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1 , Annex 1.qxp :43 Uhr Seite 445 Annexes

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3 , Annex 1.qxp :43 Uhr Seite 447 T Annex One: Taxation Compliance and Administrative Costs: An Overview* Chris Evans** I. Introduction II. III. IV. What are operating costs? 2.1 General aspects 2.2 Administrative costs 2.3 Compliance costs The growth of operating costs research around the world 3.1 Geographical spread 3.2 Focus of the studies 3.3 Methodologies used What the research tells us 4.1 Overview 4.2 Compliance costs are high and significant 4.3 Compliance costs are regressive 4.4 Compliance costs are not reducing over time V. The causes of high compliance costs 5.1 Overview 5.2 The burden created by change 5.3 The burden created by complexity VI. What can be done? 6.1 Overview 6.2 Tax policy responses * This chapter draws upon the author s previous writing in this area, and in particular upon Taxing Personal Capital Gains: Operating Cost Implications, 2003, Australian Tax Research Foundation, Sydney; and Studying the Studies: An Overview of Recent Research into Taxation Operating Costs, e-journal of Tax Research 2003, Vol 1 No 1, 64 et seq. ** Professor of Taxation in the Australian School of Taxation, Faculty of Law, University of New South Wales, Australia, and International Research Fellow, Centre for Business Taxation, Oxford Universty, UK. 447

4 , Annex 1.qxp :43 Uhr Seite 448 Chris Evans The equity-simplicity trade-off The administrative costs-compliance costs trade-off Less frequent change and more consultative change 6.3 Tax administrative responses VII. Final comments 448

5 , Annex 1.qxp :43 Uhr Seite 449 T Annex One: Taxation Compliance and Administrative Costs I. Introduction Modern taxation systems have the capacity to impose a heavy burden on taxpayers, and particularly on small business taxpayers. That burden typically consists of three elements. In the first place there are the taxes themselves, whether they are taxes on the profits, the products or the employees. Secondly, there are the efficiency costs (variously referred to as deadweight losses or excess burden), involving tax-induced market distortions. And finally there are the operating costs of the tax system: the costs to the government (ultimately borne by taxpayers) of administering and collecting the taxes (usually referred to as administrative costs ), and the costs expended by taxpayers in complying (or sometimes not complying) with their tax obligations (usually referred to as compliance costs ). The first two of these costs the tax itself and the efficiency costs are well recognized in the economic literature, and have been the subject of extensive debate and research over the years. But, until relatively recent times, there has been far less written about the operating costs of tax systems. This is a little surprising when one considers that much of the focus of Adam Smith s four canons of taxation expounded in the Wealth of Nations (1776) was on the need to minimize the operating costs involved in raising tax revenues. It is interesting to note that of Smith s four canons of taxation, usually summarized as equity, certainty, convenience and economy, two were wholly concerned with tax compliance costs and one partly so. But after many years of relative neglect so much so that Sandford (1973) was able to refer, in the 1970s, to compliance costs as the hidden costs of taxation the topic of the operating costs of taxation has been an area of taxation research that has flourished. There have been more than 100 published studies into either compliance costs or administrative costs (or sometimes both) since Haig s first tentative modern study (1935) in the United States; and more than 60 of those have occurred since Studies have now occurred in most developed and many transitional and developing countries, have utilized most of the research methodologies that are available and have encompassed the full range of taxes and tax issues. This chapter considers key aspects of that literature. It starts (in Section 2) by explaining what is usually meant by the term operating costs and discussing some of the conceptual issues that arise. It then reviews (in Section 3) the research that has taken place on this topic, including recent European Union research, and identifies (in Section 4) the key outcomes of that research. The following part (Section 5) explores some of the principal reasons for the high and regressive 1 See Appendix A to Studying the Studies: An Overview of Recent Research into Taxation Operating Costs, n.1 above. 449

6 , Annex 1.qxp :43 Uhr Seite 450 Chris Evans compliance costs that research has shown have been a feature of modern tax systems, and the final section begins to suggest some of the means through which the operating costs of the tax system can be addressed and, hopefully, reduced. II. What are operating costs? 2.1 General aspects At first blush, it may appear to be relatively simple to identify both administrative costs and compliance costs relating to taxation. The former set of costs might be thought of as those costs borne by the public sector, and which would not have been incurred if the tax did not exist (or, alternatively stated, would disappear if the tax were to be abolished) (Sandford, Godwin and Hardwick, 1989, p. 3). By way of contrast, compliance costs are private sector costs, and again, simply stated, they comprise the costs to taxpayers and third parties in meeting the requirements laid upon them in complying with a given structure and level of tax (Sandford, Godwin and Hardwick, 1989, p. 10). But first impressions can be misleading, and the literature reveals that there is some degree of uncertainty about the precise definitions of these terms, and the manner in which they are expressed for comparative purposes. As Sandford, Godwin and Hardwick note complexities and inter-relationships make it difficult if not impossible to define the various costs with absolute precision or in a neat, mutually exclusive way (1989, p. 3). 2.2 Administrative costs Allers (1994, p. 19) defines administrative costs as costs incurred by (mainly) public sector agents in order to administer the tax-benefit system. He then goes on to note that it is not immediately obvious, exactly, which activities should be attributed to the operation of the system (p. 19). For example, should the costs of the legislation itself, or the costs of legal disputes, be included within the measure of administrative costs? And how are the costs of some very other obvious elements (such as the depreciation of buildings and other physical infrastructure) to be measured? Administrative costs clearly include the costs of running and maintaining revenue agencies, including salaries of staff, pensions relating to those staff, together with accommodation and office expenses for revenue department staff. Less obviously, administrative costs can also include the costs of legislative enactment relating to the tax system, from initial policy formulation through to statutory or other rule enactment. They can also include the judicial costs of administration of the tax dispute system, which may involve local and national tribunals and at the extreme the courts themselves. Also, accounting practices may differ. For example, whether capital costs such as the installation of computers are included in a single 450

