Audits don’t happen randomly

Commissioner and chief executive of the Canadian Revenue Agency reminds us in a story in the Financial Post that there are no random audits in Canada.

If your tax return is selected for audit, the CRA has identified some aspect of your return, be it a deduction claimed or an industry that it is focusing on, for additional scrutiny.

This should be reassuring to the majority of filers, since most people earning a wage have limited deductions available to them, compared to corporations. But should there be some percentage of tax audits selected at random from the entire population?


Cigarettes and the complexity of the tax code

Sometimes people wonder why the legislation surrounding various taxes is so complex, given the relatively straight-forward nature of those taxes. The Tax Foundation provides a telling example in a recent post about the definition of a cigarette:

Cigarettes are taxed in New Mexico, as everywhere else, and at a pretty hefty rate. As the tax goes higher and higher, there’s more of an incentive to get out of it, and one way is to alter cigarettes so they no longer fall under the state’s tax code definition. When the state catches on, it adds more to the definition to encompass the new products, and the cycle then repeats itself.

So now, New Mexico’s definition of cigarette is either a roll of tobacco wrapped in paper, or a roll of tobacco wrapped in a substance containing tobacco, weighing no more than 3 pounds per 1,000 stocks, and having three or more of the following characteristics:

  1. it has a typical cigarette size and shape;
  2. it has a cellulose acetate or other cigarette-type integrated filter;
  3. it has a filler primarily consisting of flue-cured, burley, oriental, or unfermented tobaccos or has a filler material yielding the smoking characteristics of any of those tobaccos;
  4. it has a filler, binder and wrapper that together contain three percent or more by weight of total reducing sugars and four percent or less by weight of non-reducing sugars;
  5. it is sold in soft packs, hard packs, flip-top boxes, clam shells, or other cigarette-type packages;
  6. it is sold in a package that labels the product as a cigarette or a cigarette substitute, or in a package that does not clearly and conspicuously declare that the product is a cigar;
  7. it is available for sale in packages of five, ten, twenty or twenty-five sticks;
  8. it is available for sale in cartons of ten packages;
  9. it is marketed or advertised to consumers as a cigarette or cigarette substitute.

There are entire sections of the Canadian Income Tax Act devoted to definitions like this. Usually there is a Definitions subsection where certain terms specifically related to a given section are defined.

Is it ethical for corporations or individuals to try to produce what is essentially a cigarette that is outside the letter of the law but clearly violates the spirit? Clearly no. Unfortunately I think principles-based tax law is a non-starter, but I’m a big believer in principles-based GAAP as the tool we professionals need to use to accurately reflect economic reality.

(By the way, the ‘P’ in GAAP stands for principles. How can we have principles which are not principles-based, you might wonder. Well, that’s a question for the FASB, Canada’s AcSB, and the IASB!)


Ten principles of sound tax policy

The Tax Foundation’s Ten principles of sound tax policy are a must-read for those influencing tax policy. I think the list can be further refined down to about half that, but maybe they wanted to get an even ten.

For instance, maintaining the neutrality of the system (#2) will result in broad bases (#3). It’s when the system gets less neutral (i.e. favours certain groups or behaviours) that the base is narrowed. Various special interest deductions put in place to encourage desirable behaviour or punish undesirable behaviour have narrowed the base and caused rates to be kept high unnecessarily.

Harmonization of federal, state/province and local/municipal taxes (#10) is part and parcel with creating a simple tax system (#4). The provincial government has been criticized recently about its reluctance to harmonize Ontario’s sales tax with the Federal GST. The premier’s misguided reasoning for the reluctance? It would place a tax on certain exempt items, thus eliminating some of the complexity and non-neutrality in the tax.

Tax stability (#5) is important because it makes them predictable, which is also aided when there is no retroactivity (#6). When politicians can make changes to taxes retroactive, tax is not predictable. The Canadian government announced recently the retroactive increase in the Basic Personal tax credit. You’re unlikely to hear anyone complain about this, but nonetheless it isn’t ideal tax policy.

Transparency (#1) is important no matter what government initiative we’re talking about, and an open process (#9) is one manifestation of this requirement. All the workings of a democratic government must be open to its citizens and open to criticism and debate. Tax is no different from anything else in this respect.

So I humbly put forward my own principles of sound tax policy: simplicity, neutrality, transparency, and predictability. I think that basically covers it at a more abstract level than the Tax Foundation’s ten.


Lotteries are just regressive taxes

I like The Tax Foundation. They advocate some really smart tax policy in the US. They also have a good blog that regularly keeps me up on US tax, which isn’t something I ever need to know in my job, but is interesting nonetheless. They blogged about one of their Background Papers titled Gambling with Tax Policy: States’ Growing Reliance on Lottery Tax Revenue recently:

Lotteries are a source of implicit tax revenue and exemplify poor tax policy for a number of reasons. They are not economically neutral; they are regressive; they lack transparency; they unnecessarily complicate the tax system; earmarked funds are often not used as promised; and lotteries are a business for the private market, not a state government.

I don’t think too many people view lotteries as taxes, but they should. Bad taxes. The part above about lacking transparency hits close to home, as Ontario has experienced scandal lately because a disproportionate share of winners are store clerks:

Roughly 60,000 lottery ticket sellers in Ontario, retailers won nearly 200 times in the past seven years, with an average prize of $500,000. A statistician with the University of Toronto called those numbers a statistical anomaly, saying there is a “one in a trillion, trillion, trillion, trillion” chance of that many retailers winning.

And my province isn’t the only one with a problem:

The head of B.C.’s Lottery Corporation was fired last week, three days after a scathing ombudsman’s report, which found that the Crown-owned corporation was not doing enough to prevent unscrupulous retailers from fleecing the system.

Privatization is one option the BC is looking into, and the pressure is growing in Ontario to consider the option as well. What do you think? Should the lottery be a tax tool used by governments or a revenue tool used by private (for-profit or not for-profit) organizations?


Bizarre taxes to put our situation into perspective

We like to complain (and for good reason) about the litany of taxes imposed on us by various levels of government, but this post on Neatorama details some bizarre taxes through history that make current ones seem tame.

Peter the Great, czar of Russia, imposed a tax on souls in 1718…meaning everybody had to pay it (it’s similar to a head tax or a poll tax). Peter was antireligious (he was an avid fan of Voltaire and other secular humanist philosophers), but agreeing with him didn’t excuse anyone from paying the tax—if you didn’t believe humans had a soul, you still had to pay a “religious dissenters” tax. Peter also taxed beards, beehives, horse collars, hats, boots, basements, chimneys, food, clothing, all males, as well as birth, marriage, and even burial.

I have to admit current taxes seem much more logical, taxing income, consumption, property values, estates, gas, etc.

I, like Krupo, have very nearly said goodbye to preparing personal taxes for another year. I start a new four-week audit this week, which will keep me away from the office unless we get called in. The past couple weeks I’ve been mainly doing personal returns for our clients.

I don’t dislike preparing taxes, and I do corporate tax returns year round, which gives me a good break from audit work. But for the same reason I don’t think I’m interested in specializing in tax, even though you make more money. Tax is good, but only as a break from other stuff.