Membership Number/Username: Password: Remember me: [?] or Register

The Rise and Rise of Tax Compliance Costs

Cedric Sandford
Emeritus Professor of Political Economy
Growth of Research and Government Interest
1.1 One of the remarkable features of fiscal affairs over the past two decades has been the growth of interest - both by the academic community and by governments - in the subject of tax compliance costs.

1.2 Two decades ago the very term, 'tax compliance costs' was known, in its present accepted meaning, only to a few. Most people, on hearing the term, would have assumed that it related to the costs of securing compliance - enforcement costs - part of the costs of the revenue authorities administering the tax, rather than costs to the taxpayer. Now the accepted terminology is that tax compliance costs are the costs incurred by taxpayers in meeting the requirements laid on them by the tax law and the revenue authorities. They are costs over and above the actual payment of tax and over and above any distortion costs inherent in the nature of the tax; costs which would disappear if the tax was abolished. Thus, for individuals, they include the costs of acquiring sufficient knowledge to meet their legal obligations; the time taken in completing their personal tax returns, and obtaining, filing and storing the data to enable them to complete their returns; the fees paid to any advisers or tax agents; incidental expenses, such as travel costs to visit a tax adviser or the revenue authorities; and, more difficult to measure, psychic or psychological costs - the stress and anxiety experienced by some taxpayers in seeking to deal with their tax affairs. For businesses they include the costs of collecting, remitting and accounting for tax on the products and profits of the business and on the wages and salaries of its employees; and also the costs of acquiring and updating the knowledge to enable this work to be done, including knowledge of legal obligations and penalties. Besides the costs individuals incur in relation to their own tax returns, many incur substantial time costs in helping other family members or friends who are less able to cope.

1.3 The term 'administrative costs' can be used for the public sector costs of running the tax system - principally the costs incurred by the revenue departments, whilst 'operating costs' is a convenient term to embrace the total costs of running a tax or the tax system, i.e. administrative and compliance costs combined. (For a fuller consideration of these definitions see Sandford, Godwin and Hardwick, 1989, Chapter 1, pp.3-23).

1.4 If the terminology and more widespread interest in tax compliance costs are recent, the ideas behind tax compliance costs are not new. As Mike Eland reminds us in Chapter 3, Adam Smith, the father of Political Economy, himself for some years a Customs officer, had a lot to say about them. Indeed, of Smith's four famous canons of taxation: Equity, Certainty, Convenience and Economy, two, Certainty and Convenience, were wholly concerned with compliance costs. A third, Economy - that 'every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state' - related to both administrative and compliance costs (Smith, 1776, Book 5, Chapter 2, Part 2).

1.5 However, with the honourable exception of McCulloch in his Treatise on Taxation, first published in 1845, economists largely ignored Smith's last three canons and concentrated on giving meaning to the first principle: Equity. In more recent years mainstream economic research in public finance has concentrated on delineating and measuring the 'excess burdens' arising from the distortion of preferences by taxation, largely ignoring compliance costs.

1.6 Perhaps this neglect of tax compliance costs in the nineteenth century arose from the decline in taxation as a percentage of GDP and, in particular, the development of free trade, which reduced (to quote Smith's words) 'the frequent visits and the odious examinations of the tax gatherers'. In the twentieth century, theorising about excess burdens may have seemed more congenial than the painstaking empirical work of trying to measure compliance costs.

1.7 Be that as it may, it was not until well into the twentieth century - indeed, 1935 - that the first attempt was made to measure tax compliance cost (Haig, 1935). Such recorded studies as did take place before the 1970s were, with one or two exceptions, confined to North America and small scale, attracting little attention from the academic community or from governments. (For an account of early studies, see Sandord et al, 1989, Chapter 2 and Appendix A and Vaillancourt, 1987).

