Canada Revenue Agency Checks Funny Income Tax Numbers

Taxman puts mathematical quirk to work in spotting fudged returns was the way the Vancouver Sun more eloquently described it.

The Canada Revenue Agency is using a little-known statistical phenomenon named after the late American physicist, Frank Benford, to help identify which tax returns to examine more closely.  Benford’s “law” holds that in a series of naturally occurring numbers, the number 1 will appear as the first digit more often than other numbers. Whether the figures are street addresses, expense reports or tax deductions, the “loneliest number” leads off about 30 per cent of the time.

This is how Frank Benford stumbled on his law.

Frank Benford was a research physicist at General Electric in the 1930s when he noticed something unusual about a book of logarithmic tables. The first pages showed more wear than the last pages, indicating that numbers beginning with the digit 1 were being looked up more often than numbers beginning with 2 through 9. Benford seized upon this idea and spent years collecting data to show that this pattern was widespread in nature. In 1938, Benford published his results, citing more than 20,000 values such as atomic weights, numbers in magazine articles, baseball statistics, and the areas of rivers.

In recent years the value of this and similar patterns as an auditing tool has been recognized by forensic accountants, in part because faster and cheaper computers allow first-digit analysis to be performed easily on large amounts of data.  The CRA says it is now using the first-digit rule in certain circumstances to combat what it politely calls “non-compliance” in tax returns.  The agency has shown particular interest in using it to analyze corporate tax returns. 

Perhaps Benford’s law could become even more useful as more Canadians file their tax returns electronically.  Make sure that your numbers do not look too funny if you are rushing to complete your tax return online before the deadline.

Related articles by Zemanta

• Tax deadline looms: Hope you’re ready (financialpost.com)