The Underground Economy (UE) is a significant global problem that causes economic erosion for all participants in the financial eco-system. However, it also presents an opportunity for professional tax and financial advisors to rise to the occasion in educating their clients on the issue.
By definition, when people participate in the UE, they under-report or fail to report sales or income, thereby minimizing or completely avoiding the payment of tax. Think about the disadvantage that this presents for law-abiding organizations and individuals: it’s not possible to provide competitive bids for business against organizations that don’t pay taxes, nor is it possible to maintain employment levels or build community wealth and standards of living.
The OECD (Organisation for Economic Co-operation and Development) prepared a good overview of the issue a year ago, in its Statistics Brief #18 of June 2014. The most significant problems associated with the UE on a macro level include an inability to analyze economic growth, employment and productivity, the abuse of social insurance programs and the erosion of tax revenues. But most important is the erosion of trust in public institutions, which may, the paper states, lead to “a suboptimal design of policies and institutions.” That’s serious stuff.
Canada is one of 19 countries that has participated in providing data to the OECD survey in 2011-12 and in a survey by the United Nations Economic Commission for Europe (UNECE) in 2005. Fortunately, we are second amongst the countries participating, for the lowest level of underground activity. That’s certainly great news and something we can be proud of as a nation… although there is the opportunity to be first and best on this list.
Last November, CRA announced a three-year initiative to combat the UE, noting that, “Since 2006, the percentage of the GDP for the underground economy has dropped to 2.3%.” The Minister announced three strategic themes in the effort to reduce the UE in
Canada on a go-forward basis:
- To better understand the scope of the UE
- To reduce social acceptability of participation in the UE
- To deploy a range of initiatives to encourage voluntary compliance
What can professional advisors do to help? To begin, adopting the three-part role that Knowledge Bureau sets out for students in its Master and Distinguished Financial Advisor Programs is an important opportunity. To be an educator, advocate and steward of family and community resources, requires a conversation about the benefits and responsibilities of full compliance with the CRA. There are three key ways to have a professional impact on the issue:
- Encouraging the Prompt Filing of Tax Returns. Full participation within the tax system requires the filing of an audit-proof tax return under the personal, corporate and sales tax systems. Professional advisors can articulate the benefits of avoiding penalties and managing documentation requirements, made so much easier with electronic software applications.
- Encouraging Full Use of Social Benefits. Participation in financial risk management opportunities, initiated by the filing of a tax return, include the receipt of refundable tax credits which redistribute income, the building and funding of RRSP and TFSA contribution room, and the contributions to public programs like the Canada Pension Plan (CPP) and the Employment Insurance (EI) plan. Professionals can explain each of these plans and how they work to empower their clients to fully participate in the benefits of the tax system.
- Encouraging Legitimate Tax Planning. Participation in the use of legitimate tax preferences available in specific situations is important (for example, Canadians with costs of child care, moving, certain employment expenses, unreimbursed medical or charitable donations qualify for special tax deductions and credits). By teaching clients how to arrange affairs within the intent and framework of the law, to pay only the correct amount of tax, in contrast to tax evasion, can encourage full compliance with a tax system that is, for the most part, fair and equitable.
Complexity, of course, is an obstacle to tax compliance, but again, this is where the role of a designated professional can really add value. As an educator and advocate for client rights, the tax and financial professional plays a direct role in the stewardship of Canada’s financial ecosystem.
Doing your part to teach tax literacy with your clients and in your community, in short, is a noble contribution in the fight against the Underground Economy.