7 , Annex 1.qxp :43 Uhr Seite 451 T Annex One: Taxation Compliance and Administrative Costs year s costings or spread over their expected effective life; and whether the annual value of buildings owned by the government is included at all, at a nominal figure, or at an opportunity cost for accounting purposes. Typically, it has been common practice in the literature to restrict administrative costs to the costs that relate to the running of the revenue departments, but there is no inherent reason (other than simplicity of measurement and availability of relevant statistics) why this should be the case. Certainly, there are strong grounds for including legislative and juridical costs in calculations of administrative costs where they are available and where they clearly relate to the governmental costs of administering the tax system. And ultimately, the decision as to what to include or exclude from administrative costs is largely dependent on the availability of data, usually from governmental sources. 2.3 Compliance costs There is also uncertainty about what should be included in the measurement of tax compliance costs. Tax compliance costs are those costs incurred by taxpayers, or third parties such as businesses, in meeting the requirements laid upon them in complying with a given structure and level of tax (Sandford, Godwin and Hardwick, 1989, p. 10). Whilst this is an area in which there will always be debate, it is possible to identify a hard core of costs that are indisputably part of the costs of complying with tax requirements. Typically these will include: the costs of labour/time consumed in completion of tax activities. For example, the time taken by a business person to acquire appropriate knowledge to deal with tax obligations such as Pay As You Earn ( PAYE ) or VAT; or the time taken in compiling receipts and recording data in order to be able to complete a tax return; the costs of expertise purchased to assist with completion of tax activities (typically, the fees paid to professional tax advisers); and incidental expenses incurred in completion of tax activities, including computer software, postage, travel, etc. In addition to this generally accepted hard core of compliance costs, there are a number of other costs that need to be considered. For example, there is little doubt that there will always be a measure of psychological cost that is induced by the operation of the tax system. Taxpayers suffer stress, anxiety and frustration as a result of attempting to comply with their tax obligations. Unfortunately, no studies have yet managed to successfully quantify these psychological costs, although research in this area is now taking place. Research being undertaken in Australia by Woellner, Coleman, McKerchar, Walpole and Zetler (2001, pp ) uses a combination of approaches to quantify the psychological costs of the tax system, including adaptation of health studies work and analysis of legal pain and suffering compensation cases. 451

8 , Annex 1.qxp :43 Uhr Seite 452 Chris Evans As well as psychological costs, there may be other social costs that are difficult to quantify (and which therefore tend to be ignored in the literature). An example of such social costs which are often on the borderline of efficiency costs is where a tax change, such as the introduction of a higher rate of VAT on a particular range of goods, causes a trader to cease to stock those goods (in order to keep tax affairs simple), thereby inconveniencing customers who have to travel further to continue to buy those goods and possibly having to pay more because of the reduction in competition. There is also contention over other aspects of the precise boundaries of compliance costs. For example, compliance costs are sometimes divided into computational (unavoidable or involuntary) and tax planning (avoidable or voluntary) costs. This distinction, first made by Johnston (1963), has caused a controversy that has not yet been (and possibly will never be) fully resolved in the tax compliance literature. Many tax lawyers and policy-makers continue to insist that only computational costs constitute legitimate measures of tax compliance costs, and attempts have been made to disentangle the two (Pope, Fayle and Chen, 1991). However most modern major studies (for example, Sandford, 1973; Sandford, Godwin and Hardwick, 1989; Allers, 1994; Evans, Ritchie Tran-Nam and Walpole, 1997) have not distinguished computational and tax planning costs in their estimates of compliance costs if only for the obvious reason that it is often almost impossible to disentangle the one from the other. Moreover, as noted by Slemrod and Sorum, both kinds of costs are real resource costs of collecting the taxes (1984, p. 461). Similar problems of disentanglement account for the inclusion of both commencement (or once-only) and recurrent (or regular) costs in most estimates of compliance costs. Commencement costs may arise as a result of both legislative change and changes in the taxpayer population. Recent studies have attempted to distinguish the two (Evans, Tran-Nam and Jordan, 2002; Rametse and Pope, 2002), but there are, as yet, no reliable studies which focus entirely on the commencement costs of a major tax (Evans, Pope and Hasseldine, 2001, p. 414). Generally studies tend to note the distinction (for example, Allers, 1994, p. 32), recognize that the frequency of legislative and population change makes disentanglement difficult if not impossible, and integrate the two in the measurement of compliance costs. There is also another problem of disentanglement. Despite careful attempts in most modern studies to quarantine tax compliance costs from the underlying costs of being in business referred to by Sandford, (1995, p. 395) as core accounting costs there is almost certainly some overlap between business or accounting costs and tax compliance costs what Allers refers to as joint cost problems (1994, p. 31). Plamondon (1993, p. 26) argues that using trained interviewers/ accountants (with an awareness of core accounting functions and costs) to conduct face-to-face interviews with their selected clients enabled the participants to distinguish incremental compliance costs from core accounting functions. The fact 452

