Is the jockey encouraged to flog the horse? The incentives facing Canada Revenue Agency’s tax auditors

October 6, 2020
David Williams

The Canada Revenue Agency (CRA) administers the tax laws for the Government of Canada and most provinces and territories. CRA’s goal should be to administer the tax system in a fair, efficient, and unbiased manner. Its conduct should promote voluntary compliance and deter and punish tax avoidance. However, there is concern in the business community about the apparent decline in the quality of CRA audits over a number of years. These concerns are in respect of:

  1. Audit duration. There is a cost to economic activity in that the firms’ staff, equity and working capital can be tied down for many years dealing with CRA requests for information, awaiting reassessment (if any), and the outcome of appeals and/or court challenges.
  2. Uncertainty. A cloud of uncertainty can hang over the firm for the life of the audit – regardless of its outcome – and may constrain the firm’s ability to take on new projects or attract investors.
  3. A high proportion of reassessments end up being reversed in the taxpayer’s favour through appeals and/or court challenges. There appears to be little accountability borne by the CRA in respect of reassessments that end up being substantially reversed in the taxpayer’s favour.
  4. A high number of reassessments appear to be issued just before CRA’s own accountability deadlines. There can also be requests for the taxpayer to waive statute-barred periods.

In its 2016 and 2017 budgets, the federal government ramped up funding and set new fiscal targets for the CRA. A recent C.D. Howe Institute e-brief examines some of the new incentives facing CRA auditors that might be unwittingly exacerbating the apparent decline in tax audit quality. The authors highlight:

  • Funding increases for CRA in the 2016 and 2017 federal budgets included the goal that an extra $5 of tax revenue would flow into the government’s coffers from every extra $1 spent on audits. This ratio is known as CRA’s “fiscal impact”. Historically, however, this ratio has been closer to 2 to 1.
  • CRA may be overstating its fiscal impact. Its figures do not account for reassessments that are subsequently reversed in the taxpayers’ favour through appeal or court challenge.
  • CRA’s fiscal impact targets are now explicitly tied to its estimate of the “tax gap” – how much revenue theoretically exists less how much is voluntarily paid. In other words, CRA’s actual performance is being measured against an abstraction – a metric that is neither observable nor verifiable.[1]

Overall, the authors contend that the funding increases, the higher fiscal impact target, and its explicit link to the unobservable tax gap may have intensified incentives for CRA auditors to increase their assessments and to overstate fiscal impacts by not adjusting for subsequent reversals. While data is sparse, two Auditor General of Canada reports on the CRA in 2016 and 2018 provide some data suggesting the authors are on the right track.

Recommended changes

To address these issues, the authors of the C.D. Howe Institute study recommend:

  1. The fiscal impact metric should be discontinued as a target. They suggest a better target is “validated risk”, which is currently only used internally and may need further development. Validated risk indicates CRA’s confidence in the tax system based on its risk assessment process and taxes being paid voluntarily. It is similar to the “tax assured” concept recommended by the OECD.
  2. If CRA must continue to use fiscal impact as a target, it should at least be adjusted for final taxpayer assessments. CRA auditors should not be incentivized to maximize reassessments and then overstate the actual revenue impact by ignoring subsequent reversals through appeals or court decisions that favour the taxpayer.
  3. The CRA should not use the unobservable tax gap as a performance target.

The Business Council of B.C. endorses these recommendations and will include them in our advocacy efforts with the federal government going forward.


The importance of fair and timely CRA tax audits is well summarized by the paper:

The importance of Canada Revenue Agency (CRA) audits to the administration of the Canadian tax system is self-evident. So is the need for CRA to conduct high-quality audits. While audit outcomes are subject to appeals and court challenge, it is not desirable to rely frequently on appeals and the courts to ensure that the tax rules are fairly applied. (page 1)

The role of the CRA in ensuring compliance of all Canadian taxpayers is important to the integrity of the tax system. There are considerable challenges to determining the fair amount of tax to assess particularly when taxpayers have an obvious incentive to plan their activities to pay less tax. CRA auditors, however, have incentives to increase their assessments, and show larger fiscal impacts that are not adjusted for subsequent reversals. We recommend adjustments for these reversals to offset the incentives. (page 10)

Recent developments have amplified concerns about audit incentives, consistent with taxpayer and tax practitioner concerns over poor audit practice and audit behaviour. (page 10)

The last holistic review of the Canadian tax system was the Royal Commission on Taxation during the 1960s. Some sixty years later, Canada’s tax system is now widely viewed as antiquated and unwieldy. Prior to the pandemic, the federal government was running budget deficits, so perhaps it is not a surprise that the CRA was apparently put under pressure to squeeze more revenue from the existing tax base. Nevertheless, the extra funding and fiscal targets for the CRA introduced in the 2016 and 2017 federal budgets bring to mind the image of a more assertive jockey hoping to get more out of a flagging old horse.

The COVID-19 crisis is placing extraordinary pressure on government finances and on households and firms. BCBC has long been in favour of a comprehensive review and updating of Canada’s tax system, with a view to broadening the tax base and reducing the distortionary effects of existing taxes. The federal government should resist the temptation to try to wring more revenue out of the existing tax base simply by incentivizing the CRA to make its audits unduly aggressive or punitive. CRA’s role is to ensure the integrity of the tax system by administering it in a fair, efficient, and unbiased manner. Further, the government should review the incentives currently faced by CRA auditors along the lines suggested by the authors of the C.D. Howe paper.

[1] To give an analogy, this would be like the assessing the performance of the Bank of Canada on the extent of the “output gap” (the theoretical estimate of potential GDP less actual GDP) instead of the current 2% inflation target. Whereas inflation is observable, the output gap is a theoretical construct and can only be estimated with a wide degree of uncertainty.

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