December 1-2, 2011

1. Understanding the Creation of Tax Debt Enikő Vermes / Snezana Vucic / Tina ThibertInternational Conference on Taxation Research and Analytics December 1-2, 2011

2. Outline • Tax Debt Management • Canadian Context • Canada Revenue Agency • Debt Management Programs • Debt Management and Business Intelligence • Research Series in 3 Phases • Overall Objective • Phase 1: Filing and Remitting Compliance from 2000 to 2005 • Phase 2: Attitudes towards Debt • Phase 3: Factors Affecting the Creation of Debt on Initial Assessment • Translating Research into Operational Action • Research Impact

3. Canada Revenue Agency • Administers tax, benefits, and related programs and ensures compliance on behalf of governments across Canada • Framework based on voluntary compliance and self-assessment The Canada Revenue Agency (CRA) plays a key role in Canada’s economy:

4. Canadian Context Filing Tax Return • The Income Tax Act (ITA) states that all individuals have to file their income tax return on or before: • April 30th, or • June 15th if they are self-employed Paying Tax • The ITA requires individuals to pay any assessed amount payable on or before April 30th • Interest is charged, starting May 1st, on any unpaid amounts owing • Late-filing penalty is applied if a taxpayer owes taxes and does not file his or her return on time Remitting Tax • Depending on the income source, third parties are required by the ITA to withhold tax on any amounts paid to a taxpayer • Taxes are not deducted from self-employment income, investment, and property income or certain pensions. Recipients must remit the tax payable on such income directly, either through instalments or on filing their return

5. Debt Management Programs at the CRA • Debt Management Programs support CRA strategic objectives • Ensures compliance with tax laws for filing, withholding and, payment requirements, including amounts collected or withheld in trust • Debt Management Programs uses a progressive risk-based approach to allocate work • High-volume, risk-based collections and compliance strategies that leverage paper or electronic mediums, automated system responses (actions) and/or telecommunications • More complex, and higher risk collection actions, including enforcement, where intervention by a field officer is either immediately required or foreseen to be required and where other softer strategies are no longer appropriate and/or effective to resolve the debt

6. Debt Management Programs:Business Intelligence and Evidence-Based Decision Making • There has been a history of escalating receivables • Challenge is to prevent further escalation and to manage new and existing debt • To address this challenge, the CRA undertakes research to systematically identify and examine factors affecting tax debt • Debt Management Programs is working towards institutionalizing analytics such that insights provided by research will influence strategic and operational decisions

7. Research Series in 3 Phases • The purpose of this research was to enhance our understanding of the creation of individual tax debt in Canada • To determine when, where and how debt becomes a issue, the research focused on: • Tax at risk • Debt on initial assessment • To allow the CRA to move from research concepts to action by aligning its research objectives with debt management program requirements

8. Phase 1: Filing and Remitting Compliance Tax Years 2000 to 2005 • Exploratory analysis of administrative databases • Assessment and financial data • Building knowledge on use of CRA databases • Data exploration helped improve quality of data • Developed in-house data expertise • The use of administrative data has enabled CRA • To gain greater insight into taxpayer behaviour • To enhance the ability to use large amounts of taxpayer data

9. Phase 1: Filing and Remitting Compliance Tax Years 2000 to 2005 - Data Mining • Objective • To identify trends or patterns relative to individual taxpayer filing and remitting behaviour for tax years 2000 to 2005 • Method • Comparative Analysis • External: Census and Labour Force Survey Data • Internal: Administrative Data • Longitudinal Study • Explored at a micro-level how taxpayer behave over a 5-year period in regards to filing Issues • Issues • Linkages between administrative, financial and external data • Application of findings for strategic planning at the program level

10. Phase 1: Filing and Remitting Compliance Tax Years 2000 to 2005 -Data Mining (cont’d) • Major Findings • Canada has a high participation rate in the Income Tax System, where most Canadians over the age of 20 are compliant in filing a tax return • Three-quarters of all T1 taxpayers had no tax owing at the time of filing • Identified relationships between late filing and debt creation, as well as late filing and becoming a long-term collections case • Filing non-compliance appeared to be a persistent behaviour

11. Phase 2: Attitudes Towards Tax Debt • Objectives • To obtain greater in-depth understanding of what qualitative factors influence whether an individual will be compliant or non-compliant with the requirements to file on time and to pay their tax liability to the Government • To determine the perceived efficacy of penalties and interest • Method • Contracted to Sage Research Inc. • 8 Focus Groups conducted in 4 Canadian locations