1.8 The position has changed dramatically in recent years. Included in this volume are recent compliance costs studies from eight different countries: Australia, Canada, the Netherlands, New Zealand, Spain, Sweden, the United Kingdom and the United States. In most of these countries more than one major research study has taken place in the last few years. As recorded in the International Fiscal Association's Congress cahier (1989), two substantial studies took place in Germany in the 1980s but were never translated into English. Compliance cost studies are known to be contemplated or under way in Japan, Singapore, Tunisia and India and there may well be others.

1.9 If the growth of recent research in tax compliance costs has been remarkable, no less impressive has been the response of governments. Since 1985 the government of the United Kingdom has required its officials to produce compliance cost assessments (CCAs) for all regulations affecting business, including, of course, tax regulations. Each government department has established a deregulation unit, with the deregulation unit of the Department of Trade and Industry co-ordinating, monitoring and stimulating.

1.10 The requirement of minimising tax compliance costs (subject to other objectives) has been enshrined in a Taxpayer's Charter, promulgated by Inland Revenue and Customs and Excise. Moreover, the United Kingdom has taken the lead to try to ensure that compliance costs are taken into account in the legislation of the European Union. In New Zealand the Consultative Committee on Tax Simplification ( Waugh Report, 1990) recommended that tax compliance costs evaluations be prepared for new legislation and the New Zealand government accepted the recommendation in principle (p.105). During 1994, the New Zealand Inland Revenue Department set out a Compliance Cost Reduction Strategic Plan and put in place a Compliance Cost Reduction Unit to implement it. In August 1994, the Australian Government, in response to the recommendations of a Joint Public Accounts Committee's Enquiry into the Tax Office, announced its intention to accompany all future tax legislation with Tax Impact Statements (TIS) addressing the compliance cost issues of taxpayers. The Australian government also proposed to introduce a Taxpayers' Charter of Rights. In the Netherlands, since 1985, compliance cost assessments - often qualitative rather than quantitative - have been required for changes in tax legislation and (as Maarten Allers discusses in Chapter 8) the (outgoing) Minister of Economic Affairs recently introduced the concept of a 'norm' for business tax compliance costs and promised successive reductions of this norm. The United States introduced a Taxpayers' Bill of Rights in 1988 and concern at the level of compliance costs is instanced by the request to taxpayers to indicate on their tax return how long it has taken them to complete. In the 1980s, the Internal Revenue Service commissioned Arthur D. Little to undertake two studies on the time spent by taxpayers (Little, 1988); and the 1994 Business Master Plan commits the Service to reducing the time burden of paper work from tax compliance by 7 per cent and the expense by 3 per cent by fiscal year 2001; to that end the Internal Revenue Service is commissioning (early 1995) a series of research papers.

1.11 Doubtless other examples could be given. The essential point is that, from obscurity 20 years ago, for many governments and tax administrations, tax compliance costs have become a matter of real significance and high priority in tax policy-making.

Why the Increased Interest in Tax Compliance Costs?

1.12 The obvious question to ask is 'Why, in the last decade or so, has there been this outburst of academic research and also of government interest and concern in tax compliance costs?'

1.13 The first point to make is that these two - academic research and government concern - are intimately inter-connected. They have reacted on each other and stimulated each other. Early independent research findings awakened governments to matters of concern; and governments, in their turn, co-operated with, financed and sometimes commissioned, further research.

1.14 The findings of the research, which have concerned governments, might be summarised as follows.

  • Tax compliance costs are large, taking up substantial resources and potentially offering scope for substantial savings. 'Large' is a difficult term to get a handle on. One broad indicator (though far from perfect1) is to relate compliance costs to administrative costs - the costs to the revenue authorities. All the research studies, whatever the methodology, find the compliance costs of the main central government taxes: personal income tax, corporate income tax and value-added tax, to be a multiple of the administrative costs. Large tax compliance costs may reduce international competitiveness.
  • Tax compliance costs have undesirable distributional effects. They are capricious in their incidence and, especially for businesses, regressive - i.e. falling with disproportionate severity on small firms. Moreover this regressiveness is very pronounced, as is clear from all the studies in this volume where comparisons can be made between different sizes of firm. As the regressiveness applies to every tax, its effect is cumulative. Small firms competing with large firms therefore suffer a state-created disadvantage. Additionally tax compliance costs fall much more heavily on the self employed than on employees.



