eJournal

of Tax
Research
Volume 10, Number 2 October 2012
th
(Special Edition: Atax 10 International Tax Administration Conference)

CONTENTS

182 Editorial
Margaret McKerchar, Michael Walpole and Binh Tran-Nam

184 Tax compliance costs for the small business sector in South Africa
establishing a baseline
Sharon Smulders, Madeleing Stiglingh, Riel Franzsen and Lizelle
Fletcher

227 Australian business taxpayer rights to compensation for loss caused by

tax official wrongs a call for legislative clarification
John Bevacqua

250 Findings of tax compliance cost surveys in developing countries

Jacqueline Coolidge

288 Tax compliance costs for small and medium sized enterprises (SMEs):
the case of the UK
Ann Hansford and John Hasseldine

304 FACTA and Schedule UTP: Are these unilateral US actions doomed
unless accepted by other countries?
J. Richard (Dick) Harvey, Jr

School of Taxation and Business Law (Atax), Australian School of Business

The University of New South Wales

ISSN 1448-2398
CONTENTS CONTINUED

329 Navigating a transition in US tax administration

Kristin Hickman

345 Behavioural economics and the risks of tax administration

Simon James

364 Improving tax compliance strategies: can the theory of planned behavior
predict business compliance?
JoAnne Langham, Neil Paulsen and Charmine E. J. Hrtel

403 Intervening to reduce risk: identifying sanction thresholds among SME

tax debtors
Elisabeth Poppelwell, Gail Kelly and Xin Wang

436 Developing risk management strategies in tax administration: the

evolution of the Australian Tax Offices compliance model
Robert Whait

465 Tax return simplification: risk key engagement, a return to risk?

Jason Kerr

483 New dimensions in regulatory compliance building the bridge to

better compliance

Stuart Hamilton

School of Taxation and Business Law (Atax), Australian School of Business

The University of New South Wales

ISSN 1448-2398
eJournal of Tax Research (2012) vol. 10, no. 2, pp. 345-363

Behavioural economics and the risks of tax

administration

Simon James*

Abstract
Tax Administration is a risky business. When taxes are not well administered, tax morale may be undermined and
unnecessary administrative and compliance costs incurred. Mainstream economics and the self-interested rational choice
model provide a powerful contribution to understanding the effects of taxation but that analysis has not always been enough
to avoid serious and expensive difficulties. Behavioural economics has been making an increasing contribution to
understanding how tax administration may be improved. Some of the assumptions of mainstream economics have been
subject to close scrutiny and DellaVigna (2009) summarized deviations from the standard model as non-standard preferences,
non-standard beliefs and non-standard decision-making. In recent years considerable analysis and evidence have been
presented on the importance of aspects such as fairness in taxation, the endowment effect, framing of decisions, limited
attention, loss aversion and mental accounting and their impact on the operation of a tax system. A risk management
approach to tax administration has been developed by the European Commission, the OECD and others. One area that has
received less attention than may be appropriate is the performance of tax agencies themselves. This paper therefore outlines
the contribution behavioural economics can make to existing approaches in reducing the risks of tax administration and
extends it to the performance of tax authorities themselves.

1. INTRODUCTION

Challenges in dealing with taxpayer behaviour and the risks of tax administration are
as old as taxation itself. A remarkable example is that, when income tax was first
introduced in the UK in 1799, it was thought unacceptable that taxpayers should be
required to disclose the precise level of their incomes. To deal with the obvious risks
involved, the response was to require that taxpayers should declare that the tax paid
was not less than the required 10 per cent of their income. As Pitt explained in
introducing the income tax:

The statement of income is to proceed from the party himself. In doing this it is not
proposed that income shall be distinctly laid open, but it shall be declared only that the
assessment is beyond the proportion of a tenth of the income of the person on whom it
is imposed. In this way, the disclosure at which many may revolt may be avoided (Pitt,
1798).

* University of Exeter Business School

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This led to a form of declaration given in an Act (39 Geo 3, c. 22) passed three months
after the original Act, and shown in Figure 1 and one of the simplest tax returns
ever.

Figure 1 The Original UK Income Tax Return.