12. Phase 2: Attitudes Towards Tax Debt - Focus Testing • Major Findings • The majority of respondents believe that filing and payment compliance is the “right thing to do” • The main reason given for late filing was inability to pay the full amount owing at the time of producing the return • Avoidance of internal pressure – don’t have to think about it • Avoidance of external pressure – the CRA • Late payments are caused for a variety of reasons • Unanticipated amount owing • Cash flow – unexpected expenses or revenue losses • Lack of awareness of partial payment options • “Lack of money” is really about spending priorities • Penalties and interest act as a deterrent method for some, but not for others • Lack of awareness of the charges and how they are calculated

13. Phase 3: Factors Affecting the Creation of Debt on Initial Assessment • Objectives • The main objective was to determine the most important factors that create debt on initial assessment • To identify demographic, behavioural, and administrative elements that increase the odds of filing a debit return • To develop a comprehensive demographic and income profile of the debit population; and to assess compliance and collection risks • Method • Logistic regression was applied to factor in the impact of independent (explicative) variables on the dependent (response) variable • Taxpayer history built by gathering information on debtor taxpayers for previous tax years • To study the status of taxpayers in collections, data was extracted using five snapshots of collections historical data

14. Phase 3: Factors Affecting the Creation of Debt on Initial Assessment – Logistic Model • The dependent (response) was a binominal variable indicating whether or not tax was due at the time of the initial assessment • The independent variables were grouped into three types of factors: demographic, behavioural and administrative elements and they are as follows: • Since our goal was to discover relationships between the variables and no a-priori assumptions regarding relationships were made, the stepwise method of field selection was applied • The model is based on 3.6 million tax filers with a debit and a random sample of 3.4 million taxpayers with credit or zero net balance at the time of initial assessment

15. Phase 3: Factors Affecting the Creation of Debt on Initial Assessment –Logistic Model (cont’d) • The predictive success of the logistic regression was assessed by looking at the classification table, showing correct and incorrect classifications of the dichotomous (1 or 0) [1] Pseudo R2 (Cox & Snell R Square/Nagelkerke R Square) summarize the strength of the relationship [2] Hosmer and Lemeshow chi-square test is used to test the overall model of goodness-of-fit test. It is the modified chi-squaretest. Significant p value shows the goodness-of- fit model.

16. Y = -1.06 + 0.602 *X1 + 1.29 *X2 + 0.48*X3 + 1.20 *X4 + 2.22 *X5 + 2.22 *X6 + ε Phase 3: Factors Affecting the Creation of Debt on Initial Assessment – Logistic Model (cont’d)

17. Phase 3: Factors Affecting the Creation of Debt on Initial Assessment – Logistic Model • Major Findings • Likelihood of creating debt on the initial assessment increases when taxpayers: • are not compliant regarding their instalment requirements • report any type of self-employment income • whether by itself or in combination with other income source • file late • have a history of payment and/or filing non-compliance • have a history of filing debit returns • have a substantive drop in income in the year of the initial assessment

18. Translating Research into Operational Action • The CRA regularly reviews its programs to identify business risks • Risk frameworks utilize debt management research to provide insight into strategies that allow better prioritization of work • Action plans established from frameworks are influenced by debt management research

19. Research Impacts Operational Program Impact • Debt Management Research provides the CRA with the necessary intelligence to continually improve its strategies and programs by providing sound business intelligence • This research enables CRA to align workflows to better assign and collect debt cases more effectively and efficiently by ensuring that the right account is assigned at the right time to the right strategy Building Research and Analytic Capacity • Debt Management Research provides the CRA with the necessary intelligence to continually improve its acquisition and manipulation of data, as well as to continually expand tool and resource knowledge on how to manage that data • Enhancing in-house expertise for the application of statistics within the debt management framework

20. Contact us Enikő Vermes (eniko.vermes@cra-arc.gc.ca) Snezana Vucic (snezana.vucic@cra-arc.gc.ca) Tina Thibert (tina.thibert@cra-arc.gc.ca) Canada Revenue Agency Taxpayer Services and Debt Management Branch Debt Management Research and Analytics Directorate 25 McArthur ave, 4th floor Ottawa ON K1A 0L5