Ethics and Tax Profession

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Ethics and the Tax Profession: Restoring thePublic Interest Focus

Martin Stuebs and Brett Wilkinson

ABSTRACT: Tax practice is an integral component of the public accounting profession.Although accountancy as a profession embraces a strong public interest notion, there is aninevitable tension in tax practice between serving the client and maintaining the integrity ofthe tax system. Resolving this tension necessitates an ethics-infused judgment process.Ethical failures over the past decade have weakened the tax profession and called intoquestion the extent to which practitioners in fact operate in a manner consistent with thepublic interest. In this paper, we explore the fundamental causes of the ethical problemsthat have plagued the tax profession and provide a roadmap for reform of the tax profes-sion. Using Cressey’s 1953 fraud triangle as a framework, we first examine the normative

ideal for the tax profession. We then examine the recent tax shelter abuses perpetrated bythe major public accounting firms and find results consistent with our expectations underthe fraud triangle analysis. In essence, ethical breakdowns resulted from the loss of apublic interest emphasis, which in turn led to the explicit pursuit of commercial gain at theexpense of the public interest. That the frauds were perpetrated within the context of aprofession founded on a public interest notion is particularly concerning. In response to theproblems observed, we identify key cultural reforms needed within the accounting acad-emy, the accounting profession, and the tax system in order to restore trust and the publicinterest character of the tax profession to center stage and so guard against further ad-verse outcomes.

INTRODUCTIONIn recent years there has been ample evidence of an ethical crisis within the tax profession.

The development of complex tax shelters and the aggressive marketing of such shelters through-out the 1990s are behaviors symptomatic of the deeper problems plaguing the profession. Fun-damentally, the problem arises from the tension inherent in tax practice between serving the clientand maintaining the public interest focus that is an integral and defining feature of a profession.Although much attention has been devoted to understanding and resolving the crises that haveafflicted the accounting profession on the audit side, much less emphasis has been placed onresolving the tax-related issues. As Sikka and Hampton 2005, 340 note, the aggressive taxavoidance behavior of the major public accounting firms “raises major questions about the as-

sumed social responsibility and ethics of accountancy firms…

but such issues attract little atten-tion in the bourgeoning corporate social responsibility and accounting literature.” Unless the un-derlying causes of the ethical problems in the tax area are investigated and appropriate solutionsexplored, the probability that such mistakes will be repeated is high. Understanding the uniqueissues facing the tax profession is therefore a high priority.

Martin Stuebs is an Assistant Professor and Brett Wilkinson is an Associate Professor, both at Baylor University.

Accounting and the Public Interest American Accounting Association

Volume 10, 2010 DOI: 10.2308/api.2010.10.1.13

Pages 13–35

Published Online: 4 November 2010



In this paper we explore both the genesis of the ethical problems observed in the tax profes-sion and propose changes to safeguard the future integrity of the profession. We achieve this byanalyzing the tax profession within the framework of the fraud triangle Cressey 1953. Thisframework suggests that violations of the public trust occur when three elements are present: theopportunity to engage in unethical behavior, incentives to engage in such behavior, and rational-ization of the behavior. Using this framework, we first examine what the tax profession should look

like. We pay particular attention to the claims of tax practice to professional status and the be-havioral attributes that would validate such claims. One such attribute concerns the claim of aprofession to operate with a public interest focus. Sociologists have long held that a profession isdistinguished, at least in part, by a public interest focus that curbs purely self-interested behaviorpatterns Toren 1975. A professional, in essence, is motivated by something beyond commercialgain. In the tax context, this is manifested in the requirement of the tax professional to balance theneeds of the client with the duty to uphold the integrity of the tax system within which the profes-sional operates.

We then examine the way in which the profession has deviated from this normative ideal inrecent years. Specifically, using the fraud triangle framework, we examine developments in thetax shelter industry and the subsequent abuses in which each of the Big 4 public accounting firms

were implicated. We present evidence from the literature that the problems observed in the taxprofession arose as a result of the profession abandoning its public interest focus in favor ofunbridled profit seeking. This is consistent with “the commercial imperatives that drove Americanaccountancy in the 1990s” Fogarty et al. 2006.

Finally, we propose several avenues for change, by which the public interest focus of theprofession might be restored. These include reforms at the academic accounting level in bothteaching and research, reforms within the profession itself, and reforms to the administration ofthe tax system. Viewing the proposed reforms within the fraud triangle framework helps demon-strate the interdependent nature of academia, the profession, and the tax system in providingsolutions to the ethical failures observed.

The remainder of the paper is structured as follows. In the next section, we provide an over-

view of the fraud triangle framework. Following that, we employ the framework to build a norma-tive ideal for the tax profession in the third section. The fourth section provides a detailed analysisof the tax shelter industry, highlighting the way in which the profession has deviated from thenormative ideal. In the fifth section, we provide recommendations for change, followed by ourconcluding comments.

THE FRAUD TRIANGLE FRAMEWORK The fraud triangle Cressey 1953 provides a helpful and well-established framework for ana-

lyzing the tax profession. A fraud, or “trust violation” in Cressey’s 1953 terminology, generallyinvolves three elements: opportunity, incentives, and rationalization. These are depicted in Figure

1 below. Two of the fraud triangle elements, opportunity and incentives, derive primarily but notexclusively from the external environment. The third element, rationalization, is internal to theindividual.

Opportunity

In the tax reporting environment, information asymmetries, uncertainty, or ambiguity combinedwith absent or lax monitoring and enforcement mechanisms can create opportunities for taxreporting fraud. The tax law is replete with “gray” areas, thus creating opportunities to exploitso-called loopholes in order to lower taxes, but which simultaneously undermine the integrity of the

Stuebs and Wilkinson 14

Accounting and the Public Interest Volume 10, 2010

American Accounting Association



tax system. Opportunities for trust violations also exist where detection risk is low. The very natureof our tax system is such that it would be prohibitively costly to monitor all tax reporting activity. TheIRS is not sufficiently resourced to comprehensively monitor tax reporting Smith 2004. Thus, thetax system is administered using a combination of self-reporting and sample auditing. As a result,

the IRS is often at an informational disadvantage in the tax reporting environment.

Incentives

Incentives serve to influence judgment Watts and Zimmerman 1986 and represent the“return” to fraudulent tax reporting. Incentives take three primary forms: economic, social, andmoral. Economic incentives involve individuals behaving in ways that maximize their ownself-interests. Economic incentives generally involve the prospect of financial gain or loss. Forexample, increasing or maintaining client fees and retaining clients provide strong economicincentives for the tax practitioner. Counterbalancing this incentive are the associated penalties andfines for violating the law or not meeting practitioner standards of responsibility.

Social incentives involve individuals’ aversion to being seen by others as engaging in wrongfulbehavior. These can be either formal or informal; for example, corporate culture creates bothformal and informal social incentives to behave in particular ways. Avoidance of legal penaltiesserves not only as an economic incentive, but also carries with it a social incentive element. Thisis because the desire to avoid adverse publicity might limit persons from engaging in fraudulentbehavior. In addition to pressures to comply, social incentives can also involve pressures toimpress by meeting or exceeding perceived social norms and expectations. Social incentives aresimilar to “subjective norms” or an individual’s perception of social pressures in the Theory ofPlanned Behavior Ajzen 1985.