1 The main disadvantage of this indicator is the scope for transferring costs between the two. To take an example: self assessment to income tax can be expected to have higher compliance costs and lower administrative costs than revenue assessment, which affects the ratios. However, all countries, whatever their system, show the characteristic of compliance costs higher than administrative costs.

  • Tax compliance costs may generate particular resentment, adversely affecting voluntary compliance. ('It is bad enough to have to pay taxes; to have to incur substantial expense for the privilege of doing so - or to have to act as an unpaid tax collector of the government - is to add insult to injury.')



1.15 These features indicate the importance of tax compliance costs both as a subject for research and for government action. But they are not new. We still need to explain why it is only in the past decade or so that they have come to such research prominence and been taken seriously by governments. The following six reasons are suggested.

1.16 Changes in technology have had a powerful influence. The computer revolution has meant that it has become increasingly easy to undertake surveys on a large scale and analyse the data. Moreover the findings from such large-scale scientifically-selected samples have much more credibility than previous studies. The computer revolution has thus both encouraged research in the field and led governments to take the findings more seriously.

1.17 The introduction of VAT in some countries (certainly the United Kingdom and possibly Canada and New Zealand) has been a pivotal factor leading to compliance cost research which a government has taken seriously. VAT is a transaction-based tax and the compliance costs are necessarily high. Moreover, in some countries, VAT has meant that many businesses had to account for tax on their products for the first time. The introduction of VAT has often been accompanied by an outcry from small firms' organisations and (for example in the United Kingdom and Canada) highly exaggerated claims as to its compliance costs. Governments have therefore welcomed, or themselves commissioned, more objective studies.

1.18 With the growth of the enterprise culture, which influenced many countries in the 1980s, small firms and self employment have been very much in favour with many governments. Small firms are seen as a vital innovative element in the economy and also as the most likely means of reducing the high unemployment which has characterised much of the 1980s and early 1990s. Further, in at any rate some countries (of which the United Kingdom is a notable example), the number of self employed and small businesses has been increasing very rapidly over the past decade and a half, so that they have increased in importance to the national economy and as a political constituency. Tax compliance costs are one of the major burdens imposed on business, especially small business, by government regulations. Thus the de-regulation initiatives, such as those by the Conservative governments of the United Kingdom, have focused strongly on reducing the compliance costs of business in general, but especially of small businesses.

1.19 For a variety of reasons, in recent years in many countries, tax systems have become more complicated and also an increasing proportion of taxpayers have faced more complex tax situations.

The period since the 1960s has seen a big increase in p. Sweden appears to be a notable exception (see Chapter 11) but increased complications as a result of tax reform were undoubtedly an outcome in Australia, New Zealand, Canada and, almost certainly, the United States (see Sandford, 1993). Government concern wiogether. This growth in taxation may well have increased tax compliance costs by spreading the tax net more widely (of which the introduction of VAT and the introduction or extension of capital gains taxes are the outstanding examples).

Tax systems have become more complex as governments have sought to restrict evasion and, more particularly, tax avoidance. Both have been stimulated by the tax increases, aided and abetted by increasingly sophisticated taxpayers employing increasingly sophisticated tax advisers.

Rises in living standards have generated more tax compliance costs as many more taxpayers have widened their sources of income.

Economic change has generated the need for new tax provisions. Thus, for example, the increasing internationalisation of the world economy created additional avenues of tax avoidance,; whilst new financial instruments generated the need for new tax rules.

