I’ve been asked to review a book on tax minimisation, by ANU’s John Braithwaite. A draft of my review is over the fold. Comments and suggestions most welcome (the final version is due in a week).
John Braithwaite, 2005, Markets in Vice, Markets in Virtue. Annandale, NSW: Federation Press
Reducing income tax liability has been a preoccupation of citizens ever since personal income taxes were first introduced. More complex legislation leads to more intricate attempts to circumvent it, which in turn leads lawmakers to make the legislation yet more Byzantine. During the 1980s and 1990s, the Australian Income Tax Assessment Act quadrupled in length.
John Braithwaiteâ€™s highly readable paperback seeks to cut through the thicket. Based on interviews with tax advisers and government officials, he aims to describe the state of the â€œaggressive tax planningâ€ market, and put forward a series of proposals for law reform.
At the core of the book are interviews in Australia with 78 tax advisers and officials from the Australian Taxation Office (ATO). Braithwaite finds that tax schemes often follow a standard trajectory â€“ originating as a boutique product for a wealthy client, then applied to a few more clients, and finally mass-marketed by financial planners. Eventually, the scheme finds its way to mum and dad investors, described by one of the interviewees as â€œbunniesâ€ for their gullibility.
A great strength of the book is that Braithwaite also interviews 26 tax advisers in New York. Comparing the ingenuity of the Australian and US advisers, he concludes: â€œAustralia has its rocket scientists of tax shelter design, but in comparison to those of New York, they look like Saddam Husseinâ€™s scientists in comparison to those of the Pentagon.â€ Indeed, some US tax schemes are even marketed with insurance â€“ if a piece of advice is overturned by the Internal Revenue Service, the insurer will pay the bill. (This is apparently not yet a feature of the Australian tax advice market.)
Centring the analysis around interviews has its advantages. We learn interesting tidbits about effective enforcement strategies, such as the fact that ATO officials will often arrange to have a cup of coffee with a tax adviser whose schemes appear to be crossing the line. Surprisingly, Braithwaite finds that the tax advisers themselves regard this as an effective early-stage enforcement tool.
At certain points, however, the structure of the book seems to mirror that of an interview â€“ focused around common wisdom rather than hard data. As anyone who has written a public policy book knows, getting the right statistics can be maddeningly difficult. But as the boffins love to point out, data is not the plural of anecdote: statistics tell us whether our intuition accords with reality. In the case of the US, Braithwaite cites useful statistics on trends in audit probability for major firms, the share of accounting firmsâ€™ revenue derived from tax advice, and the number of mentions of the word â€œaccuracyâ€ in reports from corporate tax departments of major manufacturing firms. But he does not give the equivalent numbers for Australia, instead relying upon studies based on perceptions or unrepresentative samples.
There are occasions when a more standard economic analysis might have been warranted. For example, Braithwaite asks whether aggressive tax planning is â€œsupply drivenâ€ or â€œdemand drivenâ€. A textbook treatment of aggressive tax planning would instead see the equilibrium level as a function of the intersection of supply and demand. One might then consider whether an increase in aggressive tax planning was more likely to have been caused by a rightward shift in the supply curve (associated with a price fall) or a rightward shift in the demand curve (associated with a price rise).
At another point, Braithwaite claims that taxation has redistributed wealth from the poor and middle class to the very rich. No evidence is offered for this, and it is directly at odds with the work of the National Centre for Social and Economic Modelling, who reported in 2004 that the poorest fifth of Australian households paid 1.4% of their gross income in income tax, while the richest fifth paid 26%.
Yet for public policymakers, and anyone interested in how Australia might increase tax compliance, this book is a must-read. Braithwaite proposes that the ATO make more use of randomised audits to determine tax compliance. He suggests that ATO officials working on aggressive tax planning advice should be paid salaries commensurate with the private sector. And he points out that where the probability of detection is less than 1 in 2, penalties must be over 100% for it to be economically rational to comply with the tax code. Accordingly, current tax penalties of 25-50% should be raised to 200-400%.
Other proposals are more radical still. Braithwaite suggest enacting legislation that puts principles above rules, thereby reducing the scope for tax advisers to find loopholes. He suggests that restorative justice â€“ in which the perpetrator speaks publicly about the offence â€“ might be effective in addressing tax fraud in accounting firms. And he proposes issuing corporate certificates of â€œcontinuous improvement in tax integrityâ€. Reassuringly to the reader, Braithwaite is well aware of when he is pushing the envelope, and sensibly suggests that some of his own proposals might be tested in randomised trials.
Research School of Social Sciences
Australian National University