Towards Taxation:
Whilst the study of tax evasion/compliance is a relatively new area and the conclusions are varied, a common theme is the importance of feelings of equity and norm commitment.5
· That many taxpayers think that compliance by others is lower than their own compliance. This could indicate resentment of others not paying their fair share and also a willingness to engage in non-compliance if the opportunity presented itself. 6
· That the more evaders a taxpayer knows or is aware of, the poorer his compliance is likely to be. 7
· Citizens no longer sense an expectation that they should fully and fairly comply with the system, but instead believe that the normal expectancy is a modicum of evasion. Also referred to as the ‘bystander effect’, taxpayers may think that their evasion is only a minute amount of the revenue lost and would not make much of a difference. 8
4 See Generally, Boyd CW, ‘The Enforcement of Tax Compliance: Some Theoretical Issues’, (1986) 34. Canadian Tax Journal. 588-599 at 590.
5.See Generally, Wentworth DK & Rickel AU, ‘Determinants of Tax Evasion and Compliance’, (1985) 3 Behavioral Sciences and the Law. 455-466 at 463.
6.See Generally, I Wallschutzky. ‘Possible causes of Tax Avoidance and Tax Evasion’. Unpublished PhD Thesis, University of Bath 1983.
7 .See Generally , Casanegra de Jantscher M, “Types of Tax Non-Compliance”. (paper presented at the XVI General Assembly of the Inter-american Centre of Tax Administrators, Asuncion, Paraguay, 1982.)
8 .Above, note 5.
·Taxpayers can reduce their guilt feelings accompanying deviant behavior by employing justifications such as ‘everyone does it’. This is referred to as the ‘neutralization theory’.9
· Even if the direct revenue losses are small, a general awareness that many persons don’t comply may have a demoralizing effect on other taxpayers and prompt some of them to evade their liabilities. 10.
Whilst focussing on ‘soft targets’ may be simple and efficient for the ATO in the short term, the long term effects could be disastrous. “This behavior would condone a lot of tax evasion and would generate tax revenue in a way that would be far from optimal. It would also conflict with other objectives of taxation such as neutrality and equity”. 11. The long term effect would be a serious deterioration in taxpayer’s attitude towards the payment of tax. Taxpayers who are in the ‘soft target’ category would lose respect for the tax system, become resentful about others not paying their fair share and attempt to find ways to avoid or evade their taxes.
This attitude is already evident in the Australian Community. According to Tax Commissioner, Michael Carmody “The general sentiment …is that salary and wage earners see themselves as the target, that they are bearing the weight of the tax system, while those in the cash economy and others with ‘smart advisors’ are getting out of paying their fair share”. 12.
Some examples of ‘soft target’ taxpayers finding ways to avoid or evade their taxes are; negatively geared investments, hobby farms, tax driven investment schemes (e.g. Emu’s), interposing an entity such as a Family Company or Trust, or avoiding the PAYE scheme by converting to a Contractor. Another common rebellion tactic is to take advantage of the cash economy by offering cash payments in return for a cheaper price.
9.See Generally, Henderson, WT Jr, ‘Criminal Liability under the Internal Revenue Code: A Proposal to make the Voluntary Compliance System a Little less Voluntary’. (1992) 140. University of Pennslyvania Law Review. 1429-1461
10. Above, note 7.
11. Tanzi V & Shome P, “A Primer on Tax Evasion”, Bulletin for International Fiscal Documentation, IBFD, vol 48, no6/7 1994. 328-336
12. Media Release 97/19 ‘Tax Office Responds to Task Force Report on Cash Economy’.
The effects of previously compliant taxpayers converting to avoiders/evaders can have disastrous long term consequences due to the ‘catastrophe effect’ and the ‘inertia theory’. The catastrophe theory suggests that an initial decrease in the audit rate can result in a catastrophic increase in evasion. The initial increase in evasion decreases the effectiveness/output of future audits, thereby further increasing evasion, whether further decreases the effectiveness/output of future audits, etc.13. The inertia theory asserts that after an individual routinely engages in a given practice, he has little incentive to change. This applies to both compliant and non-compliant behavior. The danger for the ATO is that if it does not maintain public confidence previous compliant taxpayers may convert to non-compliers and then their behavior may be very hard to change. 14.
Whilst in the process of writing this paper the author was exposed to two classic examples of the ATO’s focus on ‘soft targets’ having a negative effect on taxpayer attitudes and increasing evasion. In one example the taxpayer had been a subject of the ATO Project on Life Insurance Agents. He received a letter advising him that information suggested that he had been in receipt of interest free loans that should have been subject to Fringe Benefits Tax. He was requested to voluntarily admit to the misdemeanor, calculate his own liability and pay the amount. In return he would be granted reduced penalties. He was threatened that failure to comply would result in a full audit and maximum penalties. He did as requested and voluntarily paid $7,500.00. However, five of his associates ignored the letter and never heard from the ATO again. Needless to say he is quite bitter and is unwilling to voluntarily comply in future.
In the second example, a relative who is an elderly pensioner has been subject to a Dividend and Interest check three times in three years. One error was as a result of an ATO mismatch. The remaining two errors involved genuine mistakes resulting in less than $500.00 tax. On the other hand, three other relatives are tradesmen practicing in the cash economy. Despite considerable non-compliance, they have never been contacted by the ATO. Needless to say, they are also increasing their non-compliance due to lack of ATO action and the pensioner is getting back at the ATO by paying cash at every opportunity.
13.Boyd CW, ‘The Enforcement of Tax Compliance: Some Theoretical Issues’, (1986) 34. Canadian Tax Journal. 588-599 at 590.