9 , Annex 1.qxp :43 Uhr Seite 453 T Annex One: Taxation Compliance and Administrative Costs that the results from Plamondon s study into the GST compliance costs of small businesses in Canada were significantly lower than virtually all other estimates in Canada and overseas is not conclusive one way or the other. The important point is that there is uncertainty about the extent of overlap and therefore most estimates of taxation compliance costs can only be indicative at best. Another major conceptual issue that has proved to be very important in the literature is the distinction between what have variously been termed total, gross or social compliance costs and net or taxpayer compliance costs (Allers, 1994; Evans, Ritchie, Tran-Nam and Walpole, 1997). The former represents the costs to the economy (and is a figure likely to be of greater interest to Treasury and economists). The latter can be taken as the costs directly borne by taxpayers (and is therefore the figure which is likely to be of greatest interest to the business or other taxpayer lobbies and to revenue departments). The difference between social compliance costs and taxpayer compliance costs is primarily accounted for by two factors. In the first place there are various offsetting benefits that are generated for taxpayers as a result of compliance with their tax obligations. These include, fairly obviously, certain cash flow benefits that may arise as a result of the timing difference between receipt of funds and payment of tax relating to those funds. Most modern empirical studies quantify the value of these benefits with some certainty. Less obviously, managerial benefits may also occur as a result of tax compliance. For example, better accounts and record keeping may lead to improved business decision-making and reduce the costs of audit for small businesses, resulting in lower accounting fees. These managerial benefits are less easy to quantify than cash-flow benefits, and most major empirical studies have omitted them. Two major studies in the UK that did attempt, somewhat imprecisely, to quantify the managerial benefits generated for business taxpayers, concluded that the value of these managerial benefits can be quite significant (Sandford, Godwin, Hardwick and Butterworth, 1981, p. 96; National Audit Office, 1994, pp ). More recent work is being undertaken in this area by Lignier (2006). The second factor that causes social compliance costs to differ from taxpayer compliance costs is the availability of a tax deduction for many of the compliance costs incurred by business taxpayers. This, as is the case with cash-flow benefits, has the effect of transferring the cost from the taxpayer to society by reducing the flow of tax revenues. The tax deductibility of business taxpayer compliance costs has been taken into account in some of the major studies into compliance costs that have occurred in the last 50 years, but, more often than not, has not featured in the studies. The three major studies that appear to have factored in a value for the tax deductibility of certain compliance costs are those conducted by Johnston (1963), Allers (1994), and Evans, Ritchie, Tran-Nam and Walpole (1997). 453

10 , Annex 1.qxp :43 Uhr Seite 454 Chris Evans III. The growth of operating costs research around the world 3.1 Geographical spread Studies into compliance costs, and/or administrative costs, have now occurred in most parts of the world. Tran-Nam and Evans have noted (2002, p. 393) that the early quantitative studies of tax compliance costs in the 1930s to 1960s took place in North America. Those early studies were undertaken by researchers from diverse academic backgrounds, including management science, business studies, accounting and economics. North American studies into operating costs have not been quite so prolific in the last 25 years compared to those earlier time periods, but there have still been a number of major studies in both the USA and Canada in more recent years (for example, Vaillancourt, 1989; Blumenthal and Slemrod 1992), and evidence that interest is being re-ignited (for example, Slemrod and Venkatesh, 2002; Stavrianos and Greenland, 2002). Some compliance costs studies took place in Europe at about the same time as the early North American wave, but they tended to be small scale and low key. This has been a region, however, where a great deal of large-scale activity has taken place in the last 30 or so years, particularly in the UK following the publication of Sandford s seminal text in 1973 (for example, Sandford, Godwin and Hardwick, 1989; Collard, Green, Godwin and Maskell, 1998; Hasseldine and Hansford, 2002). Other major European studies have taken place in the Netherlands (Allers, 1994), Spain (Diaz and Delgado, 1995), and a sprinkling of other European countries (including Germany, France, Ireland and Sweden). Before 1990 there were no published operating cost studies in Australasia or Southeast Asia. Since then, the floodgates have opened, with published studies in Australia (Pope, Fayle and Duncanson, 1990; Pope, Fayle and Chen, 1991; Pope, 1992; Pope, Fayle and Chen 1993a, 1993b, 1994; Wallschutzky and Gibson, 1993; Evans, Ritchie, Tran-Nam and Walpole, 1996, 1997; Rametse and Pope, 2002; Tran-Nam and Glover, 2002), New Zealand (Sandford and Hasseldine, 1992; Prebble, 1995), Singapore (Ariff, Loh and Talib, 1995; Ariff, Ismail and Loh, 1997), Malaysia (Loh, Ismail, Shamsher and Ali, 1997) and Hong Kong (Chan, Cheung, Ariff and Loh, 1999). Finally, there is a small but growing list of studies from countries as diverse as Tanzania (Shekidele, 1999), Brazil (Bertolucci, 2002) and India (Chattopadhyay and Das-Gupta, 2002), as well as evidence of interest from supra-national bodies such as the OECD (Cordova-Novion and De Young, 2001) and the European Commission (2004) in the production of comparative and cross-country compliance costs studies. 3.2 Focus of the studies It is a difficult task to summarize on any systematic basis the taxes that have been the subject of research in the various studies that have been undertaken in recent 454

