On Thursday 9th October I’m doing a presentation at a conference of The Tax Institute, the Australian professional association for tax specialists, introducing decision analysis techniques. The presentation will illustrate (with live demonstration) the following applications:
- Using quantitative risk analysis (Monte Carlo simulation) to help a client gain better insight into the probable or possible outcomes of a certain tax strategy;
- Using decision trees to help a client decide whether to purse a dispute with the Tax Office through the courts.
Decision analysis techniques are well-developed and used, more or less widely, in various other professions such as engineering and finance. However, they are rarely used by tax specialists, or by lawyers and accountants more broadly.
Why? One perspective is that decision analysis is fundamentally ill-suited to the kinds of reasoning and decision making involved in tax matters, which are thought to involve unquantifiable issues and nuances requiring intuitive nous of the kind only highly trained and experienced legal or accountants can provide.
An alternative perspective is that tax matters would almost always benefit from decision analysis, and that tax specialists fail to use it only because they are trapped behind boundaries imposed by their professional traditions, their training, and their intellectual inertia. A strong version of this view is that tax specialists are derelict in failing to provide their clients with an easily-obtainable level of clarity and rigour.
In the spirit of John Stuart Mill, this paper takes a middle position. It suggests that decision analysis is potentially useful for certain types of problems regularly handled by tax specialists, while not being appropriate for many others. Decision analysis may represent an important opportunity for tax specialists to provide greater value to sophisticated clients.
1.2.1 Three Thinking Modes
At a high level, the relation of decision analysis to the kinds of intellectual labour generally undertaken by tax specialists is summarized in this diagram.
To indulge in some useful caricatures, qualitative thinking is the domain of the lawyer. It uses no numbers at all, or at most simple arithmetic. The central concept is the argument. Making the most important decisions is always a matter of “weighing up” arguments expressed in the legally-inflected natural language
Quantitative deterministic thinking is the speciality of the accountant. It is epitomised in the structures and calculations in an ordinary spreadsheet, in which specified inputs are “crunched” into equally specific outputs. The central concept is calculation; uncertainties are replaced by “assumptions”. Decisions generally boil down to comparing the magnitudes of numerical outputs, in the penumbral light cast by the background knowledge, intuitions and biases of the decision maker.
The third mode of thinking, probabilistic, is of course the decision analyst’s territory. The central concepts is uncertainty, and the essential gambit is framing and manipulating probabilistic representations of uncertainty.
In this context, the “master” tax specialist has facility, or even advanced expertise, in all three modes of thinking.