14. Jenkins GP & Forlemu E, ‘Enhancing Voluntary Compliance by Reducing Compliance Costs: A Taxpayer Service Approach’, (unpublished) International Tax Program, Harvard University, 1993. 1-31.
As explained above focussing on ‘soft targets’ is not a viable long term option. To maintain public confidence and respect for the tax system, the ATO has to be seen to be focussing on some of the more challenging issues. A strong enforcement program, by deterring evasion, ensures that the tax burden is spread more equally and reassures honest taxpayers that their honesty is not misplaced.15.
It has been found that an individual’s decision to pay or evade tax “depends upon his attitude toward risk taking, his perception of the morality of the tax, and his perception of the probability of detection”. 16. Jenkins & Forlemu suggest that taxpayers will continuously attempt to evade taxes whenever the benefits from tax evasion outweigh the risk of detection and punishment.17. Studies have also shown that compliance varies directly with changes in the audit rate. 18.
The above findings indicate that a taxpayer’s perception of the audit rate directly influences his ‘voluntary compliance’. Many taxpayers’ view evasion as a ‘game’ in which the less likely they are to get caught the more they are willing to evade. 19. If taxpayer’s feel that the ATO is focussing on ‘soft targets’ only they are more likely to attempt to evade their taxes through some of the methods the ATO finds more challenging. To combat this the ATO needs to ensure that they are seen to be targeting the more challenging issues. Some of the significant issues challenging the ATO are Electronic Commerce and the Cash Economy. These issues will now be discussed.
According to the ATO’s Discussion Report on Tax and the Internet 20. a high level of non-detection of tax evasion through the Internet could lead to tax evasion in a highly competitive global business environment. Businesses may be forced to adopt non-compliant facilities to compete with other businesses, thus exacerbating non-compliance. The migration of businesses to the Internet may then be increased due to tax avoidance and evasion opportunities it presents. It is important that there is broad neutrality between the treatment of businesses engaged in traditional physical commerce and those engaged in electronic commerce.
15. Melia RM, “Is the Pen Mightier than the Audit?”. (1987) 34. Tax Notes 1309.
16. Above, note 13
17. Above, note 14
18. Alm J, Jackson BR & McKee M, ‘Estimating the Determinants of Taxpayer Compliance with Experimental Data’, (1992) 45. National Tax Journal.107-114.
19. Above, note 11.
20. ATO’s Discussion Report on Tax and the Internet (ATO Electronic Commerce Project Team). August 1997. AGPS
According to Tax Commissioner, Michael Carmody in his speech ‘A Driving Force in Electronic Commerce’21 not addressing the electronic commerce issue could leave Australia without a taxation base that supports the Australian community. The ATO recognizes this risk and must act now.
According to Tax Commissioner, Michael Carmody “The cash economy represents a major cost to the Australian community in lost revenue and an unfair shouldering of the tax burden”.22
According to background research23 into the cash economy there is still no reliable estimate of the size of the cash economy. However, there is sufficient anecdotal evidence to suggest that it has a major impact on community perceptions of the fairness of the tax system and imposes significant costs to the Australian community in terms of:
· Unfair price competition on honest business;
· Welfare fraud;
· Avoidance of superannuation, workers compensation and child support obligations; and
· Lost tax revenue that is used to fund community services and government programs.
Further, the cash economy generates increased welfare costs as it impacts on means tested social benefits. 24
The ATO has recognized that of greater concern is the growing perception that tax evasion is an escalating problem which, if not addressed, may impact on the level of voluntary compliance with the taxation laws and in turn, government’s ability to fund their programs. In particular, the ATO recognizes that tax evaders are seen to have a competitive advantage over businesses that do the right thing. The message from the small business community is that the ATO needs to do its part in ensuring there is a level playing field. 25
21. Carmody M, ‘A Driving Force in Electronic Commerce’. Tradegate ECA Business Forum. 16 September 1997.
22 Above, note 12.
23 Improving Tax Compliance in the Cash Economy. Background Research. http://atoassist/general/business/cashecon/compliance/htm
24 Above, note 12
25 Improving Tax Compliance in the Cash Economy. Cash Economy Task Force Report. 12 May 1997. Pg 12.
According to Tax Commissioner, Michael Carmody, 26 what makes the cash economy such a difficult issue to tackle is that the community has a split personality on the issue. On one hand they realize they are victims of the cash economy and think that everyone should pay their fair share of tax. On the other hand, the community willingly participates in it by accepting a lower ‘cash price’ for a product or service. According to Curt Rendell, Chairman of the Institute of Chartered Accountants Small Business Committee, “While many PAYE taxpayers think they are getting a bargain for their house-painting or plumbing, they will end up paying more anyway, as the ATO tries to raise more revenue to make up for the tax lost in hidden cash transactions”. 27
Perhaps, these ‘soft target’ taxpayer’s are rebelling against the fact that they shoulder the majority of the burden of the tax system by making these cash payments. The sentiment could be ‘Well, if you can’t beat em, join em and at least get some benefit from the wide cash economy’.
The comment that the ATO should concentrate on taxes and taxpayers they can catch does not have efficacy in the long term. Such a focus, whilst being simple and efficient in the short term, is inequitable and would have disastrous consequences on long term revenue collections. As explained above, revenue collections can be increased through improving taxpayer’s attitudes and deterring evasion. The suggested approach would therefore not increase revenue collections as it would have negative effects on taxpayer attitudes therefore increasing evasion. Instead the ATO needs to at least appear to be attempting to combat tax evasion in challenging areas such as the Cash Economy and Electronic Commerce. As explained by Melia, RM, compliance requires good tax administration. “Citizens must be confident that the tax laws are firmly and fairly enforced, that everyone is paying his or her fair share and that delinquents and evaders will be caught and punished”. 28
26. Above, note 12.
28. Above, note 15.