___________________________________________________________________________

I do declare that I am willing to pay the sum of for my contribution for one year,
from the fifth day of April until the fifth day of April in pursuance of an Act passed
in the thirty-ninth year of the reign of His present Majesty intituled[the full name of the Act
was entered here] and of another Act for amending the said Act: and I do declare that the said
sum of is not less than one tenth part of my income, estimated according to the directions
and rules prescribed by the said Acts, to the best of my knowledge and belief. Dated this day
of
Signed
___________________________________________________________________________

To deal with the risk the Commissioners could demand further information and a
hearing. Nevertheless, after the taxpayer had stated his case at the hearing and made
an oath as to the truth of his return, he:

shall not be compelled to answer; his books shall not be called for, not his
confidential clerks or agents examined. If, however he declines to submit to
the investigation of his books, and the examination of his clerks, and other
means of ascertaining the truth, it shall be competent for the Commissioners
to fix the assessment, and their decision shall be final, unless he appeals to
the higher Commissioners. No disclosure is necessary, but if the party is
unwilling to disclose, he must acquiesce in the decision of the
Commissioners, who shall not be authorised to relieve without a full
disclosure (Pitt, 1798).

Since that time, the level and complexity of taxation have risen enormously and so has
the pressure to deal with non-compliance. Behavioural economics has also been
developing rapidly and adds to the contribution of more traditional analysis of
economic behaviour. Mainstream economics has made a considerable contribution to
understanding taxation but its basic assumption of self-interested rational behaviour
narrowly defined does not give a good explanation of tax compliance. The penalty for
ordinary tax convictions is usually modest, the chance of detection often trivial and yet
most individuals pay their taxes. Hence some further explanation is required (Posner,
2000, p. 1782).

Sometimes the limitations of the mainstream approach are dramatically exposed. At a

briefing by economists on the credit crunch at the London School of Economics on 5
November 2008, the Queen was reported as asking why no one saw the credit crunch
coming. Her Majestys question was debated by economists and others at a forum at
the British Academy and their response indicated the importance of factors not

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normally included mainstream economic analysis such as wishful thinking, a

psychology of denial, and the psychology of herding (Besley and Hennessy, 2009,
pp. 2-3). Furthermore, the Queen was advised that Everyone seemed to be doing their
own job properly on its own merit. And according to standard measures of success,
they were often doing it well (ibid., p. 3).

Behavioural factors can improve understanding of such events including tax

compliance and non-compliance. As described further below, the behavioural
approach draws on a wider range of assumptions than purely rational ones in
understanding individuals actions. One particular example is that it is conceptually
better placed than the rational approach to give issues of fairness and tax morale
the importance they deserve.

Tax systems have, of course, taken account of phenomena described by behavioral

economists, even if they were not explicitly recognized as such. For example,
withholding at source, which can be traced back to the sixteenth century in England
(Soos, 1995), deals with phenomena now described as the endowment effect, loss
aversion and status quo bias. Nevertheless, taking account of such factors more
explicitly may improve compliance more generally and systematically. This is
particularly true because measures to improve compliance have often taken the form
of mechanistic and relatively simplistic arrangements regarding auditing and penalties
on the assumption, implicitly or explicitly, that taxpayers are motivated to comply
with the tax system only on the balance of the associated financial gains and losses.
They may also, of course, be motivated by other factors. Furthermore, it has always
been clear that some areas of taxation are more likely than others to have a higher risk
of uncollected taxation and consequently have been subjected to a greater level of
enforcement activity. In recent times more systematic approaches have sometimes
taken the form of developing risk management procedures. The paper therefore begins
with a discussion of risk management in the present context in Section 2 followed by
the contribution behavioural economics adds to more rational approaches in Section
3. Section 4 turns to the related area of responsive regulation in taxation.