11 , Annex 1.qxp :43 Uhr Seite 455 T Annex One: Taxation Compliance and Administrative Costs years, as many of the studies were not focused upon one particular tax, but embraced a variety of taxes or tax-related matters. For example, the study of employerrelated taxes in Australia by Pope, Fayle and Chen (1993a) covered specific taxes such as Fringe Benefits Tax (FBT) and payroll taxes, as well as tax collection or reporting mechanisms such as PAYE and the Prescribed Payment System (PPS). Roughly a dozen of the studies in the past 25 years have focused solely on Personal Income Taxes (PIT), and about the same number have considered just Corporate Income Taxes (CIT). Eight other studies (for example, Evans, Ritchie, Tran-Nam and Walpole, 1997) considered all federal taxes, whether business or personal. Indirect taxes are also well represented in recent studies, with seven Value Added Tax/Goods and Services Tax (VAT/GST) and four sales tax and excise duty studies identified. The balance of the studies are spread across a range of tax and tax-related areas, including tax expenditures (Gunz, Macnaughton and Wensley, 1995), Petroleum Revenue Tax (Sandford, Godwin and Hardwick, 1989) and road tolls (Friedman and Waldfogel, 1995). Just as the types of taxes that have been the subject of study over the last 25 years is diffuse, so is the nature of the taxpayer. As in previous periods (see Tran-Nam and Evans, 2002, p. 393), there has inevitably been a greater emphasis on business taxes and taxpayers. But despite this emphasis, very few types of taxpayer have escaped scrutiny over this period. Taxpayers not in business (employees, the retired) have been included in many of the studies (Slemrod and Sorum, 1984; Allers, 1994; Evans, Ritchie, Tran-Nam and Walpole, 1997; Chattopadhyay and Das-Gupta, 2002), but usually only as part of a broader survey. They rarely feature as the central part of the study (though see Stavrianos and Greenland, 2002, which focused entirely on individuals with wage and investment income). In contrast, employers have been the sole or primary focus of the research in at least six studies (Leonard and O Hagan, 1985; Sandford, Godwin and Hardwick, 1989; Vaillancourt, 1989; Pope, Fayle and Chen, 1993; Plamondon, 1997; Collard, Green, Godwin and Maskell, 1998). Where the research has been into the operating costs of business taxpayers, studies are more or less equally split between those that have specifically targeted small businesses and those that have specifically targeted the large corporate sector. Most studies into business operating costs are not specific to any one sector, however, but embrace all business segments, large and small. The vast majority of the studies look at the costs incurred by taxpayers. In contrast, very few studies (for example, Green, 1994; Evans 2003b) consider the perspective of the practitioner, even though practitioner costs have always been a very significant component of the compliance costs incurred by business and non-business taxpayers. It is also slightly surprising how few truly international comparative studies have taken place over the last 20 years. Some of the national studies contain com- 455

12 , Annex 1.qxp :43 Uhr Seite 456 Chris Evans parative sections where the outcomes for one country are compared with those in others (for example, Evans, Ritchie, Tran-Nam and Walpole, 1997, pp ). But the dangers of international comparisons are well known to most researchers. Sandford (1995, pp ) identifies a number of reasons why such comparisons are more likely to mislead than enlighten, and, in an earlier piece (1994) the same author offered the advice that comparisons of operating costs should be used sparingly, with the greatest care and with a comprehensive statement of their limitations. One relatively early study and three more recent studies have countered the trend for studies to be national rather than international. Bannock and Albach (1989) compared VAT compliance costs in Germany and the UK. More recently, Cordova-Novion and De Young (2001) undertook a multi-country survey of business tax compliance costs in eleven different countries for the OECD, Evans (2003a) has completed a comparative study of the operating costs of taxing personal capital gains in Australia and the UK, and the European Commission (2004) surveyed corporate compliance costs in 14 Member States. In summary, studies in the last 20 years have considered most of the different types of tax and most of the different types of taxpayer. The level of coverage has varied some taxes and taxpayer types have received very comprehensive coverage while others have been relatively under-researched. The analysis now turns to the manner in which that research has been conducted. 3.3 Methodologies used Research literature has typically categorized the study of human and social phenomena by reference to two broad camps the quantitative (or traditional, positivist, empiricist) and the qualitative (also referred to as the constructivist, naturalistic, interpretive, post-positivist or post-modern). The quantitative paradigm is the more traditional approach to research and typically adopts a deductive approach. In contrast, the qualitative approach relies upon an inductive logic. Theories develop through the study rather than being established at the outset, and the methodology is also likely to emerge as part of the process of research rather than being predetermined. Studies into tax operating costs borrow from both traditions, though there is a far greater emphasis on quantitative techniques. The studies use a variety of specific research methodologies to research into aspects of compliance costs. These include surveys (invariably using questionnaires) conducted through commercial polling organizations (Allers, 1994), or by mail (Green, 1994), (Bertolucci, 2002) and telephone (Yellow Pages, 1996, CPA Australia, 2003), other interview-based methodologies (Plamondon, 1993; 1997), diary and case study approaches (Wallschutzky and Gibson, 1993), and documentary analysis (Arthur Andersen & Co, 1985) and estimating/simulating techniques (Thompson, 1984). Often the studies employ a combination of these approaches (Collard, Green, Godwin and Maskell, 1998). 456