Although economic and social incentives derive primarily from the environmental situation

FIGURE 1Fraud Triangle Model—Factors Contributing to Tax Reporting Frauds

Opportunity

• Situational Characteristics:

o Information asymmetries, ambiguities,

uncertainties.

o Regulation and monitoring

characteristics

Incentives

• Economic

• Social (including legal)

• Moral

Rationalization

• Categories of Rationalization

o Regulatory arbitrage

o Strategic non-compliance






external to the individual, moral incentives are internal and involve individuals’ aversion to doingsomething they consider to be wrong. Moral incentives focus on duties, responsibilities, andobligations. For example, the tax accountant has dual responsibilities to advocate for the client andto serve the public by maintaining the integrity of the tax system.

Incentive effects are both pervasive and interrelated Nelson 2003 and often conflict with oneanother. For example, economic incentives can be problematic motivators when dealing with the

nature of public goods like the accounting profession’s asset, public trust. Fox 2008, 1099provides a helpful summary of this concern, noting:

A public good is underproduced because the person creating it incurs all the costs butreceives only a small portion of the benefits , which are spread over some larger population.Each gatekeeping firm bears the full cost through lost monetary income of its contributionto the public purposes of the profession. It receives, however, only a small portion of thebenefits , since the identification-enhancing effect of the increase in the social practicearising from the particular firm’s contribution is spread over all the agents working in theentire gatekeeper industry emphasis added.

As a result, economic considerations of costs and benefits frequently lead to an underproduc-

tion of public goods, and thus economic incentives can be seen as conflicting with social andmoral incentives. The empirical behavioral tax research literature provides evidence of this effect.For example, Cloyd and Spilker 1999 find evidence that practitioners are biased in their infor-mation search toward evidence that supports the client’s position. This reflects the economicincentive associated with pleasing the client. Kadous et al. 2008, 135 find the same confirmationbias in low risk situations, but find that in high practice risk situations practitioners pursued a morebalanced search, resulting in “more objective judgments about the authoritative support for theclient-preferred position.”

Changes in the 1990s intensified the conflict between economic and moral incentives. Theeconomic boom of the 1990s increased incentives for companies and individuals to decrease theireffective tax rates and thus increase economic gain. At the same time, Congress was reducing the

IRS’s budget, leading to less effective monitoring and enforcement. These changes placed in-creased pressure on individual tax professionals’ moral incentives to maintain professional trustby meeting duties and responsibilities to both clients and the public. 1

Rationalization

The third essential component of the triangle, rationalization, involves the individual’s internalresponse to the external opportunities. The response reconciles an individual’s internal moralincentives with economic and social incentives present in the environment and created by thesituation. Rationalization arises when tax preparers justify aggressive reporting behaviors. Bratton2003 identifies two primary ways in which a tax preparer’s applied reporting objective may

deviate from a tax law’s originally communicated objective: regulatory arbitrage, and strategicnoncompliance. In effect, these rationalization approaches involve the tax preparer mentallyeliminating the difference between what should be done and what is done. Regulatory arbitrageinvolves “the practice of structuring an inappropriate transaction so it stays within the bounds setby a rule” Bratton 2003, 1044. In other words, regulatory arbitrage modifies the characteristics of

1Interestingly, in a more recent study, Kadous et al. 2008 find evidence of increased conservatism among practitioners, whichthey note contrasts with the results of earlier research see Cloyd and Spilker 1999. They suggest that “We expect that thisconservatism is a response to the new regulatory environment that discourages aggressive recommendations” Kadous et al.2008, 153.






the actual transaction to meet the tax law’s technical and literal requirements. The preparer canthen rationalize the action because it is technically in compliance with the law; that is, the publicinterest condition has been satisfied.

In contrast to regulatory arbitrage, strategic noncompliance modifies the interpretation andapplication of tax law to fit the transaction. Strategic noncompliance involves an “action under aninterpretation of the law in conflict with the stated interpretation of the regulator” Bratton 2003,

1044. It takes advantage of opportunities to exercise judgment within the law. Effectively, therationalization occurs when the preparer imbues meaning to the law that is different from theoriginal intent of the regulators. Although the original intent of the law may not always be clear,strategic noncompliance implies an aggressive use of judgment such that the practitioner distortsthe underlying spirit of the law in order to achieve a positive tax result for the client. It is intentionaland not a mere unanticipated deviation from the original intent of the regulators.

Ultimately, then, when they coincide, opportunity, incentives, and rationalization can cause taxpractice to deviate from its intended ideal. Conversely, if each of the elements is not present,according to Cressey 1953, fraud will not occur. The challenge, then, is to find ways to control theimpact of each of the three elements, thus curtailing the occurrence of tax fraud. We next examinethe manner in which, in an ideal world, the public interest dimension of the profession operates on

each of the three elements to provide an environment that is not conducive to fraud.

THE NORMATIVE IDEALIn this section, we establish a normative definition of the tax profession. This normative ideal

provides a benchmark against which we can evaluate the current state of the profession and, tothe extent that the current practice diverges from this ideal, propose a roadmap for reform. Asnoted above, the very nature of our tax system creates incentives and leaves open opportunitiesfor trust violations. As a result, such a system relies on a practitioner’s internal good judgment tolimit rationalization and prevent fraud. A practitioner’s internal understanding of and commitmentto what it means to be a professional limits internal rationalization even in environments where

external opportunities and incentives exist, like our tax system.In this section, we posit that the central tenet of avoiding trust violations in tax practice is

embedded in the professional requirement to serve the public interest in preference to purelyprivate interest. This is operationalized by developing the competence and character of a “profes-sional.” Professional competence and character limit rationalization and form the cornerstone ofthe normative tax system model in Figure 2. They also play a key role in shaping moral incentives,which serve to counter-balance some of the economic and social incentives toward fraud. Al-though these qualities are within the professional, the profession can take external steps todevelop, reinforce, support, and protect the professional’s internal competence and character.Specifically, the profession can take steps to guide practitioner judgment, constrain opportunities,and manage incentives.

To the extent that tax practitioners embrace and develop the self-regulatory professional con-trols of competence and character, both at the individual level and collectively at the professionallevel, there is less need for additional external systemic regulation. We turn our attention, then, tothe meaning of a “profession” and apply it to normative tax practice.

Internal Self-Controls: Professional Competence and Character

Although the concept of profession has been widely debated in the literature, Toren 1975, 325identifies two key characteristics of professions that appear to be accepted within the literature: “abody of theoretical and technical knowledge and a service orientation.” These foundational






professional responsibilities of technical competence and service-oriented character build trustCovey 1989; Covey et al. 1994. Responsibly creating and maintaining this public trust yieldsprofessional rights and benefits including professional autonomy, certain monopoly power, and theright to control the entry of new members, among others Toren 1975.2 The first of Toren’s 1975characteristics, a body of specialized knowledge and technical competence , sits neatly with the taxprofession. Tax practitioners operate within a highly complex regulatory environment in whichknowledge of the tax law is critical. One of the primary services provided by the tax practitioner iscompetently negotiating the myriad tax rules, from both a planning and compliance perspective.

The second of Toren’s 1975 characteristics, the service-oriented character , warrantsadditional exploration. In effect, this service orientation amounts to the members of a professionadopting a public interest, rather than merely a private business perspective. Numerous authors inthe accounting domain have affirmed this public interest role. Public accountants “have aresponsibility to third parties including the general public ” Almer et al. 2005, 5; emphasis addedto provide trustworthy , useful information. Puxty et al. 1994, 77–78 summarize the accountingprofessional’s primary commitment to the public interest and ethical actions in the following way:

A recurring feature of accountancy’s claim to professionalism is a commitment to ethical

2 This is consistent with the importance of rights and responsibilities in Dillard’s 2008 “ethic of accountability” model.