A relatively under explored application of the behavioural approach is the contribution

it may make with regards to the performance of tax agencies. External change and
management fashion (see Abrahamson, 1966) can pose serious risks to the functioning
of organisations including tax authorities. In Section 5, this paper therefore turns to the
management of tax agencies. It examines some of the risks of a rational approach to
management reform and the importance of a behavioural perspective. Some of issues
are illustrated by drawing on radical changes to UK tax administration. Finally,
Section 6 draws some conclusions.
2. RISK MANAGEMENT AND TAX ADMINISTRATION

Within the study of management, risk management has expanded dramatically in the
last twenty years, developing from an element of management control to an aspect of
good governance for many organisations. Despite this huge growth and the impressive
development of concepts and techniques (see for example, McNeil, et al. 2005) it can
still be argued that risk management is first and foremost about sound general
management (Culp, 2001, p. ix) and that perhaps it is not all about real hazards and
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opportunities but quite a lot about organisational accountability and legitimacy

(Power, 2007). It is therefore relevant to examine not only risk management with
respect to taxpayers, of which there is an existing literature, but also risk management
with respect to the conduct of tax administrators more generally, about which less has
been said in this respect.

The European Commissions Risk Management Guide for Tax Administrations (2006,
p. 13) described risk management as taking deliberate action to improve the odds of
good outcomes and reducing the odds of bad outcomes. It is not a magic formula that
will always give the right answers but it is a way of working and thinking that will
give better answers to better questions. Interestingly, the EC guide goes on to suggest
that the concept of risk has its roots in the ancient Italian maritime trade from the
concept of uncertainty and possibility of loss. Risks consist of the characteristics of
vulnerability, severity or significance and relative occurrence or frequency. The
European Commissions Guide also states that Risk analysis also involves the why
question: why is the taxpayer behaving in a particular fashion. This is important
because it contributes to the assessment and the choice of the most efficient and
effective form of treatment (p. 6).

The OECDs (2004, p. 37) Compliance Risk Management cites the analysis of James
et al., (2001) in identifying two main approaches to examining compliance. The first
of these is based on economic assumptions of rationality of the sort mentioned above
with a reliance on penalties. However, there has been an increasing awareness that
understanding the factors influencing taxpayers behaviour may also have an
important role to play and this is examined further in the following section. The
OECD (2004, p. 8) formally describes compliance risk management as a structured
process for the systematic identification, assessment, ranking and treatment of tax
compliance risks such as the failure to register or the failure to report tax liabilities
properly. The OECD outlines the way a compliance risk management process may be
applied by a revenue authority in the following stages:
Identify risks
Assess and prioritise risks
Analyse compliance behaviour (causes, options for treatment)
Determine treatment strategies
Plan and implement stages.
The two stages that may benefit most from a behavioural approach are the analysis of
compliance behaviour and determining treatment strategies. The process would
continue with the compliance outcomes regarding registration, filing, reporting and
payment being evaluated and performance measured against plan. As the OECD
(2004, p. 8) points out this is consistent with the existing management literature which
has also been applied more generally, for example by James and Edwards (2007) to
income tax.

The International Bureau of Fiscal Documentation (2012) provides an online

collection of tax compliance arrangements in different countries including a guide to
tax risk management for designing an internal structure and strategy for minimising
the unintended risks of non-compliance. A further contribution by Thompson (2008)

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on behalf of the Caribbean Organization of Tax Administration illustrated the

principles and application of risk management and how tax authorities may use them
to improve voluntary compliance.

An additional point has been made by the OECD (2009): that large businesses are
increasingly considering tax risk management as a specific element of corporate
governance. In examining the experience of three countries Australia, Canada and
Chile - the OECD found that large businesses that have good corporate governance
and more transparent relationships with tax administrations can expect fewer audit
interventions and greater certainty.
3. THE CONTRIBUTION OF BEHAVIOURAL ECONOMICS

The academic literature relating to behavioural economics is now very substantial.

Schwartz (2008) and Wilkinson (2008) have both provided introductions and
collections of papers on behavioural economics have been edited by Altman (2006),
Loewenstein, (2007), and Maital (2007). There is also a collection of readings
specifically on behavioural public finance edited by McCaffery and Slemrod (2006).
There have been specific applications to taxation for example, Congdon et al. (2009)
related behavioural economics and tax policy and Reeson and Dunstall (2009)
examined the implications of behavioural economics and complex decision-making
for the Australian tax and transfer system.