Ironically, although 'simplicity' or 'simplification' was frequently a declared objective of the tax reforms which characterised the 1980s, these reforms often led to increased complication of the tax system. Sweden appears to be a notable exception (see Chapter 11) but increased complications as a result of tax reform were undoubtedly an outcome in Australia, New Zealand, Canada and, almost certainly, the United States (see Sandford, 1993). Government concern with compliance costs in these countries is part of a drive to simplify the tax systems in the wake of tax reform.

1.20 An increased emphasis on voluntary compliance with the tax laws has made governments more concerned about compliance costs. Although it may not yet have percolated all the way through revenue departments, a change of culture is certainly noticeable at the upper echelons of revenue departments in many OECD countries, by which the taxpayer is regarded as a customer and client, entitled to explanations and help, and assumed to be honest unless demonstrably shown to be otherwise. This new emphasis gets it formal statement in Taxpayers' Charters and Bills of Rights and in the establishment of Tax Ombudsmen and Independent Adjudicators. With this emphasis naturally goes a concern to minimise the compliance costs of taxpayers.

1.21 Measures taken to reduce administrative costs may increase compliance costs and in the early 1980s, some governments keen on reducing public public expenditure obtained savings in the revenue departments by shifting the burden to the private sector (2.9). Later it was more fully appreciated that, from the national viewpoint, this was not necessarily a sensible policy and might take up more rather than less resources as well as being one more factor deterring the effort and enterprise on which economic growth depends.

Purpose and Book Structure
Objectives
1.22 The purpose of the book are two-fold.

(1) The prime purpose is to consider the methodologies used to measure tax compliance costs with a view to improving measurement for policy-making purposes. This objective includes considering, in the light of best practice, how a particular methodology might be improved; examining the respective merits of different methodologies; and seeking to assess which methodologies (or which combination of methodologies) are best suited for which purposes.

(2) The secondary objective is to provide a survey of the recent research findings on tax compliance costs from around the world.

1.23 To help achieve the primary objective, all contributors presenting research results were asked to include in their chapters the following points:

  • objectives of the study;
  • reasons for choice of method;
  • population to be studied;
  • source of sample and representativeness;
    sample size;
  • use or otherwise of a pilot study;
  • response rate as percentage of population;
  • any attempt to test for characteristics of non-respondents;
  • any special methods used to increase response rate;
  • method used for valuing time;
    methods adopted for checking the validity of the responses;
  • any other special features of the methodology;
  • what they saw as advantages of their methodology;
  • what they saw as limitations of their methodology;
  • what they would do differently if repeating the study.

1.24 The costs of alternative research methods are very relevant to method choice when budgets of academics or revenue departments are tight. Contributors were therefore asked to indicate the costs of their research. This proved to be a tricky question to answer. Often the principal academic researchers for a study were not paid at all or were paid at a rate well below their market rate. To try to meet this situation costs could be given either as an approximate total sum in sterling or/and US dollars at 1994 prices (for example, where a study had been commissioned, like that of the Canadian study in Chapter 14) or as an estimate of the time taken by the principal paid (or underpaid) researchers, with other costs in sterling or/and US dollars at 1994 prices

1.25 Contributors were free to include their responses to the questions in any way they wished. Some chose specifically to list the questions and their answers. Others wove the answers into their general narrative. Not all the questions were relevant to every kind of research; thus, for example, questions about testing for the characteristics of non-respondents were of nil or limited relevance to a study (like that of the Australian in Chapter 13) which consisted of twelve case studies of small firms.



1 Only Maarten Allers of the Netherlands attempted to estimate the costs of complying with the research.



Structure of the Book
1.26 Part I consists simply of this introductory chapter designed to set the scene, to describe how and why tax compliance costs have become so much more prominent both in research and in government policy during the past decade or so.