FIGURE 2Normative: The Role of “Profession” in Countering Abusive Trust Violation Behaviors in Tax Accounting

Opportunity:

External: Monitoring andenforcement of standards curb

opportunities:

Rationalization:

Internal: Professional competenceand service-oriented character

(grounded in an understanding of the public interest role of the

profession).External: Standards provided by

the profession that guide judgment

Incentives:

External

Economic: Economic reward for providing trustworthy information to

clients and to the system.

Social: Standards’ sanctions providedisincentives for fraud because of the

loss of status

Internal

Moral: Professional duties to both

clients and the tax system to provide

trustworthy information






actions. The claim involves an assurance that the accountancy bodies and their memberswill not pursue their material self-interests as sellers of accounting labor in ways thatconflict with their duties to the public interest.

Cohen and Holder-Webb 2006, 26 note that “serving the public interest is arguably the raisond’etre for the accounting profession.” Dillard 2008 notes that the very existence of the publicaccounting profession depends on what he terms an “ethic of accountability.” This ethic of ac-

countability, he suggests, refers to the dual responsibility of managers to account to society for theuse of resources and the responsibility of society to hold managers accountable for their actions.

Much of the literature concerning the public accounting profession’s public interest responsi-bilities focuses on the audit role. There seems to be broad acceptance that, beyond the duty to theclient, the auditor owes a primary duty to provide trustworthy information to the public. In contrastto auditors, tax accountants’ public interest responsibilities may be less apparent because theynot only have public interest obligations, but also serve as client advocates Brody and Masselli1996; Shaub and Fisher 2008. The Statements on Standards for Tax Service SSTS identify theexistence and importance of tax accountants’ public interest responsibilities by stating that “Inaddition to a duty to the taxpayer, the professional has a duty to the tax system … The standards… recognize the professional’s responsibilities to both taxpayers and to the tax system” SSTSNo. 1.

Recent IRS commissioners have made comments supporting the tax accountants’ dual re-sponsibilities to clients and the public. Then-Commissioner of the IRS, Shapiro 1986, 136, 139pointed out:

The public responsibility is of pervasive importance … In the normal practitioner-clientrelationship, both duties are recognized and carried out. However, there are situations inwhich this is difficult. In those situations, the practitioner is required to decide which obli-gation prevails and, in so doing, may correctly conclude that the obligation to the tax system is paramount … The IRS relies on tax practitioners to assist it in administering the tax laws by being fair and honest in their dealings with the Service and by fostering confi-

dence by their clients in the integrity of the tax system and in complying with it. emphasisadded

Then-Commissioner Mark Everson expressed similar sentiments in his statement to the Sen-ate Finance Committee in 2003 by commenting that “professional standards have eroded in somecorners of the practitioner community. Attorneys and accountants should be the pillars of our system of taxation , not the architects of its circumvention” Everson 2003 emphasis added. Inan interview with the Journal of Accountancy , Commissioner Everson went so far as to point outthat both clients and the IRS rely on the trustworthy information of tax practitioners in administer-ing the system. He noted that:

We can’t administer the tax system alone. We rely on the work of accountants and attor-

neys to make sure people get good advice and take the proper tax positions…

Individualand business taxpayers rely on their CPAs to give them answers that are correct under thelaw without causing them to pay more than they have to. It’s a delicate balance, and onethat requires integrity. Pickard 2005, 31

The accounting professional’s service orientation, or character dimension, holds also in the taxcontext. To expand upon Dillard’s 2008 ethic of accountability, we might suggest that the tax-payer owes a responsibility to society to pay his or her fair share of tax, while society has aresponsibility to ensure that all taxpayers pay their fair share. The tax profession, as an integralpart of the tax system that facilitates this tax ethic of accountability, must balance serving the client






with the need to maintain the system. Although there is a tension between serving the client and

meeting the public interest obligations associated with being a professional, a professional “whoidentifies strongly with the professed public purposes of her profession is more likely to resist

trust violations because, whatever the rewards of doing so, it will reduce her self-respect” Fox

2008, 1098. Thus, the notion of profession, and the central role of serving the public interestembodied in that notion, serves to counter rationalization of inappropriate behavior the lower

right-hand point of the triangle in Figure 2 and to mobilize moral incentives in the presence ofeconomic incentives the apex of the triangle in Figure 2.

Supportive Professional Self-Regulatory Controls

As noted above, a true understanding of the public interest role of the tax professional serves

to limit trust violations by reducing rationalization and strengthening the moral incentives that thetax professional faces. To be completely effective, however, these need to be further supported by

profession-wide self-regulatory controls. Self-regulatory controls at the profession level serve tosupport and develop the individual tax practitioner’s self-regulatory professional character and

competence. Expressed in another way, the profession, in order to protect its asset, the public’s

trust, may act to limit the behavior of its members that might lead to trust violations. This may occurin one of two ways, both of which are incorporated into Figure 2. First, the profession may

influence judgment by providing guidance to help members resolve conflicts of interest betweenthe client and the public interest. This serves to limit the professional’s rationalization of abusive

behavior because the professional has an external support structure for dealing with the conflict.

This may be particularly helpful for members who face pressure from clients because it serves asa mechanism for explicitly incorporating the public interest into the decision-making process.

Second, the profession may curb opportunity and incentives by imposing specific standardsand accompanying sanctions on its members. The setting of standards removes some of the

opportunity to commit tax fraud because the professional must now confront an additional obstacle

before engaging in the trust violation. As noted earlier, one of the problems arising from the

complexity of our tax law is that there are ample opportunities to use ambiguity in the law toengage in unethical behavior i.e., the complexity of the law presents opportunity.

The use of sanctions serves to counter the economic incentive to engage in fraud by

introducing an explicit cost both in monetary terms but also in loss of status for such behavior. In

effect, an appropriate use of sanctions internalizes some of the costs noted earlier, namely that theindividual professional who engages in fraud shifts costs onto the profession as a whole Fox

2008.

DEVIATION FROM THE NORMATIVE IDEALAlthough the profession began with a strong grounding in the public interest ideal, develop-

ments in recent decades would imply that something has gone awry in the balance betweenpublic and personal interest. In this section, we examine the tax shelter industry as an examplethat demonstrates a major failure of professional ethics in the tax profession. The tax shelterevidence contrasts with the expressed normative claims of ethical conduct and “social responsi-bility” made by the accounting profession. We use this example for three reasons. First, it dem-onstrates that the ethical failures in the profession are widespread and occur in some of thelargest and most influential tax firms in the world. Second, it demonstrates that failures occur evenin the context of professional and legal constraints, and within firms with explicitly stated ethicalcodes of behavior. Third, tax shelters represent a continuing and significant problem for the tax






profession. In fact, abusive3 tax shelters have been described as “the most serious compliance

issue threatening the American tax system” Bergin 2000 and, despite changes addressing the

shelter industry, it likely remains a major compliance issue. Further, little of the initial response to

the tax shelter crisis dealt with self-regulatory reforms to develop tax practitioners’ competence

and character. Instead, initial responses proposed additional systemic reforms and external con-

trols which can continue to perpetuate an “illusion of control” Rosanas and Velilla 2005, 87;

Dermer and Lucas 1986, 471 rather than addressing the root causes of the problem. In thispaper, we suggest that real change will occur only if practitioners return to a foundational under-

standing of the public interest role of the tax profession.