Behavioural economics has been described as increasing the explanatory power of

economics by providing it with more realistic psychological foundations Camerer and
Loewenstein (2004, p. 3) though it also draws on other disciplines. Its approach
involves modifying the standard economic model to account for psychophysical
properties of preference and judgement, which create limits on rational calculation,
willpower and greed (Camerer and Malmendier, 2007, p. 235) and further analysis is
presented by Tomer (2007).

A particular theme arising from this approach is the importance of fairness both in
economic behaviour in general (see for example Kahneman et al., 1986a and 1986b)
and behaviour with respect to tax compliance in particular (for instance Bordignon
1993 and Cowell, 1992).

Such an approach is consistent with the contribution of the classical economists. For
example Adam Smith has been described as a behavioural economist and his world is
not inhabited by dispassionate rational purely self-interested agents, but rather by
multidimensional and realistic human beings (Ashraf et al. p. 142). However, the
main thrust of the analysis in mainstream economics and, indeed, parts of some other
disciplines such as management, has developed on the basis of that part of Adam
Smiths (1776) contribution that economic behaviour was motivated by self-interest.
Economics therefore became the mechanics of utility and self-interest and simply a
calculus of pleasure and pain (Jevons, 1888). Such an approach has led to many
important insights and understanding of economic behaviour but the central
assumption that human beings are largely motivated by immediate self-interest and

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rationality, narrowly defined, has its limitations. This approach has been vividly
described by Veblen as follows:

The hedonistic conception of man is that of a lightning calculator of

pleasures and pains who oscillates like a homogeneous globule of desire of
happiness under the impulse of stimuli that shift him about the area, but
leave him intact. He has neither antecedent nor consequent. He is an isolated
definitive human datum, in stable equilibrium except for the buffets of the
impinging forces that displace him in one direction or another. Self-imposed
in elemental space, he spins symmetrically about his own spiritual axis until
the parallelogram of forces bears down upon him, whereupon he follows the
line of the resultant. When the force of the impact is spent, he comes to rest,
a self-contained globule of desire as before (Veblen, 1898, pp. 389-90).

However, such an approach does not explain much observed behaviour such as the
willingness of citizens to act in the public interest, even when it may not appear to be
in their own immediate self-interest. As already mentioned above, this happens when
taxpayers meet their liabilities to a large extent without the need for an unduly
coercive tax regime. Another example is the well-known tendency of some US
taxpayers to make interest-free loans to government by having more income tax than
necessary withheld from their salaries followed by a refund after the end of the tax
year (Fennell, 2006).

Furthermore it taxpayers may not react well to an onerous regime, however much it
may look to be effective. For instance both Schmlders (1970) and Strmpel (1969)
reported that the German system was very rigid in its assessment procedures which led
to an effective but expensive and confrontational system. A notable outcome of the
relatively coercive tax-enforcement techniques is the high degree of alienation from
the state[which] negatively influences the willingness to cooperate (Strmpel,
1969, p. 29).

In contrast to the approach based heavily on self-interest, behavioural economics has

involved subjecting the assumptions of mainstream economics to close scrutiny.
DellaVigna (2009) summarized deviations from the standard model as non-standard
preferences, non-standard beliefs and non-standard decision-making. In recent years
considerable analysis and evidence have been presented on the importance of aspects
such as fairness in taxation, the endowment effect, framing of decisions, limited
attention, loss aversion and mental accounting that may impact on the administration
of a tax system. Congdon et al. (2009: 375) stated: the implications of behavioural
economics for public policy, including tax policy, have yet to be systematically
explored, and this oversight leads to both mistaken policy and missed opportunity.

Behavioural economics has also reached a wider audience. For example, the book
Nudge by Thaler and Sunstein (2008) became required reading on a 2008 summer
reading list for Conservative MPs in the UK. This was because authors argue that
sometimes voters need a gentle push to do the right thing, a view seemingly consistent
with the Conservative Partys tax and welfare policies. From that approach came the
Behavioural Insight Team or nudge unit which was set up 2010 in the UK Cabinet
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Office. Its role is to develop ways of helping people make better choices rather than
trying to force them to do so. One early initiative in taxation improved some
taxpayers responses by changing letters from the tax office to explain that most
people in their area had already paid their taxes.