13 , Annex 1.qxp :43 Uhr Seite 457 T Annex One: Taxation Compliance and Administrative Costs Postal surveys feature prominently, with nearly two thirds of the studies using this methodology wholly or in part. Roughly one quarter of the studies used interviewing techniques, usually on a face-to-face basis and with a structured survey instrument or script built into the process. The labour-intensive diary and case study approaches tend to be the least used methodology. There have been some recent developments in the use of estimation/simulation modeling techniques, with the UK revenue authority adopting the Standard Cost Model (SCM), previously used by governments in Denmark and the Netherlands, in order to identify and measure the tax regulatory burden on business. Working with KPMG, Her Majesty s Revenue and Customs has built a model, utilizing activity-based accounting, that maps UK legislation to the activities that business actually has to do to be compliant with the requirements of the tax system (KPMG, 2006, p. 4). The SCM also known as the Dutch model applies a base formula (Activity Cost = Price (tariff time) Quantity (population frequency rate)) to measure the burden of UK tax regulation. The resulting estimate of costs is only a partial measure of full compliance costs (for example, it does not seek to measure voluntary compliance costs and a host of other costs) but nonetheless may provide a further useful methodology for benchmarking purposes. Administrative costs have primarily tended to be identified through analysis of relevant documentary evidence. Surprisingly, there is very little evidence that researchers have considered other possible methodologies, such as structured or in-depth interviews or case studies, in attempts to assess administrative costs. IV. What the research tells us 4.1 Overview Three major themes emerge from the literature that has flourished in recent years: compliance costs are high and they are significant; compliance costs are regressive; and compliance costs are not reducing over time. Each of these themes is explored in more detail below. 4.2 Compliance costs are high and significant Compliance costs are highly significant for the main central government taxes such as PIT, CIT, VAT/GST. They are high however measured whether in absolute money terms or relative to tax yield, GDP or administrative costs. For example, the studies suggest that compliance costs of such taxes are typically anywhere between two percent and ten percent of the revenue yield from those taxes; up to 2.5% of GDP; and usually a multiple (of between two and six) of administrative costs. In contrast, compliance costs for property taxes are low in absolute and relative terms, as are compliance costs of some excise duties in developed countries (for example, tobacco and petrol) where the sales are high and the number of business- 457

14 , Annex 1.qxp :43 Uhr Seite 458 Chris Evans es involved are low. Compliance costs for excise duties in developing countries appear to be significantly higher than those in developed countries, though the evidence is somewhat thin at the moment (Shekidele, 1999). The studies also suggests that administrative costs are absolutely and relatively less burdensome than compliance costs. Those studies that do address administrative costs suggest that they rarely exceed one percent of revenue yield, and more usually come in well below one percent. 4.3 Compliance costs are regressive The research also points strongly to the regressivity of compliance costs of such taxes, particularly where VAT-type taxes are involved. The size of the business is a key factor in determining compliance costs, and most of the studies confirm that smaller businesses carry disproportionately higher compliance costs. For example, in Australia it was established that the compliance costs per dollar of turnover in for the very smallest firms (those with an annual turnover of up to $100,000) were 25 times greater than the compliance costs for their medium-sized counterparts (those with annual turnovers between $100,000 and $10 million). There are two major reasons for this regressivity. In the first place, there are large diseconomies of scale involved in complying with tax requirements, and small firms have to carry the high fixed costs of compliance regardless of the fact that the particular activity or transaction that gives rise to the compliance costs may only occur once or infrequently. Associated with this, there is a learning curve effect that militates strongly against small firms they may have to commit resources to identify the tax implications of a one-off transaction, compared to a larger business which may be able to amortize that learning cost against a large number of similar transactions. Research undertaken by the European Commission (2004) confirms both the significance and the regressivity of compliance costs in the corporate sector. Seven hundred companies across 14 Member States of the European Union responded to the survey, which showed that compliance costs for the large companies (those employing 250 or more employees) averaged 1.5 million, which represented 2% of the taxes paid and 0.02% of sales. By way of contrast, small and medium-sized enterprises (those with less than 250 employees) incurred compliance costs, on average, of 200,000, which represented 31% of the taxes paid and 2.6% of sales. The same study identified that cross-border activity (for example, establishing a subsidiary in another Member State) was likely to lead to higher absolute and relative compliance costs, as were transfer pricing issues, and repayments and refunds in the VAT area. 4.4 Compliance costs are not reducing over time The evidence from the studies also points to the fact that compliance costs are perceived to be an on-going cause for concern. The problem is not perceived as im- 458