The Big 4 public accounting firms played an extensive and dominant role in the tax shelter

industry Wang 2003, and there is ample evidence that each firm was complicit in the abuses. For

example, according to the Permanent Subcommittee on Investigations of the Committee on

Homeland Security and Governmental Affairs, U.S. Senate 2005, which investigated the role of

professional firms in the tax shelter industry, Ernst & Young and PricewaterhouseCoopers sold

generic tax products to numerous clients, in spite of evidence that some were potentially abusive

or illegal tax shelters. Wang 2003, 1261 reports that “Deloitte & Touche promised to zero out a

company’s taxes for a contingency fee of 30 percent of the tax savings,” and in Smith 2004, agovernment official describes KPMG as “one of the worst perpetrators.” Although all of the Big 4

firms developed aggressive tax shelters, much of our discussion will focus on KPMG and the

abuses that were discussed by the Permanent Subcommittee on Investigations of the Committee

on Homeland Security and Governmental Affairs, U.S. Senate 2005; hereafter, Permanent Sub-

committee.

Similar to the other Big 4 firms, KPMG’s tax shelter activities illustrate the manner in which

external opportunities and incentives in the tax reporting environment influenced practitioner judg-

ment and led to internal rationalization. Ultimately, KPMG was quick to trade on its reputation to

develop a thriving, highly profitable tax shelter practice Rostain 2006, demonstrating the way in

which commercial interests came to dominate the public interest.Tax shelters provided the tax professional with all the elements opportunity, incentive, and

rationalization necessary for a trust violation. Ambiguous legal guidance and limited monitoring

and enforcement provided opportunities for accounting firms to develop and sell aggressive tax

shelters. The ability of accounting firms to obtain sizeable profits from tax shelter sales by charg-

ing contingent fees created enormous economic incentives . Weak penalties and the perceived

low risk of detection failed to create a significant deterrent cost. Rationalization occurred as

competitive pressures drew attention away from the professional duty owed to the public, in favor

of short-run commercial gain. The Big 4 rationalized their aggressive pursuit of tax shelter profits,

through both regulatory arbitrage and technical compliance and through strategic noncompliance.

Although profitable, the primary consequence of the tax shelter abuses was a loss of client,

government, employee, and public trust. In this section, we document the relevant characteristics

of the tax shelter environment that resulted in trust violations. These are summarized in a fraud

triangle framework in Figure 3:

3There is an important distinction between legitimate tax shelters and abusive tax shelters. For example, Murphy and Higgins2008 note that some shelters are intentionally provided by Congress to encourage investment in certain activities and that eventax-exempt municipal bonds would constitute a shelter in the broadest sense of the term. As we discuss later, and as defined bythe Permanent Subcommittee 2005 report, abusive shelters are intended to subvert the law.






External Elements: Opportunity and Incentives

OpportunityWe begin our discussion of the fraud triangle Figure 3 with a discussion of the opportunity

point. The legal uncertainty surrounding the tax shelters created great opportunity to exploit thisuncertainty. A tax shelter is, by definition, a “device used to reduce or eliminate the tax liability ofthe tax shelter user” Permanent Subcommittee 2005, 1. Not all tax shelters are illegal and, infact, legality depends heavily on the taxpayer’s purpose and intent in using a tax shelter MinorityStaff of the Permanent Subcommittee on Investigations 2003, 2 hereafter, Minority Staff 2003.The primary purpose behind unwarranted abusive tax shelters is the avoidance or evasion of taxes in a manner not intended by the law Permanent Subcommittee 2005. In practice, thedistinction between abusive and legal shelters is not always clear. In fact, “the legality of KPMG’stax shelters was a subject of debate within the government itself” Wall Street Journal 2006, A26.

The ambiguity surrounding the legality of tax shelters made it easier for the Big 4 to find lawyerswilling to issue “more likely than not” opinion letters supporting aggressive tax shelters Wang2003, 1259. Further fueling the opportunity for the use of tax shelters was the lack of monitoringand enforcement of the accounting industry Wang 2003. Ultimately the IRS lacked the resourcesto monitor the tax shelter operations Smith 2004, and this limited monitoring and enforcement,along with ambiguous tax shelter laws, enhanced the opportunity for tax shelter fraud.

Economic Incentives

In the tax shelter fraud, economic incentives dominated incentives, the second point of thetriangle Figure 3. As noted earlier, often the return to abusive tax behavior can be significant and

FIGURE 3Deviation from the Normative Ideal: Tax Shelter Trust Violations

Opportunity:

1. Tax Shelter Legal

Uncertainty2. Limited monitoring and

enforcement

Rationalization:

1. Awareness of legal flaws.

2. Legal rationalization3. Economic rationalization

a. Cost-benefit analysis

b. Accepted practice in

industry

Incentives:

1. Economic:

a. Weak penalties

b. Contingent and Joint Feesc. Strong market and competitive

pressures2. Social:

a. Corporate culture pressures

3. Moral:

a. Received secondary consideration

Results:

1. Shift from a profession to a career.

a. Shift focus from ‘service interest’ to ‘self

interest’

b. Aggressive ‘self-interested’ marketing of tax

products

2. Compliance with legal form not substance3. Avoiding detection

4. Failure to consider professional practice and ethical

dimensions.

5. Unintended wealth redistribution6. Loss of trust






can induce self-interested action. In the tax shelter cases, the immediate economic gains weresubstantial and the potential penalties involved were largely inconsequential when compared withthe tax shelter earnings. For example, Smith 2004 reports a former employee of KPMG assuggesting that the “penalties associated with not registering paled in comparison to the revenuesthat would be generated by these tax shelters that had to be registered. And if they were regis-tered, KPMG decided they couldn’t sell them. So they made a business decision not to register

them.”Contingent fees exacerbated the impact of economic incentives. The ability to charge contin-

gent fees raised the return potential, and such fees were a key economic incentive in the aggres-sive sale of tax shelters Wang 2003. The use of contingent fees is professionally questionablebecause they can divert attention from maintaining the tax system’s integrity in favor of pursuit ofhigh fees and breed “disrespect for the tax system” Wang 2003, 1268. Such contingent fees,however, became more attractive in an environment of competitive market forces. Market pres-sures diverted accounting firms away from steadfastly administering their entrusted client advo-cate and legal administrate responsibilities in favor of commercial gain Permanent Subcommittee2005, 88. For example, KPMG’s tax shelter approval process was driven by market consider-ations, such as revenue potential and speed to market. Ethical and professional considerations

received only secondary consideration Minority Staff 2003, 7. Strong economic incentives,coupled with weak disincentives and strong market forces, played a key role in the developmentof the tax shelter industry.

Social Incentives

In addition to the economic incentives, social pressures reinforced the drive toward the use oftax shelters. As noted earlier, social pressures can be exerted via factors such as firm culture. Inthe KPMG approval process, superiors placed intense pressure on subordinates to comply withand impress superiors by “signing-off” on the merits of a proposed product even with seriousquestions about its legal compliance Permanent Subcommittee 2005, 22; Minority Staff 2003, 7.This reflects a strong social pressure to serve the private interest of the firm over the public

interest.

