The latest news from the accounting firm front — KPMG’s apparent failure to register a tax shelter — offers strong support for an assertion by Nobel Laureate Gary Becker.
Becker, famous for his applications of microeconomics theory to marriage and family decisions, argued that thieves make a rational cost-benefit decision before committing crimes. Thieves estimate the value of what they will steal and compare that to the monetary value of any penalty if they are caught multiplied by the probability that they do get caught.
The conclusion is that if you want to deter criminal activity, you need to increase the penalties for crimes or the probability that criminals get caught or both. The deterrent effects of severe punishment and more policing are not new ideas. But Becker cast these common assumptions into a new rational profit-maximizing model.
Many criminologists and economists were skeptical. Yes, some criminals do take the likelihood and severity of punishment into account. But other, less rational, motives play a big part in decisions to break the law. Becker’s ideas do not predominate in criminal justice studies.
Those who champion Becker’s style of analysis will find vindication in recent news about KPMG. Like its peers, the major accounting firm makes a lot of money from devising increasingly arcane schemes to enable their corporate clients to avoid paying taxes.
Such tax shelters must be registered with the Internal Revenue Service. But registering a new tax dodge discloses ingenious new stratagems to competitors and thus cuts into the fees generated by the firm that designed it.
KPMG reportedly made a Becker-like decision to break the law and not register a new tax avoidance plan. As last Monday’s Wall Street Journal reports, a KPMG tax partner presented the cost-benefit analysis about marketing one of the firm’s tax-shelter strategies.
According to the partner’s memo, KPMG calculated it would make $300,000 per shelter sold but pay only $31,000 in penalties if discovered. The Wall Street Journal quoted this part of the memo: “The rewards of a successful marketing of the product (and the competitive disadvantages which may result from registration) far exceed the financial exposure to penalties that may arise.”
Let me take back any reservations I ever expressed about Becker’s thesis, at least as it applies to white-collar crime. There it is, in black and white — one of the nation’s largest and most prominent accounting firms saying, in effect, “Let’s break the law because the money we will make from doing so will far exceed any penalty if we get caught.”
U.S. Sen. Norm Coleman, R-Minn., has a subcommittee that is investigating this sort of malfeasance. What should senators recommend for corrective legislation?
Becker’s advice would be clear: Raise the penalty for sneering at the law. Raise the penalty from a flat $21,000 per offense to the total revenue gained plus a 100 percent surcharge. Increase IRS surveillance of big accounting firms. Then, even the most amoral and calculating malefactor will think twice before writing this type of memo.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.