For the present purpose, the behavioural economics approach examines a range of
factors which may influence taxpayers compliance behaviour. Some of the work also
draws on other academic disciplines such as sociology in considering variables such as
social support, social influence and certain background factors such as age, gender,
race and culture. Psychology reinforces this approach and has even created its own
branch of fiscal psychology pioneered by Schmlders (1959) and reinforced by
others such as Lewis (1982). A specific example of a relevant factor is referred to as
framing where it has been observed that the way an issue is framed can be an
important influence on individuals responses (Tversky and Kahneman (1981). This
seems to be true in general and with respect to tax compliance in particular (see, for
example, Holler, et al., 2008). Other important aspects include fairness in taxation, the
endowment effect, limited attention, loss aversion and mental accounting.

There are many detailed contributions to the behavioural approach. Reflecting widely
held views, Braithwaite et al. (2003) examined such factors as the perception of justice
and Feld and Frey (2007) suggested that taxpayers are prepared to comply with the tax
system if they perceive the political process is fair and legitimate. The roles of
individuals in society and accepted norms of behaviour have also been shown to have
a strong influence (Wenzel 2004 and 2005). This all has links with the rapidly
expanding literature on tax morale which might be defined as an individuals intrinsic
willingness to pay taxes (Alm and Torgler, 2006, p. 224) and which is examined
further in Torgler (2007). Background factors such as cultural influence have been
examined by Coleman and Freeman (1997) and Cummings et al. (2004), and so have
the implications of different political systems (Pommerehne et al., 1994). More direct
contributions to policy in this area have come from a number of authors. For example,
one is an appeal to taxpayers conscience (Hasseldine and Kaplan, 1992) and also to
feelings of guilt and shame (Erard and Feinstein, 1994). Others have suggested more
positive help for taxpayers (Hite, 1989) and different methods of achieving this - such
as the use of television to change taxpayers attitudes towards fairness and compliance
(Roberts, 1994) and information campaigns about the public goods and services paid
for by taxation (Leder, et al. 2010).

Experimental work has also generated some potentially useful insights and one of
these is the echo effect Kastlunger, et al. (2009). This is the idea that tax audits can
reverberate in a taxpayers mind and increase their compliance with the tax system in
the future. Experimental evidence suggests that when taxpayers are audited early in
their taxpaying careers this can lead them to overestimate the probability of being
audited in the future and thus increase their compliance. However the echo effect may
be much less if such a tax audit is only undertaken after an individual has experienced
many years without such an audit. There are other ideas coming from experimental
evidence, such as the bomb crater effect (Mittone, 2006), which may be less
convincing. The term comes from the observation that troops in battle take cover in
the craters of recent explosions thinking it unlikely that subsequent shells will fall in

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exactly the same place. Similarly it is conjectured that some taxpayers think a tax
audit will not soon be followed by another one. However it is not known how
significant such an effect might be in practice, particularly as tax authorities are likely
to pay additional attention to less compliant taxpayers. Nevertheless all such aspects
are worth exploring. In addition, a similar development to behavioural economics has
taken the form of responsive regulation and to this we now turn.
4. RESPONSIVE REGULATION IN TAXATION

Like the behavioural approach, the development of responsive regulation has made
an additional contribution to regulation including its application to taxation. There
have been some valuable contributions such as those by Braithwaite (2007), Kirchler
et al., Leviner (2008) and Ventry (2008). Responsive regulation fits well with
behavioural economics as Valerie Braithwaites (2007: 5) comment illustrates:

Responsive regulation is a complex business. It welcomes the voice of

dissidents, it deliberates on shared community goals and understandings, it
enforces agreed upon standards, preferably through teaching, persuading and
encouraging those who fall shortIt seeks to dismantle any formula that
presumes that individuals or groups are uniformly programmed in the way
that they will respond to regulatory demands.

Since responsive regulation is also based on taxpayer motivation, further

developments may benefit considerably from insights generated by behavioural
economics. Essentially, the idea is that the response to non-compliance should be
related to the reasons for non-compliance. Official activity with respect to taxpayers
may therefore vary from the case of individuals or firms who are deliberately non-
compliant to people who are trying to comply and simply need help to do so. In terms
of taxation, there have been considerable developments, not least in Australia and
New Zealand and the approach is illustrated in Figure 2 where the action taken by the
tax authorities is responsive to taxpayers willingness to comply.