Moral Incentives

In the normative case depicted earlier, moral incentives should be fueled by a deep internalunderstanding of and commitment to the public interest role of the profession. However, in the taxshelter case, the combined economic and social incentives to engage in abusive behavior over-whelmed ethical and moral incentives associated with the profession’s public interest role see theapex of the fraud triangle in Figure 3. In fact, it is ironic that the firms that sold tax sheltersfrequently traded upon their strong reputations for integrity. KPMG’s case serves as a helpfulexample. An internal firm email that has subsequently been made public stated: “Our reputationwill be used to market the transaction … The business decisions to me are primarily two: 1 Have

we drafted the opinion with the appropriate limiting bells and whistles…

and 2 Are we being paidenough to offset the risks of potential litigation resulting from the transaction?” Permanent Sub-committee 2005, 20. Thus, the public interest reputation of the profession was not only disre-garded but used to pursue commercial gain.

Internal Element: Rationalization

The accounting firms were aware of the highly questionable and precarious legality of their taxshelters Permanent Subcommittee 2005. Although they were aware of the dubious legality, thefirms often justified aggressive tax shelters on the basis that the structures adhered to the






technical “letter of the law.” For example, KPMG’s tax shelters complied with the literal form of the

tax law but not the intended substance Permanent Subcommittee 2005, 1. As noted above, more

often than not the behavior was driven by economic rather than ethical concerns. For example,

KPMG increased fees to reflect the increased risk from dubious tax products Permanent

Subcommittee 2005. The economic benefits provided the primary rationale for creating and

marketing the tax shelters. A now-public KPMG email discussing the registration and sale of OPIS,

a tax shelter product, notes the following economic reasons:

“KPMG should make the business/strategic decision not to register the OPIS product as a

tax shelter … First, the financial exposure to the firm is minimal … Third, the tax community

at large continues to avoid registration of all products … Fourth, there has been and,

apparently, continues to be a lack of enthusiasm on the part of the Service to enforce

section 6111 … I believe the rewards of a successful marketing of the OPIS product … far

exceed the financial exposure to penalties that may arise.” The memorandum advises

KPMG to knowingly violate the law requiring tax shelter registration, because the IRS is not

vigorously enforcing the registration requirement, the penalties for noncompliance are

much less than the potential profits from the tax product, and “industry norms” are not to

register any tax products at all. Permanent Subcommittee 2005, 57–58

The analysis outlined in the email simply considers the economic factors of reward, risk, and

market considerations. KPMG felt that not selling the tax shelters would put KPMG at a “severe

competitive disadvantage” Rostain 2006. Thus, economic and legal rationalizations were used

to support the sale of tax shelters and apparently little consideration was given to ethical profes-

sional principles. The government’s investigation of KPMG’s tax shelter decisions notes this glar-

ing deficiency:

One might have expected a thoughtful discussion or analysis of the firm’s fiduciary duties,

its ethical and professional obligations, or what should be done to protect the firm’s good

name. Unfortunately, evidence of those thoughtful discussions was virtually nonexistentand considerations of professionalism seem to have had little, if any, effect. Minority Staff

2003, 16

Maintaining the integrity of the tax system by reporting trustworthy information deserves and

requires the accounting profession’s primary attention. As noted earlier, it is indeed the foundation

on which a profession is established. However, in the case of the tax shelter industry, the public

interest role was essentially disregarded in favor of an emphasis on the private interests of the

firm. This private interest focus permitted rationalization of the tax shelter activity using both

regulatory arbitrage structuring a transaction to meet the technical requirements, but not the

spirit, of the law and strategic noncompliance interpreting ambiguous law in a way that fits and

justifies the transaction.

Results

Although aggressive tax shelters initially resulted in economic benefits, significant costs

accrued to the profession and society as a whole. In this section, we outline several tax shelter

consequences that have the potential to undermine the very core of the tax profession, the

commitment to the public interest. In the following section, we address changes that the profession

might make in order to recapture its public interest focus and restore the reputation of the

profession.






Shift from a Profession to a Career

Aggressive tax shelters provided an example of a shift from professionalism to commercialism

Permanent Subcommittee 2005. Firms emphasized customer-driven commercialism and client

service rather than public-spirited responsibilities to the public or the state Hanlon 1994. Thepursuit of higher financial rewards eclipsed traditional values Sikka and Hampton 2005. As Mike

Hamersley, an ex-KPMG employee, states, KPMG’s “objective was to change the mindframe of a

tax professional from finding problems with transactions and trying to address them objectively togoing out and proactively selling tax shelters and trying to close sales” Smith 2004.

This shift from professionalism to commercialism signals a shift from “service interest” to“self-interest,” and is consistent with the commercialization trend within the broader public ac-counting profession see, for example, Fogarty et al. 2006. As Toren 1975, 326 notes, onedriver of deprofessionalization is that “the service ideal is liable to subversion by self-interest ornarrow vested group interests.” Instead of directing primary attention to client advocate and publicinterest responsibilities, KPMG’s attention was first focused on revenue generation. Rather thandeveloping tax products to serve clients and the public, tax products were expressly developedand marketed to generate revenue Permanent Subcommittee 2005, 9, 12.

KPMG’s tax shelter approval process reveals the primary “revenue generation” purpose for taxshelters. Initial screening for revenue and technical potential was the first stage in the tax shelterapproval process. Instead of receiving primary attention, screening for ethical considerations wasthe third and final stage in the tax shelter approval process. In the second stage of the reviewprocess, the tax strategy received a thorough review to determine whether the product met thetechnical requirements of existing tax law Permanent Subcommittee 2005, 14, 15. In addition tosecondary consideration in the approval process, KPMG allocated insufficient resources to theDepartment of Professional Practice DPP, the group performing the ethical compliance reviewsof new tax products Permanent Subcommittee 2005, 15. Finally, KPMG’s response to DPPreviews reveals a shift to commercialism. Instead of respecting DPP reviews and removing sus-pect tax products, KPMG would often try to influence and alter DPP reviews Permanent Sub-

committee 2005.KPMG’s aggressive marketing tactics also signal a move away from service-interested profes-

sionalism to self-interested commercialism. Tax shelter services were no longer client-specific.Instead, generic tax shelters were developed and then methodically and aggressively sold Wang2003, 1251. The goal of KPMG’s tax sales initiatives was to create an aggressive sales culture tomaximize revenue through aggressive sales Permanent Subcommittee 2005, 42. InternalKPMG communications encouraged this aggressive culture and promoted aggressive marketing.For example, one such communication read: “We are dealing with ruthless execution—hand tohand combat—blocking and tackling. Whatever the mixed metaphor, let’s just do it” PermanentSubcommittee 2005, 36.

This aggressive marketing demonstrates that KPMG was no longer a disinterested profes-

sional. It was now a self-interested entity. In pursuit of self-interest, KPMG turned tax profession-als into tax product salespersons, pressured tax professionals to meet revenue targets, and usedquestionable marketing tactics Permanent Subcommittee 2005, 33. Often, KPMG’s marketingwas primarily done to increase revenue—not to help the client as a client advocate. For example,KPMG marketed tax shelters to persons with little interest in tax shelters and who “did not under-stand what they were being sold” Permanent Subcommittee 2005, 33. The self-interested mar-keting tactics KPMG applied to these clients bordered on the deceptive. For example, KPMG’sdevelopment process was marketed as one that guaranteed tax product legitimacy. In reality, thedevelopment process was motivated less by quality concerns and more by profitability and market






potential Rostain 2006. KPMG’s own internal documents recommended deceptive hard-sell tac-tics like making misleading statements to convince uninterested or hesitant clients PermanentSubcommittee 2005, 42.

