D Murali

Evasion culture

D. MURALI | Updated on October 16, 2011

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Culture appears to play an important role in tax evasion, and the current enforcement policies seem less effective in dealing with it, observe Jason DeBacker, Bradley T. Heim, and Anh Tran in ‘ Importing Corruption Culture from Overseas: Evidence from Corporate Tax Evasion in the United States,' a recent paper in the Social Science Research Network (www.ssrn.com). “Our findings call for the consideration of cultural factors in designing corporate governance and law enforcement. In this globalised world, what happens far away may have implications for us at home,” the authors conclude.

Studying the results of more than 2,60,000 IRS corporate tax audits from 1996 to 2007 with corruption measures from the foreign owner's country of residence, what the authors find is that the norms of high corruption strongly increase tax evasion among small and medium firms. For instance, a firm with annual revenue and total assets equal to the sample mean and with an owner from a country with Nigeria-level corruption, on average, exceeds a similar firm from Sweden in tax noncompliance by about $14,800 (equivalent to about 2 per cent of mean total corporation income tax or 0.3 per cent of mean net income), one learns.

“However, as the firm's assets reach $18 million, the difference in their tax evasion behaviour becomes negligible.” Another example in the paper is that a firm having $2.6 million assets with an Iraqi level of corruption (8.7) on average evades more tax than a similar firm with a Singaporean level of corruption (0.7) by 0.58 percentage points of their annual revenue.

A fervent call for cultural factors to be considered seriously when designing effective law enforcement programmes.

Behavioural levy

Martin Fochmann of the Otto-von-Guericke University Magdeburg and Martin Jacob of the WHU-Otto Beisheim School of Management make a case for the taxman to consider the risk averseness of investors. Stating that tax authorities often implement identical loss offset rules for different investors, the authors write in ‘ Behavioral Explanation of Tax Asymmetries' that there should be specific loss offset rules for investors who differ in risk attitude as well as in loss aversion. “Loss offset rules should be more restrictive for investors which are (1) more risk averse in case of gains, (2) less risk seeking in case of losses, or (3) more loss averse.”

A proposition in the paper says that if an investor A is closer to risk neutrality in case of gains and losses and less loss averse than an investor B, the tax authority should tax gains and losses of A less asymmetrically than B's. Towards this, the tax authorities should carefully take into consideration the differences in risk attitude and loss aversion across investor groups (for example corporations versus private investors, female versus male investors, or low versus high income investors), the authors urge. “For example, loss offset rules should be more generous for well diversified investors (corporations or wealthy investors) than for less diversified investors (sole proprietors or low income investors).”

There are several ways of implementing loss offset restrictions, the authors advise. Such as, introducing investor-specific annual loss offset limits, restricting the use of carry-backs and carry-forwards to time periods that differ across investors, and defining specific loss offset rules for different income baskets.

Wonder if such an approach of the taxman may trigger behavioural changes among the assessees, as a method to save on the tax bill.

Cash-flow taxation

To those who are looking for ‘a better way to tax oil and gas development,' it should be useful to read ‘ Rethinking Royalty Rates' by Colin Busby, Benjamin Dachis, and Bev Dahlby. Set in Canadian context, the paper states that the total resource revenues can be increased by relying more on auctions than on royalties. “Although we are not able to point to a specific ‘optimal' royalty rate, our analysis does indicate the superiority of lower royalty rates and the substantial effect that gross royalty rates have on distorting investment decisions,” they write.

In emerging fields – such as in Quebec and British Columbia, which have significant potential reserves of natural gas yet to be exploited – a high royalty rate would restrict development and have a net negative effect on provincial revenues if there are few existing producers to which a high rate would apply, the authors caution.

An educative section in the essay is about cash-flow taxation, which allows firms to deduct production costs on an oil and gas development project from their taxable production revenues. This creates a tax base that consists of pure abnormal profit, and in theory, a government can apply a high tax rate on the cash-flow tax base without creating disincentives to invest in resource exploration and production.

“With more expensive horizontal wells becoming more common than lower cost shallow wells, the average well (excluding the oil sands) is forecast to cost over $2 million to drill by 2015, up from less than $1 million in 2005 (Tertzakian and Baynton 2011). These higher costs make applying cash-flow taxation to the conventional oil sector increasingly important.”

Many takeaways for the oil and gas sector, closer home.

Two-sided market

Grim tidings for the print media are that, in many countries currently levying low indirect taxes on newspapers, there is a debate whether this policy should be continued. A recent paper titled ‘ Newspaper Differentiation and Investments in Journalism: The Role of Tax Policy' by Hans Jarle Kind, Guttorm Schjelderup, and Frank Stähler considers the two-sided nature of the newspaper market – viz. of advertisers and readers – and sees a strong relationship between the size of the advertising market and the optimal taxation of newspaper sales. If the ad market is large, newspapers tend to be insufficiently differentiated and are likely to make socially excessive investments in order to attract readers, the authors opine. “The British tabloids' willingness to pay for paparazzi pictures, for example, may be seen as an indication that newspapers have too strong incentives to cater for the masses. If this is the case, and politicians expect the advertising market to remain strong (after correcting for business cycle effects), it might be unwise to increase taxes on newspapers.”

The authors are of the view that if, in contrast, the advertising market becomes significantly smaller, politicians might consider increasing the tax rate on newspapers to avoid excessive differentiation, though lobbyists from the newspaper industry regularly argue that a smaller advertising market calls for low tax rates on newspaper sales in order to avoid unnecessary financial distress for the newspaper industry.

Now, should we print that in a newspaper and give ideas to our netas?

Published on October 16, 2011

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