Let's talk: the role of responsive regulation in Australia

Let's talk

More and more regulators are following the ATO’s example of using less of the big stick approach and more of the consultative process in dealing with business.

In 2011, the then assistant deputy tax commissioner Stuart Hamilton CPA and his team at the Australian Taxation Office (ATO) identified 17 large businesses they considered to be at high risk of breaking the tax rules.

At this point, many tax authorities would have sent in teams of auditors and lawyers. Instead, the ATO got in touch and starting talking. They worked through the issues, clearing up misunderstandings and identifying grey areas of the law. They gradually whittled down their list of issues to the point where, by the following year, just one remained – with a business whose owner had made challenging tax rules part of his “high risk, high return” strategy.

By the time Hamilton – now a Washington-based consultant to the International Monetary Fund (IMF) – left the ATO in 2014, he estimated that among the large companies that were the focus of his group’s work (those with an annual turnover of A$250 million or more, who together accounted for about 60 to 70 per cent of the company tax take), the compliance rate was between 92 and 95 per cent. 

As an exercise in what is called responsive regulation, it was a gratifying result.

Responsive regulation’s origins

The ATO did not invent responsive regulation. The idea came from Australian sociologist John Braithwaite and US law professor Ian Ayres, who together turned regulatory thinking on its head in their 1992 study, Responsive Regulation: Transcending the Deregulation Debate. 

Braithwaite and Ayres made the case for regulators to improve compliance by understanding the behaviour of those they regulated, and shaping their strategies to suit. Most people dealing with regulation are trying to do the right thing, they argued, and when they don’t it is often because of misunderstanding, ignorance or simple inability. Smart regulation should make it as easy as possible for those willing to do the right thing.

The two authors explained their ideas with a regulatory pyramid, where the greatest emphasis is on consultation, education and persuasion. Enforcement action escalates through regular reviews, warnings and audits for those who cannot or do not want to comply – with prosecution only for those determined not to comply.

Building trust and confidence

The shift to responsive regulation has been spurred by regulators’ expectations of better, more effective and less costly compliance. 

That’s an especially attractive proposition for agencies such as the ATO, for whom litigation is a major expense. On top of its in-house lawyers, the ATO paid A$47 million in external legal costs in 2014-15.

The ATO began looking at responsive regulation well over a decade ago, making it perhaps the first big regulator to adopt the approach. 

Encouraged by its experience with large firms, the tax collection agency has now adopted responsive regulation for small businesses as well.

For the past three years, the ATO has been developing what deputy commissioner for small business Steve Vesperman says is a more sophisticated and consultative approach aimed at building trust and confidence in the system.

More recently, the agency has been promoting its new stance through its own small business newsroom on its website, as well as roadshows, meetings with small businesses and tax advisers and the development of an ATO app. Vesperman says the approach has already resulted in an increase in voluntary compliance.

This does not mean the taxman has suddenly become a soft touch. Hamilton says the Tax Office will generally take a lenient view of taxpayers perceived to be trying to do the right thing. 

Yet as its legal bill shows, the ATO still resorts to the courts when necessary. Those deemed to be careless and negligent can expect to be audited and possibly penalised. Those judged aggressively non-compliant face investigation and possible civil or criminal action. 

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Partners against crime

At the Australian Transaction Reports and Analysis Centre (AUSTRAC), chief executive Paul Jevtovic is spreading the same responsive philosophy. 

AUSTRAC acts against threats to Australia’s financial system, including incursions by organised crime and attempts to use the system for money laundering or to fund terrorism.
Jevtovic says it is a task that AUSTRAC cannot, and should not, seek to do alone. He argues that AUSTRAC will succeed best through close engagement with banks, remitters and other organisations. 

“The day of the big stick is gone,” he says. “I want there to be a culture of trust between AUSTRAC and the regulated entities. Let’s trust everyone until we have reason not to.”

In it together

An increasing number of other countries and sectors have likewise taken the leap. The approach has spread beyond Australia to the UK, Canada, New Zealand, the Netherlands, the US and the European Union.

An international study – Applications of Responsive Regulatory Theory in Australia and Overseas, conducted by the US-based Social Science Research Network in March 2015 – found responsive regulation has been applied in areas as diverse as public administration, health, agriculture, mining, pharmaceuticals, welfare systems, communications, transport, energy and the environment. 

Hamilton, acknowledged as a leading expert in the field, is in demand as more countries and sectors examine the possibilities. As well as his consultancy work with the IMF, he has recently completed a report on improving taxpayer compliance in Romania and has addressed the Organisation for Economic Co-operation and Development on the issue. 

Twenty-five years after Braithwaite and Ayres gave the idea life, responsive regulation appears on its way to achieving orthodoxy. 

It pays to dig deeper

Former ATO assistant deputy commissioner Stuart Hamilton recalls how, in 2006, his section was involved in an investigation of a failed mass tax avoidance scheme. One of those who had signed up to the scheme was a goldminer in Kalgoorlie, Western Australia, and he, along with dozens of other participants, were sent letters of demand from the ATO.

Hamilton and his colleagues were baffled that the man made no response, even when they threatened to seize and sell his property, and an official went to talk to him in person. The reasons for the man’s stubborn silence quickly became apparent: “The guy was basically illiterate; he could not even read,” says Hamilton. “He was just out of his depth.” 

Once the situation was explained to him, the miner reached agreement with the ATO and paid his tax bill.

Changing mindsets on both sides

For the past three years, the ATO’s small business unit has been changing a work culture built around enforcement to one of engagement, education and problem-solving.

The pyramid of complianceDeputy commissioner for small business Steve Vesperman says the emphasis is on prevention – “getting up-front and assisting taxpayers before they get into trouble, rather than dealing with a bigger and more complicated mess down the track”.

However, moving to an outlook in which taxpayers are considered clients and made the central focus of operations is no easy process.

Former ATO assistant deputy commissioner Stuart Hamilton, who pioneered the implementation of responsive regulation at the agency, says part of the problem is that tax officials involved in an audit or pursuing a tax debt usually have no sense of why taxpayers might have behaved the way they did or how that behaviour fits into the relevant market. From this narrow viewpoint, every taxpayer is viewed with suspicion – a mindset that’s anathema to building trust and cooperation.

Hamilton says a much richer understanding of taxpayers is fundamental to transforming such attitudes.

Those being regulated need to play their part by shrugging off the instinct to hide and dissemble. They must be willing to take officials into their confidence and share with them often very sensitive information.

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