Compliance with the Form and Not the Substance of the Law

While aggressive marketing placed commercial interests ahead of client advocate responsi-

bilities, legal compliance of form over substance subjugated public interest responsibilities toself-interest. Many tax shelters produced unwarranted or unintended results even though theycomplied with the literal language of specific tax provisions. They had no business purpose oreconomic substance other than to reduce taxes Permanent Subcommittee 2005, 1. For ex-ample, SC2, a KPMG tax shelter, had very little economic substance in spite of its legal formPermanent Subcommittee 2005, 29, 30. Such an outcome results from using regulatory arbi-trage as a rationale to support decisions. Such an approach demonstrates a disregard for sub-stantive compliance with the tax system and signals a primary concern for commercial self-interest over the public and even clients’ interest.

Avoiding Detection

Because the legal substance of many tax shelters was somewhat spurious, the Big 4 account-ing firms took explicit steps to create “a high degree of secrecy” Wang 2003, 1250. For example,KPMG concealed its tax shelters by refusing to register shelters with the IRS, restricting filedocumentation, and using improper reporting techniques Minority Staff 2003. In addition to non-transparent reporting, firms took steps to conceal the marketing of shelters Wang 2003, 1250;Permanent Subcommittee 2005, 65. For example, many tax shelter transactions required thattaxpayers sign a nondisclosure agreement4 Sikka and Hampton 2005, 333. In some cases, firmswere alleged to have purposefully limited a tax shelter’s sales in order to evade scrutiny Wang2003, 1250. For example, KPMG stopped sale of tax products after one or two years in order tolimit the evidence and make it more difficult for the IRS to detect the activity Permanent Sub-committee 2005, 55.

Failure to Properly Consider Professional Practice and Ethical Dimensions

These nontransparent activities demonstrate that accounting firms, including KPMG, failed toproperly consider ethical responsibilities in the pursuit of profit. KPMG failed to appropriatelyhandle other professional responsibilities including contingent fees, auditor independence, andconflicts of interest Permanent Subcommittee 2005, 66. KPMG charged contingent fees basedon the amount of tax savings from tax shelters Smith 2004. Although these fees may have beenstructured in a way that was legal, the position can be taken that such “fees based on projectedclient tax savings were contingent fees prohibited by AICPA Rule 302” Permanent Subcommittee2005, 67. Of deeper concern is the ethical question as to whether such fees create incentivesinconsistent with the role and objectives of the public accounting profession.5 Auditor indepen-

dence was another ethics issue. KPMG used financial service firms it audited, like DeutscheBank, at various times to help market and implement KPMG tax products Permanent Subcom-mittee 2005, 69. Like other firms, KPMG also took advantage of the auditor-client relationshipand marketed tax products to its own audit clients Permanent Subcommittee 2005, 70. This

4To some extent, such behavior may be justified by virtue of the need to protect the firm’s intellectual property from beingdissipated. However, even this would signal a trend toward commercialism rather than the operation of a profession with thepublic interest at heart.

5The committee also noted that “Many states prohibit accounting firms from charging contingent fees due to the improperincentives they create” Permanent Subcommittee 2005, 67.






created a conflict of interest and compromised auditor independence Rostain 2006, 111. As aresult, KPMG failed to use disinterested professional skepticism in making its decisions Rostain2006, 112, 113.

Social Costs and Loss of Public Trust

This failure to meet professional responsibilities resulted in significant social costs, includingunintended wealth redistributions. The sale of tax shelters “shifts tax burdens to less mobilecapital and less well-off citizens. It also erodes the tax base and brings the firms into direct conflictwith the state” Sikka and Hampton 2005, 325.

Furthermore, the tax shelter industry ultimately undermines the public confidence in the taxsystem and in the tax profession. For a profession grounded in the public trust and the responsi-bility to promote the public interest, this is a significant cost. By placing pursuit of personal gainahead of client advocate and public interest responsibilities, firms lost the trust of clients, employ-ees, and the public. In KPMG’s case, one client’s reported comments aptly highlight this loss ofconfidence not only in the firm but in the accounting profession more generally:

KPMG’s fees were more important than their integrity and honesty to their client andprotecting their clients. So “let’s keep on selling it. If the IRS doesn’t audit it, we’re fine.” I

trusted the quality and reputation of one of the largest accounting firms in the world. I guessyou cannot even do that anymore. I do not know who you can trust. Smith 2004

Ultimately, the root of the problem lies in the loss of understanding of the profession’s publicinterest role. Although it is possible to restore the notion of the public interest and the professionalobligation of placing public over personal interest, the challenges in redressing the shift in thinkingthat occurred in recent decades are substantial. It is to these challenges that we turn our attentionin the following section.

RESTORING THE IDEAL: RECOMMENDATIONS FOR REFORMIn the previous two sections, we have examined both the normative model for the tax profes-

sion how things should be and the way in which the current reality has deviated from thisprescribed norm. In fact, based on the tax shelter examples outlined, current practice has devi-ated so far from the normative model we outlined earlier as to call into question the ability of taxpractitioners to claim professional status. More than a decade ago, Brody and Masselli 1996noted that increased preparer penalties were related to IRS concerns that practitioners were notdisplaying an appropriate level of loyalty to the tax system. This could be interpreted as implyingthat practitioners were not meeting the public interest obligation embodied in the notion of pro-fession. In the past two years we have seen attempts by Congress to again strengthen preparerpenalty standards, implying a loss of professional freedom and status. Rather than self-regulationby the profession, we are seeing an increased encroachment by government.

In this paper, we advocate cultural changes aimed at restoring the self-regulatory public inter-est focus of the profession. Such a focus depends on the foundational elements of character andcompetence. Our cultural changes involve three groups: the tax system, the profession, and theacademy. We discuss these recommendations in the context of the fraud triangle/trust violationanalysis shown in Figure 4. Although we advocate solutions that address and limit each of thefraud triangle elements, we suggest that ultimately change will only be successful if it is internallybased that is, practitioners must collectively and individually ascribe to the professional obligationto serve the public interest. Additional external reforms without corresponding internal reformssimply perpetuate an “illusion of control” Rosanas and Velilla 2005, 87; Dermer and Lucas 1986,471. Internal self-regulatory reforms control an individual’s rationalization as well as influencemoral incentives in the fraud triangle see Figure 4.






We explore these recommendations in detail below.

External Opportunities and Incentives

Necessary systemic changes were recommended by the Permanent Subcommittee 2005 atboth the tax system and profession level to limit future abusive behavior. These can be categorizedinto reforms that limit opportunities for abusive behavior and reforms that limit incentives forabusive behavior. We provide a summary of the Permanent Subcommittee 2005recommendations in Table 1. Changes designed to limit opportunity center around modifications tothe tax system to improve clarity and transparency such as strengthening the economicsubstance doctrine and strengthening the Circular 230 rules and to increase monitoring andenforcement not only by the IRS, but also by the Department of Justice and federal bankregulators. The Permanent Subcommittee 2005 similarly recommended profession-basedreforms such as AICPA-mandated rules of conduct for tax shelters, mass marketing, and otheractivities. These recommended monitoring and enforcement changes are intended to limitopportunities for future trust violations.