15 , Annex 1.qxp :43 Uhr Seite 459 T Annex One: Taxation Compliance and Administrative Costs proving over time (Blumenthal and Slemrod, 1992; Evans, 2003a), despite attempts by governments (ostensibly) designed to reduce the burden faced by taxpayers. A US study undertaken by Crain and Hopkins (2001) identified that regulatory costs (environmental, economic, workplace and tax) for all businesses decreased by 15% in the period from 1992 to 2000, but that the tax element of such regulatory costs increased by 25% in that same period. Similar conclusions have been reached in other national and international studies (European Commission, 2004). V. The causes of high compliance costs 5.1 Overview Some of the factors that may help to determine the level and incidence of compliance costs have already been mentioned. Clearly, the size of the business is one such factor, and the type of tax (for example, direct versus indirect, personal versus corporate) as well as the particular nature of the taxpayer (business versus nonbusiness) will also have a significant bearing on compliance costs. Other research has identified the importance of such factors as the manner in which the business is transacted (i.e. the legal form of the business), the industry or sector in which the business operates, and a host of related variables, as further critical determinants of the compliance burden. But two particular factors stand out as major, over-riding determinants of compliance costs: change and complexity. 5.2 The burden created by change As noted in the KPMG report (2006, p.6) change creates both cost and uncertainty. Frequent change in legislation, or the introduction of new legislation, can significantly impact upon the compliance burden, and it does not matter whether that change is as a result of the introduction of a relieving provision or the introduction of an integrity measure designed to protect the revenue base. In this sense, an old tax is a good tax. The notion is that change interferes with the smooth operation of the tax administrative machinery that facilitates the interactions that necessarily occur between taxpayer and revenue authority, which takes time to settle down to cope with change. Research by Evans (2003a), which considered the major drivers of the compliance costs of the capital gains tax for personal taxpayers in Australia and the UK, confirmed that frequency of change was considered to be one of the two most significant of the causes of the compliance burden the other being complexity. 5.3 The burden created by complexity Complexity is clearly a major determinant of the compliance burden. But it is important to recognize that there may be different forms of complexity at work. 459

16 , Annex 1.qxp :43 Uhr Seite 460 Chris Evans McCaffery (1990, pp ) identifies three types, or layers, of complexity. There is technical complexity which relates to the level of understanding or comprehensibility of a particular legislative provision in isolation. Often, this technical complexity is a product of the policy considerations underlying the particular provision. There is also structural complexity (sometimes referred to as transactional complexity), which relates to the way in which laws are interpreted and applied, and which can affect the certainty and manipulability of legislative provisions. And finally there is compliance complexity, which relates to the variety of record-keeping and form-completing tasks a taxpayer must perform to comply with the tax laws. This final layer of complexity is neatly described in the KPMG report (2006, p. 6) as grit in the system the way that the taxpayer interacts with the revenue authority at the operational, day-to-day, level. VI. What can be done? 6.1 Overview Researchers in the field of tax compliance and administrative costs have clearly made significant progress in identifying and measuring the operating cost burden imposed by the tax system, and in establishing the principal drivers or causes of those costs. Inevitably, they have also considered very carefully what action governments and regulators can take in order to seek to minimize that burden. While it is clear that there is no single silver bullet that can act as the panacea, a number of obvious and less obvious proposals and measures emerge from the literature. Often these involve suggestions which fall into one of two camps; tax policy responses and tax administration responses. That divide is adopted for convenience in the following analysis, although it is readily admitted that the split is entirely arbitrary. Tax policy and tax administration are inextricably linked. Tax policy (incorporating tax law design) is very clearly inter-connected with the tax administrative processes needed to implement the policy. Sensible tax law design must therefore always be informed by an understanding of the impact that such design will have on the burden that taxpayers will face and the administrative costs that the revenue authority will be required to carry. 6.2 Tax policy responses The equity-simplicity trade-off Taxpayer compliance costs are often, ironically, the product of tax policy and tax law designed to offer taxpayers choice. Choice can help to reduce the burden of tax and provide a more equitable tax system than would otherwise be the case; but such equitable outcomes often come at the price of a higher compliance burden. The employee in Australia, given the choice of calculating the amount of work- 460