Responsive regulation involves taking account of a range of factors which may affect
the response of taxpayers to changes in legislation, supporting taxpayers in meeting
their obligations to comply and recognising that different taxpayers may respond in
different ways. Baldwin and Black (2008: 59) go on to suggest that really responsive
regulation with respect to firms seeks to add to current theories of enforcement by
stressing the case for regulators to be responsive not only to the attitude of the
regulated firm but also to the operating and cognitive frameworks of firms; the
institutional environment and performance of the regulatory regime. The next task is
to consider these ideas with respect to tax authorities themselves.

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Figure 2
Compliance Model Developed in Australia and New Zealand

Taxpayer decides
not to comply Force of
the law
*******

Do not want Deter by

to comply detection

**********

Try to but Assist to

dont always comply
succeed
*********

Willing to Make it
do the easy
right
thing

create pressure downwards

Attitude to compliance Compliance strategy

Source: James (2006)

5. RISK MANAGEMENT AND THE TAX AUTHORITIES

The approach of behavioural economics may also contribute to avoiding the risks of
poor performance of the part of tax authorities themselves since, of course, tax
officials are also human! In a study of Australian taxpayers and tax officials, Kirchler
et al. (2006, p. 515) concluded that treating taxpayers reasonably and fairly, explaining
rules and decisions and providing reliable information will improve the reputation of
tax officers which may lead to an increasing willingness to comply with the spirit of
the law. Unfortunately, a poor level of service may lead to the opposite outcome and
sometimes tax administrations can face difficulties even - paradoxically when
spending considerable effort on changing their management systems.

Also unfortunately, tax administration in the UK provides an illustration of such

difficulties, with a major merger, a substantial cut in resources and a radical change in
management culture involving private sector techniques based on rational rather than
behavioural principles. Indications of problems had been emerging for some time
with taxpayer complaints about the failure of HM Revenue and Customs (HMRC) to
respond to telephone calls and letters. In addition there were several serious errors
which affected millions of taxpayers and the difficulties increasingly attracted official
attention. The Treasury Select Committee (2011, Conclusions and
Recommendations, para. 46) report on HMRC concluded:

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The evidence we have received in this inquiry has been disturbing. HMRC's
delivery of services to the general public has fallen to unacceptable levels in
several areas. Many factors have contributed to this process: overly
ambitious expectations for IT projects, sustained cuts to resources, a
management culture of command and control, increasingly complex tax
legislation and the legacy of the merger.

The Treasury Select Committee (2011) also looked specifically at management issues.
It reported that the Cabinet Offices people survey of Autumn 2010 ranked HMRC
bottom of the entire civil service indeed the HMRC score was even lower than in the
previous year. The Committee stated in its conclusions and recommendations (para.
4) that:

The evidence we have received about the management culture within

HMRC, supported by the staff survey results, is very disturbing. There is a
perception that the Department is run on the principles of close control and
management scrutiny, with little opportunity for individuals to develop
autonomy and exercise their skills. Whilst there is a need for consistency in
dealing with people's tax affairs and appropriate performance management, a
culture such as the one described to us is likely to harm staff morale and lead
to disengagement and poor performance.

The first of the factors mentioned above the merger between the Inland Revenue and
Customs and Excise to form HM Revenue and Customs - took place in 2005. Both
departments had very long and well-established but different cultures and
organisation. The Financial Times (9 July 2004), described the merger as the mating
of the Inland Revenue retriever with the Customs and Excise terrier. The Inland
Revenue was primarily responsible for direct taxation and its origins can be traced
back to the Board of Taxes established in 1665. A separate Board of Stamps was set
up in 1694. Customs and Excise was responsible for collecting customs duties, excise
duties and value added tax and also had certain agency functions. The role of customs
officers can be traced back to the thirteenth century and a Board of Customs to the
seventeenth century. After the merger of the two departments HM Inspectors of Taxes
and other tax officials were all designated Officers of Revenue and Customs, which
may not have helped morale either.