With regard to reducing the incentives for future trust violations, the Permanent Subcommittee2005 recommendations focused on strengthened civil penalties for tax evasion tax systemreform and strengthened professional sanctions for inappropriate behavior profession-basedreform.

FIGURE 4Restorative: Cultural Recommendations for the Tax System, the Profession, and Academia to Improve

Professional Character and Competence

Opportunity:

1. Tax system: Modify regulatory

monitoring and enforcement

activities.

2. Profession: Modify self-

regulatory monitoring and

enforcement activities.

Rationalization:

1. Profession: Create a professional

culture that fosters self-

regulatory character and

competence development.

2. Academia: Create an academic

culture that fosters professional

development of both competence

and character through:

a. Comprehensive instruction

b. Diverse research

Incentives:

1. Tax system: Modify regulatory

economic and social

disincentives and sanctions.

2. Profession: Modify professional

economic and social

disincentives and sanctions.






One interesting first step toward tax system reform has been the recent changes to thestandards tax preparers must meet to avoid penalties. Prior to the surprise changes in 2007,preparers were required only to meet a “realistic possibility standard,” implying a confidence levelof one in three that their position would be sustained in a court of law. 6 In 2007, regulators initiallyraised the bar and required practitioners to meet the “more likely than not” standard, implying a

6The realistic possibility standard is defined in U.S. Treasury Department Circular 230. The IRS has provided interim guidancethat “substantial authority” has the same meaning as in Regulation Section 1.6662-4d2.

TABLE 1

Recommended External Reformsa

Panel A: Reforms Limiting the Opportunities for Abusive Tax Behavior

Tax System Reforms

Reforms Improving Clarity and Transparency

Strengthen and clarify the Circular 230 rules

Reduce uncertainty through legislation clarifying and strengthening the economic substancedoctrine

Improve transparency by requiring the IRS to disclose relevant tax shelter information to otheragencies such as the PCAOB

Reforms to Monitoring and Enforcement Activities

Increased IRS funding for more enforcement personnel and increased enforcement activities

Conduct a review of tax shelter activities at major law firms by both the U.S. Department of Justiceand IRS

Conduct a review of tax shelter activities at major banks by the IRS and federal bank regulators

Review of tax shelter activities at financial services firms by the SEC to limit such firms from aidingand abetting tax evasion by third parties

Review tax shelter activities at charitable organizations

Profession Reforms

The AICPA should establish and clarify rules of conduct and procedures for tax shelters, massmarketing, and other activities

The PCAOB should strengthen and finalize proposed rules restricting tax services provided to auditclients, contingent fees, and aggressive marketing tactics

Panel B: Reforms Addressing the Incentives to Engage in Abusive Tax BehaviorTax System Reforms

Strengthened civil penalties for tax evasion

Profession Reforms

Strengthen sanctions on unprofessional behavior

a These reforms are taken from the Permanent Subcommittee 2005 and Minority Staff 2003 reports, among other sources.






confidence level of greater than 50 percent. This change represented a step in the direction oflimiting aggressive tax planning opportunities, but also represented a significant encroachment bygovernment on the freedom enjoyed by the profession. Recently, after much concern in the taxcommunity, Congress retroactively revised the standard downward to a requirement that taxpreparers have “substantial authority” for positions adopted. What these changes signal, however,is that unless practitioners take seriously their professional self-regulatory public interest

obligation, government regulators will systemically regulate and limit profession behavior in orderto protect the public interest and maintain the integrity of the tax system.

Internal Rationalization

While these external tax system and profession-based changes are necessary, they are notsufficient to re-focus the profession’s attention on its public interest role. External reforms aloneperpetuate an “illusion of control” Rosanas and Velilla 2005, 87; Dermer and Lucas 1986, 471.Tax system changes ultimately attempt to control practitioner behavior by limiting opportunitiesand countering incentives. Nonetheless, real change is unlikely unless external changes arereinforced by internal changes. It is interesting to note the comments of former IRS CommissionerCharles Rossotti, who suggests that tax shelter activity is likely to rebound even following theproposed reforms because the fundamental factors that drove the behavior are unchanged Smith2004. In this paper, we suggest that cultural reforms in the accounting community are necessaryin order to develop practitioners’ competence and character and to restore the public interestdirective embodied in the notion of profession. These cultural changes should come from theprofession and from academia and are presented in Table 2. Some of the proposedrecommendations are similar to the professional development recommendations made in Cheffersand Pakaluk 2007. Our suggested reforms are broad enough to be generalizable, yet specificenough to be substantive.

The Profession

Fundamentally, what is needed for real character development is a renewed commitment to,

communication of, and training in professionalism. Sikka and Hampton 2005, 329 describepublic accounting firms as being a “part of the contemporary ‘enterprise culture’ that persuadesmany to believe that ‘bending the rules’ for personal gain is a sign of business acumen.” Thisstands in stark contrast to the differentiating public interest perspective of a profession, and wesuggest that cultural change in the profession is necessary for real and lasting change to occur.Some evidence of change is emerging, and the Permanent Subcommittee 2005, 6 noted thatfollowing the tax shelter investigations, firms have “committed to cultural, structural, and institu-tional changes.” It is important, however, that firms not only be seen to be restoring professionalcharacter and competence, but are in fact actively committed to genuine change. Such changeinvolves recommitment, communication, and training.

A recommitment to professionalism is one cultural change the accounting profession mustmake to foster professional development. This recommitment can manifest itself in leadership’sactions and initiatives. Using stringent ethical criteria in hiring practices also communicates arecommitment to professionalism. An organization can also observe and enforce a clear code ofethics to communicate professional standards and accountability. Accountability should commu-nicate the professional understanding that each practitioner has authority and responsibility for hisor her decisions. In addition to communicating professional expectations, an organization shouldfoster an open atmosphere receptive to employee perceptions and supportive of ethical conduct.

An organization should also actively train and develop professionalism. This can include cre-ating and supporting an ethics training program. Firms should encourage professionals to develop






a “unity of life” marked by integrity and service, and foster involvement in community service

activities Cheffers and Pakaluk 2007. Additionally, firms must develop concrete incentives to

TABLE 2

Recommended Reforms to Improve Professional Character and Competencea

Panel A: Profession Reforms

Recommit to Professionalism

Leadership actively involved in initiatives for professionalism

Leadership should act and appear to act in a way above reproach

Use stringent ethical criteria in hiring

Communicate Professionalism

Awareness of organization and employee perceptions by using surveys, suggestion boxes, informalconversations, etc.

Open atmosphere supportive of ethical conduct

A clear and recognized code of ethics that is observed and enforced

Publish widely the firm’s code of ethics to create a sense of accountability

Ensure that each practitioner has genuine authority and responsibility for his or her own decisions

Train Professionalism

Implement an ethics training program

Create incentives by rewarding employees in concrete ways for good judgment

Create disincentives by making it clear that unethical conduct is punished including dismissal inserious cases

Panel B: Academia Reforms

Research

A greater diversity in research and reduced emphasis on so-called scientific methods that eliminateawareness of moral judgments

Explicitly encourage research into ethics

Teaching

Model high ethical ideals for students to serve as an example and mentor for them

Present education as part of professional training and part of a unified life of integrity

Broaden education to include professional character development as well as competencedevelopment

Focus the teaching of accounting in explicitly professional schools like law and medicine as per the

U.S. Treasury 2008 recommendation

a These modified reforms are based on recommendations in Cheffers and Pakaluk 2007 and the U.S. Treasury 2008 report.






reward good judgment and professional actions and introduce clear disincentives for unethicalconduct. Through recommitment, communication, and training, the profession can make culturalchanges to foster professional character and competence development.