17 , Annex 1.qxp :43 Uhr Seite 461 T Annex One: Taxation Compliance and Administrative Costs related travel costs she or he can deduct for tax purposes on the basis of four different methods, will almost certainly incur high compliance costs (in computing the outcome under all four methods) in order to reduce the tax bill by a few cents by choosing the method which produces the best tax outcome of the four. It is not entirely rational behaviour but it is understandable. It sometimes behooves those who devise policy and design tax laws to consider the trade-off between equity and simplicity. There are occasions and situations where we may not have the balance right, and where we might obtain better outcomes by reducing the amount of choice and by electing for a greater degree of simplicity rather than seeking the ultimate level of equity. Sometimes, a rough and ready outcome that may not be entirely fair but which is reasonably simple may be the better outcome The administrative costs-compliance costs trade-off Compliance costs and administrative costs together represent the operating costs of the tax system, and their relationship with each other is an important aspect of the overall picture. Often compliance costs and administrative costs move in the same direction. For example, a simplification of the tax system is likely to reduce both sets of costs. In similar vein, if a tax system is being inefficiently administered (with consequent high administrative costs) the inefficiency is also likely to translate to high compliance costs for taxpayers as they struggle to deal with the consequences of the poor tax administration. Moreover, taxes with high compliance costs (such as VAT and CGT) are often taxes that also have high administrative costs (Sandford, 1973, 13). Note, however, that administrative costs may sometimes be inversely related to compliance costs, in that an increase in one may cause a fall in the other. For example, in a system of self-assessment, it is quite likely that the compliance cost burden on taxpayers will increase as a consequence of the reduction in administrative costs. Haig, in one of the earliest American studies on tax compliance costs, makes precisely this point when he notes that curiously enough, the taxes which involve the public fisc in the least expense appear to involve the taxpayer in the greatest expense and vice versa (Haig, 1935, pp ), citing several examples from American state and federal taxes to illustrate the point. Whether the relationship is inverse or direct is not, perhaps, so relevant, as an appreciation of the fact that the split between administrative costs and compliance costs is not fixed. Costs can be shifted from the public sector to the private sector and back (Allers, 1994, p. 41). Inevitably, the precise relationship will depend upon a host of factors, including relevant legislation, the type of tax and taxpayers involved, and other aspects of the political and economic culture Less frequent change and more consultative change If frequency of change is a major cause of tax operating costs, then careful consideration must always be given to the need for change. Legislation should only be 461

18 , Annex 1.qxp :43 Uhr Seite 462 Chris Evans introduced or changed once the case has very clearly been made and after the operational cost implications have been carefully considered. Operational cost implications are only one part of the cost-benefit analysis but they are an important part. Moreover, if tax change is needed, it is imperative that as much consultation with affected parties as is possible and practical should be undertaken. Taxpayers, representatives from tax professional bodies, and tax practitioners as well as tax administrators all have a very real knowledge of the temporary and recurrent compliance and administrative costs that are likely to occur as a result of change, and can help to ensure that tax change is introduced in a manner that minimizes the expected burden. Failure to consult, as the UK s 2006 proposals on the bringing forward of dates for filing of annual returns has shown, can be disastrous. In that case some seemingly sensible recommendations by Lord Carter, made without any meaningful input from affected parties, had to be withdrawn when it became obvious that they were not capable of sensible implementation and would not be happily accepted by tax practitioners because of the compliance cost implications. Earlier and more appropriate consultation would have averted an otherwise embarrassing situation. 6.3 Tax administrative responses In recent years there has been an increased social awareness of the potential intrusiveness of modern governments and a greater sensitivity on the part of governments to the burdens that regulations of all sorts impose. There is a world trend towards regulatory reform, whether this comprises deregulation or better regulation, and this has impacted on the evaluation of tax laws as well as other areas of government. There has thus been a far greater emphasis upon understanding, measuring, monitoring and evaluating the impact of the burden of compliance with the tax system or aspects of it. Many countries now have formalized systems and processes whereby the operational costs of the tax system, and of changes to it, are monitored. Research conducted by Evans and Walpole (1999) showed that in 1998 five out of 25 OECD members (Australia, the European Union, New Zealand, the UK and the USA) made extensive use of taxation impact statements (or their equivalents) in formulating and implementing tax changes, whilst nine further countries made partial use of them. In those countries that did make extensive use of taxation impact statements, the research showed that there were certain common features. The taxation impact statements tended to be mandatory, quantitative and prepared by a central administrative authority (usually the revenue department itself) using established guidelines. Preparation of the impact statement generally took place at the initial proposal stage, involved some external consultation, and was designed primarily for consideration by policy-makers and legislators. 462

19 , Annex 1.qxp :43 Uhr Seite 463 T Annex One: Taxation Compliance and Administrative Costs In addition to such formalized responses, some countries have also fully embraced the importance of considering compliance cost implications when tax changes are contemplated. New Zealand, for example, has a well-established and on-going compliance costs benchmarking and analysis project, and often chooses to focus on compliance costs hot-spots as part of its generic tax policy process. Other administrations engage in appropriate process engineering to ensure that the obligations imposed upon taxpayers and their advisers fit as comfortably as possible with normal business or taxpayer activity. In addition, there is an increasing focus upon enhanced taxpayer education and revenue authority-generated products, as well as simplified lodgment and tax payment options (including prepopulation techniques) (Evans and Drum, 2006) designed to minimize operating costs. In these and related ways, the grit in the system can be reduced. VII. Final comments In 1973 Sandford was able to refer to tax compliance costs as the hidden costs of taxation. Since then, an extensive literature has developed in the area, and the major research that has taken place has cast considerable light on those hidden costs, and upon the administrative costs that revenue authorities also incur. But whilst that research has been extensive and has identified many important considerations, the task of governments and revenue authorities in tackling the operating costs of the tax system has now only just begun. A lot more yet needs to be done. Pope identified a number of possible stages in the awareness of compliance costs (Pope, 1992, pp. 2 7). These ranged from initial neglect, through recognition by professionals (tax advisers etc.), quantification (usually by academics), policy recognition, effective policy measures resulting in lower compliance costs, and finally to continual monitoring of compliance costs. Many countries have clearly passed through the first four of these stages, and there is even some lip-service paid to the need to take operating costs into account when policy is formulated. But there is still a long way to go before most countries can truly claim that their tax laws are designed with a clear focus on the implications that design will have on the operating costs of the tax system 463