In addition to the merger, the resources available to HMRC are being reduced it is
required to reduce its running costs in real terms by 25 per cent by the end of 2014-15
(National Audit Office, 2011, para. 3). Both the merger and the cut in resources were
likely to lead to difficulties but the focus here is on managerial change where a
behavioural approach may have most to offer.

The management changes at HMRC can be seen as a feature of the New Public
Management (NPM) in many countries as described, for example, by Pollitt and
Bouchaert (2011). NPM takes a business-like approach to public sector management
and places a greater emphasis on performance particularly through the measurements
of outputs, market-type mechanisms and treating service-users as customers. As
Pollitt and Bouchaert, (ibid. p. 10) point out, a number of commentators have
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observed tensions between the economistic low trust way of thinking involving
rational systems of rewards and punishments and a more behavioural way of thinking
with a greater trust in the inherent creativity of staff provided they are properly led and
motivated.

The implicit economistic assumption of some fashionable management theories may

account partly for their initial appeal. Managing people within a formal and rational
structure with incentives, targets and so on seems consistent with a basically logical
process and to promise improvements in efficiency. Indeed, there has been comment
about such theories being advanced in this way by vested interests. For example,
Newall et al. (2001, p. 8) describe active management fashion setters (consultants,
gurus, IT suppliers, professional groups and so on) developing rhetorics about best
practice...by echoing felt gaps in efficiency and performance. It was put even more
clearly by Baskerville and Myers (2009, p. 647) who defined a management fashion as
a relatively transitory belief that a certain management technique leads to rational
management progress.

With respect to the UK and the HMRC, concerns have been examined in the academic
literature (for example by, Carter, et al. 2011a and 2011b). One issue of concern has
been the use of lean techniques at HMRC. Such techniques were developed in the
business sector, primarily in the motor industry, and the central idea is that removing
wasteful processes from production will lead to improvements in efficiency and
quality (see for example, Womack et al. 1990 and Holweg, 2007). It was an indication
of how things were to be changed that Sir David Varney from the private sector joined
HMRC in 2004 and was appointed as the first Chief Executive of the newly merged
HMRC 2005. Also in 2005 it was decided to introduce lean management techniques
across HMRC and lean management formed a major part of the PaceSetter
Programme which had the aim of improving business performance and staff
engagement (National Audit Office, 2011, para. 5). In a review for HMRC, Radnor
and Bucci (2007, p. 20) found that the principles of lean management were absorbed
by HMRC staff and there was a very good understanding of the background to Lean
and its principles across all the sites they visited and across all grades of staff. They
also found that the most commonly cited principles of Lean were customer focus,
developing and improving standard processes, increasing efficiency, removing waste
and increasing productivity and quality. In a later paper, Radnor and Bucci (2008 as
quoted by Carter et al. 2011a) stated that HMRC are the closest of any public service
to date in implementing the Lean philosophy.

Furthermore it was anticipated that the changes would address the requirement to save
resources. For instance the Varney Review (2006, p. 5) by Sir David Varney required
an improvement in public sector contact centre performance by establishing
performance targets and best practice benchmarks [so]reducing operating costs
by 25 per cent.

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No doubt changes in tax administration are necessary as the tax environment and
technology change but possibly there was insufficient appreciation of advantages of
the methods of tax administration that had developed over long periods. There were
also concerns whether such management techniques were entirely appropriate in such
a public sector context. Indeed there has been a growing body of evidence that this
approach is associated with some undesirable outcomes.

A study by Carter et al. (2011a and 2011b) of HMRC staff in 2008/09 involving an
initial interview analysis followed by a questionnaire survey produced results that
were some way removed from the advantages claimed for such management
approaches. They found that the fragmentation of processes and the imposition of
hourly targets had adversely affected quality and productivity, there had been a
negative impact on non-targeted work, a loss of control and discretion leading to
deskilling and difficulties for managers and supervisors in managing effectively as
their attention was focused on statistical information. A conclusion of particular
concern was that while statistics may reveal productivity and performance
improvements, further investigation reveals that they are constructed accordingly and
collusion in this process occurs on many different levels (Carter et al. 2011a, p.120).
In a further paper on the subject, Carter et al. (2011b, p. 94) concluded that the
enforcement of the appositely named lean PaceSetter system generated a series of
damaging outcomes for a hitherto skilled and loyal public servant workforce, with
much previously skilled service reduced to little more than semi-skilled assembly line
work (p.95).