Academia

Business schools play a crucial role in developing professionals who exhibit both competence

and character. Collectively, we need to accept and meet this responsibility. Ghoshal 2005, 75suggests that “we—as business school faculty—need to own up to our own role” in the ethicalfailures that have plagued the business world in recent years. He attributes part of the problem tobusiness school teaching and research that largely excludes ethics and morality and insteadlegitimizes aggressive self-seeking behaviors. Similarly, Cohen and Holder-Webb 2006, 19 sug-gest that “we as accounting educators must ask ourselves how much responsibility we collectivelybear for this apparent decay.” To the extent that business schools are failing to equip students withthe ethical sensitivities required in their profession, change is required. We see the problem andthe solution as being applicable both in the context of business school research and in businessschool teaching, which are closely interrelated. We address each of these in turn.

According to Ghoshal 2005, the central problem with business school research is that busi-

ness researchers have sought over a long period of time to make our endeavors increasinglyscientific, and therefore more respected. He suggests that in the quest for scientific status, how-ever, business researchers have essentially removed all notions of morality, ethics, and humanintentionality because the scientific approach leaves no room for such factors. Rather, sciencerequires causal determinism and the ability to reduce complex situations to manageable math-ematical models. As Bennis and O’Toole 2005, 98 note, the “scientific model … is predicated onthe faulty assumption that business is an academic discipline like chemistry or geology.” Thisfaulty premise has had adverse consequences.

A particular consequence of adopting the so-called scientific approach is that we have in factlegitimized inappropriate behaviors and we “have actively freed … students from any sense ofmoral responsibility” Ghoshal 2005, 76. In the words of Ferraro et al. 2005, 14, “the core

economic assumption of self-interest is a prediction about how people will behave, but it also serves as a norm that regulates behavior ” emphasis added. Essentially, according to Ferraro etal. 2005, if the theories we teach assume that managers will act in opportunistic ways, weeffectively teach that such behavior is normal and, by implication, acceptable. If indeed businessschool research is actually creating the very conditions the theories purport to explain, this is adamning indictment on business school teaching and research and one which needs to be takenseriously for real change to occur.

Furthermore, by inappropriately emphasizing only so-called scientific research, business re-searchers have substantially downplayed alternative forms of research, including research inethics. As Tuttle and Dillard 2007 show, the homogenization of accounting research seems morelikely a reflection of institutional isomorphism pressures than a competitive market outcome. Busi-ness schools need to commit to and communicate a greater diversity in research to counter theseproblems.

Educators need to commit to, communicate, and train professionalism in the classroom as wellShaub and Fisher 2008. Professional character and competence development problems arisewhen agency theory assumptions of aggressive self-interested behaviors become self-fulfillingprophesies and business topics are taught in an ethical vacuum Ghoshal 2005; Ferraro et al.2005; Cohen and Holder-Webb 2006. Professional behavior is guided less by self-interestedincentives and more by service-oriented motives. Instructors can commit to and model these highservice-oriented professional ideals for students in their actions and interactions with students.






Business education can be presented as part of professional training and practice Shaub andFisher 2008. It is part of a unified and complete life guided by integrity. Professional educationtakes a holistic perspective. One possibility for increasing the professional emphasis in account-ing may be to pursue a model involving post-graduate professional schools of accounting similarto schools of medicine and law, an idea suggested in the Treasury report on the auditing profes-sion U.S. Treasury Department Advisory Committee on the Auditing Profession 2008. Complete

professional education involves more than competence and skill development. As Dillard 2008,13 notes, “the public expects universities to transcend the production of accounting techniciansby exploring the societal role of accounting, integrating and enhancing technical competence withan understanding of the complex responsibilities of accounting to organizations, society, and theenvironment.” To the extent that students are not exposed to this kind of thinking by professors, itis unsurprising that they fail to see their responsibilities as anything greater than minimizing theclient’s tax liability by any mechanism possible. Several state boards of accountancy have re-sponded to this need. Texas requires a three-semester-hour course in ethics as a prerequisiteeducation requirement for CPA examination candidates, and three other state boards of accoun-tancy Maryland, New York, and Nebraska also have ethics education prerequisites for CPAlicensure Hurtt and Thomas 2008.

To some extent, the problem may lie in the training of professors. The increasingly narrowemphasis of accounting Ph.D. programs Lee 1995; Schwartz et al. 2005; Cohen and Holder-Webb 2006; Williams et al. 2006; Shaub and Fisher 2008 leaves the greater majority of account-ing professors without the tools with which to explore the ethical dimensions of our discipline.Equipping professors with such tools is necessary, as is encouraging professors to explore thedimensions of our profession beyond abstract models and capital markets-based research. A lackof competence in professors is not a valid reason for a deficient, incomplete educational processthat does not instill professional character and competence in our students. Character develop-ment is an important part of the development of trustworthy professionals. It should be an integralpart of our restorative professional education process.

CONCLUSIONSAlthough tax practitioners claim professional status, behavior over the past decade casts

some doubt on whether tax practitioners take seriously the professional obligation to serve thepublic interest. The cost of ignoring the public interest role is a loss of professional freedom andincreasing government regulation of the profession. Using a fraud triangle framework, our analysisprovides an overview of the normative ideal for the tax profession against which we may comparecurrent developments within the profession. The framework suggests that for a trust violation tooccur, three factors must be present: opportunity, incentive, and rationalization. We suggest that atrue understanding of the service-oriented notion of profession self-regulates the professional andlimits rationalization even in the presence of incentives and opportunity. Client advocate and taxsystem responsibilities take precedence over self-interest and necessitate a balancing of clientinterests with the public interest.

Our comparison of the normative ideal with the tax shelter activity engaged in by leading publicaccounting firms provides an example of professional failure and “trust violation.” The fundamen-tal cause of this failure is the loss of a public interest emphasis within the accounting professionleading to a focus on the pursuit of self-interest. In response to the failure of the profession torecognize its public interest obligations, we propose reforms to the tax system, the profession,and the accounting academy. While we agree with and support many of the government’s pro-posed changes to the tax system and the profession, we recognize the fundamental necessity ofcultural changes to the profession and academia. Such changes are necessary in order to de-






velop practitioners’ character as well as their competence. Collectively, these reforms aim torealign the interests of tax practitioners with the public interest perspective required of any pro-fession. We suggest that unless deliberate steps are taken to restore the public interest perspec-tive to tax practice, the errors of the past will inevitably be repeated. As former CommissionersShapiro and Everson have noted, the IRS simply cannot administer the system alone but ratherrelies on the inputs of tax practitioners. The failure of the profession to step up and meet this

challenge poses a significant risk to the sustainability of the tax system. We conclude by notingformer Commissioner Everson’s comment that balancing the client and public interest “is a deli-cate balance, and one that requires integrity” Pickard 2005, 31. Restoring the appropriate bal-ance will necessitate a return to an emphasis on integrity and the profession’s responsibility toserve public interest.

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http://dx.doi.org/10.1006/cpac.1995.1023



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Ethics and Tax Profession

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