1.27 The centrality of policy-making to the purpose of the book is emphasised by placing the most policy-oriented chapters immediately after the Introduction. Part II consists of the chapters presented by the United Kingdom revenue departments. The United Kingdom is amongst the leading countries in the policy measures taken to try to contain and reduce tax compliance costs. The experience embodied in the two papers, one by Inland Revenue and one by Customs and Excise, on 'Tax Compliance Costs: the Problems and the Practice' will therefore be of especial interest to revenue departments of other countries that may be contemplating travelling down the same road. A series of Annexes to the papers give practical examples of tax Compliance Cost Assessments.

1.28 Part III is the largest section of the book. It consists of large-scale sample surveys of one or more taxes from eight different countries, followed by an innovative paper which, using Canada as an example, suggests a possible means by which one survey may be used as a baseline for subsequent compliance cost estimates of income tax. The large-scale sample surveys (which may also be accompanied by some interviewing of respondents or tax professionals) fall into two main methodological groups: mail surveys and interview surveys using questions bought in from a commercial polling agency. It might have seemed sensible to give each a Part to itself: but this procedure was precluded because several of the studies (for example, those of Canada, The Netherlands and Sweden) employed both methods in the group of surveys which comprised the research project in each of these countries. The comparisons and the respective claims for each method are considered in some detail in the concluding part of the book.

1.29 Part IV considers studies using different methodologies from those of Part III, with the emphasis on surveys in depth. A study in Australia involves a series of interviews with each of twelve small businesses. A Canadian study, using innovative interview methods, investigated some 200 small to medium-sized businesses to discover their compliance costs arising from the Goods and Services Tax (GST), the Canadian VAT. John Prebble outlines a remarkable study he undertook for the Finance Department on the costs of compliance associated with the New Zealand controlled foreign company regime, in which he interviewed virtually the total population of the affected businesses.

1.30 The final paper in this Part, by Sue Green, is different again. It is a survey of tax accountants rather than taxpayers, obtaining their views about aspects of the United Kingdom direct tax system by means of an exceptionally detailed mail questionnaire. The research was sponsored by the Tax Faculty of the Institute of Chartered Accountants in England and Wales, which probably accounts for the respectable response rate despite the exceptionally long questionnaire.

1.31 Finally, in Part V, the editor attempts to draw conclusions - to answer the questions which formed the objective of the book. How can existing methods of measuring tax compliance costs be improved? What are the respective merits of the different methods? Might a combination of methods be ideal? If so, what combination? Where should research with a practical policy-making purpose be heading? What policy initiatives might be undertaken? In short, where do we go from here?

1.32 For ease of cross-referencing (particularly important for supporting the conclusions of Part V) all paragraphs have been numbered.

References
Haig, R.M., 'The Cost to Business Concerns of Compliance with Tax Laws', Management Review, pp.232-333, 1935.

International Fiscal Association, Studies on International Fiscal Law, Volume LXXIVb, Administrative and Compliance Costs of Taxation, Kluwer, The Netherlands, 1989.

Little, Arthur D. Corporation, Development of Method of Methodology for Estimating Taxpayer Paperwork Burden, Final Report to the Department of Treasury, IRS, Washington, D.C., 1988.

Sandford, C.T., M.R. Godwin and P.J.W. Hardwick, Adminstrative and Compliance Costs of Taxation, Fiscal Publications, Bath, 1989.

Sandford, C.T., Successful Tax Reform: Lessons from an Analysis of Tax Reform in Six Countries, Fiscal Publications, Bath, 1993.

Smith, A., Inquiry into the Nature and Causes of the Wealth of Nations, Book 5, Chapter 2, Part 2, 'Of Taxes', Everyman Edition, pp.307-9, 1977.

Vaillancourt, F., 'The Compliance Costs of Taxes on Businesses and Individuals: A Review of the Evidence', Public Finance, 42, No.3, pp.395-419, 1987.

Waugh Report, Final Report of the Consultative Committee on Tax Simplification, Ministry of Finance, Wellington, New Zealand, 1990.