20 , Annex 1.qxp :43 Uhr Seite 464 Chris Evans References Allers, M. (1994), Administrative and Compliance Costs of Taxation and Public Transfers in the Netherlands, Groningen: Wolters-Noordhoff. Ariff, M. Loh, A. and Talib, A. (1995), Compliance Costs of Corporate Income Tax in Singapore, 1994, Accounting Research Journal, Vol. 8, No. 2, pp Ariff, M. Ismail, Z. and Loh, A. (1997), Compliance Costs of Corporate Income Tax in Singapore, Journal of Business Finance & Accounting, Vol. 24, Nos. 9 & 10, (October and December), pp Arthur Andersen & Co, (1985), The Administrative and Compliance Costs of the Federal Sales Tax System with a Brief Comparison to the Retail Sales Tax System of Ontario, Ottawa: Department of Finance. Bannock, G. and Albach, H. (1989), The Compliance Costs of VAT for Smaller Firms in Britain and West Germany, in Bannock, G. and Peacock, A. Governments and Small Business, London: Paul Chapman, pp Bertolucci, A. (2002), The Compliance Costs of Taxation in Brazil: A Survey of Costs in Brazilian Public Companies, Faculdade de Economia, Administracao E Contabilidade, University of Sao Paulo, unpublished paper. Blumenthal, M. and Slemrod, J. (1992), The Compliance Costs of the US Individual Income Tax System: A Second Look after Tax Reform, National Tax Journal, June. Chan, S. Cheung, D. Ariff, M. and Loh, A. (1999), Compliance Costs of Corporate Taxation in Hong Kong, International Tax Journal, Vol. 25, No.4, pp Chattopadhyay, S. and Das-Gupta A. (2002), The Compliance Costs of the Personal Income Tax and its Determinants, New Delhi: National Institute of Public Finance and Policy. Collard, D. Green, S. Godwin, M. and Maskell, L. (1998), The Tax Compliance Costs for Employers of PAYE and National Insurance in , Inland Revenue Economics papers, No. 3, London: Inland Revenue. Cordova-Novion, C. and De Young, C. (2001), The OECD / Public Management Service Multi-Country Business Survey Benchmarking Regulatory and Administrative Business Environments in Small and Medium Sized Enterprises, in Evans, C. Pope, J. and Hasseldine, J. (eds.), Tax Compliance Costs: A Festschrift for Cedric Sandford, Sydney: Prospect. CPA Australia, (2003), Small Business Survey Program: Compliance Burden, Melbourne: CPA Australia. 464

21 , Annex 1.qxp :43 Uhr Seite 465 T Annex One: Taxation Compliance and Administrative Costs Crain, W. and Hopkins, T. (2001), The Impact of Regulatory Costs on Small Firms, The Office of Advocacy, US Small Business Administration, Washington, DC. Diaz, C. and Delgado, M. (1995), The Compliance Costs of Personal Income Tax in Spain, in Sandford, C. (ed.), Taxation Compliance Costs Measurement and Policy, Bath: Fiscal Publications. European Commission, 2004, Taxation Papers: European Tax Survey, Working Paper 3/2004, Directorate-General Taxation and Customs Union, Luxembourg. Evans, C. (2003a), Taxing Personal Capital Gains: Operating Cost Implications, Australian Tax Research Foundation, Sydney. Evans, C. (2003b), Studying the Studies: An Overview of Recent Research into Taxation Operating Costs, e-journal of Tax Research, Vol 1 No 1, pp Evans, C. and Drum, P. (2006), Ten Million Reasons for Personal Tax reform in Australia, paper presented at the Atax Seventh International Tax Administration Conference, Sydney (April). Evans, C. Pope, J. and Hasseldine, J. (eds.), (2001), Tax Compliance Costs: A Festschrift for Cedric Sandford, Sydney: Prospect. Evans, C. Ritchie, K. Tran-Nam, B. and Walpole, M. (1996), A Report into the Incremental Costs of Taxpayer Compliance, Canberra: Australian Government Publishing Service (November). Evans, C. Ritchie, K. Tran-Nam, B. and Walpole, M. (1997), A Report into Taxpayer Costs of Compliance, Canberra: Commonwealth of Australia (November). Evans, C. Tran-Nam, B. and Jordan, B. (2002), Assessing the Potential Compliance Costs/Benefits of the Tax Value Method, Australian Tax Forum, Vol. 17, No. 1, pp Evans, C. and Walpole, M. (1999), Compliance Cost Control: A Review of Tax Impact Statements in the OECD, Sydney: Australian Tax Research Foundation. Friedman, D. and Waldfogel, J. (1995), The Administrative and Compliance Costs of Manual Highway Collection: Evidence from Massachusetts and New Jersey, National Tax Journal, Vol. 48, No. 2, pp Green, S. (1994), Compliance Costs and Direct Taxation, London: The Institute of Chartered Accountants in England and Wales. Gunz, S. Macnaughton, A. and Wensley, K. (1995), Measuring the Compliance Costs of Tax Expenditures: The Case of Research and Development Incentives, Canadian Tax Journal, Vol. 43, No. 6, pp