A behavioural perspective of such issues has considerable advantages over such an

approach. Echoing Veblens comment above, in a management context, Kaufman
(1999, p. 387) suggests that the closest real world approximation of economic man
and the model of self-interested rational choice is a child under eight years old where
behaviour can be predicted on the basis of getting what you want makes you happy.
Kaufman concludes that, although the rational choice model is a powerful device, it
cannot adequately explain employee behaviour in many cases. In contrast, behavioural
economics has indicated directly some of the advantages of management based on
employee involvement, commitment and empowerment[but not]employee
control (Tomer, 2001, p. 64). Indeed there is substantial evidence that using workers
contributions in this way produces better results in complex situations than have more
mechanistic approaches to management.
5.1 Fairness

A further general concern in the UK in the recent past has been the fairness of tax
administration. As pointed out above, behavioural economics recognises the
importance individuals place on fairness in a way that the rational approach does not.
In taxation this can mean the difference between a successful tax and a failed one
such as the UKs community charge (James, 2012). HMRC has been the subject of
considerable press coverage about the allegedly favourable terms granted to certain
very large organisations but not to the great majority of taxpayers. One of the
conclusions of the Public Accounts Committee (2011) was:

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risks of tax administration

The Department is not being even handed in its treatment of taxpayers. It is unfair
that large companies can settle their tax disputes...at less than the full amount due
and that they have been allowed up to 10 years to pay their tax liabilities, while
small businesses and individuals on tax credits are not allowed similar leeway.

While the approach of doing deals with large taxpayers might be consistent with a
business-like approach described above, it can undermine the public sector ethos of
tax administration and therefore the tax morale of the vast majority of individuals.
6. CONCLUSION

Mainstream economic analysis, based on the self-interested rational choice model, has
proved to be a powerful means of understanding taxation. However this approach has
its limitations and a more comprehensive approach can be developed by drawing on
behavioural economics. Tax authorities have managed risk throughout the history of
taxation but in recent years there have been considerable developments in applying
risk management to tax administration by the European Commission, the OECD and
others. There have also been considerable developments in behavioural economics.
These offer valuable insights regarding taxpayer behaviour and many further
applications are likely to prove worthwhile. Responsive regulation has also
contributed to a more sensitive approach to managing taxpayer risk and is based on
taxpayer motivation. Responsive regulation may also benefit from applications of
behavioural economics.

Taxpayers are also affected by the operation of tax agencies. Individuals who are
treated reasonably and assisted effectively where appropriate are more likely to
comply with the spirit of the law than individuals who are poorly treated. Insights
from behavioural economics may not only be helpful in improving taxpayer
compliance but also the performance of tax officials. A particular aspect has been the
development of management methods used within tax authorities themselves.
Unfortunately management techniques, often transplanted from the private sector and
based on the self-interested rational choice model, have not always delivered the
promised benefits. Some of the difficulties arise because tax authorities are not market
based profit maximizing organizations. However, difficulties may also arise because
tax officials have to deal with important and complex issues in a public sector context.
The performance of tax officials may be enhanced if they are able to develop a
professional approach to their duties rather than be subject to more mechanistic
methods of management.

In conclusion, there is evidence to suggest that many taxpayers do not act in their own
immediate self-interest by pursuing every possible opportunity to avoid or evade
taxation and so do not have to be tightly regulated. Rather, there may be significant
advantages in shifting the emphasis of tax compliance policy towards treating the
majority of them as responsible citizens and using the insights of behavioural
economics to do this in the most effective ways. Similarly using a more behavioural
approach might avoid the disadvantages of some managerial systems being employed
in tax agencies with outcomes such as those noted above. Developing a professional
approach among tax officials would also encourage responsible citizens to fulfil their
tax obligations.

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risks of tax administration

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