Information Asymmetry and Credence Goods: The Economics of International Tax Advice

The marketplace can organize itself most efficiently when there is an equal amount of information about both the sellers and buyers available to each side. However, this equal availability of information does not always hold true in the real world, and therefore many products or services may be traded in an inefficient manner due to a lack of equal access to available information by both sellers and buyers. One example of this is the marketplace for International Tax Advice services. International tax advisory services represent a distinct case that illustrates information asymmetry, which is a central concept in microeconomics, first made popular by the work of George Akerlof, as it relates to complex and high risk professional services.

Information asymmetry occurs when one side (the advisor) of a transaction has information that is more abundant or better than the information possessed by the other side (the client) of the transaction. In the context of international tax advisory services, the advisor typically has a much greater store of knowledge about important issues such as tax treaties, residency rules, and reportable events than does the taxpayer (i.e., the client) who may be receiving the advisory service as it relates to a cross border income transaction or cross border business transaction, thereby making it very difficult for the taxpayer to determine whether the advice they are receiving from their advisor is accurate, optimal, or compliant.

International tax services can be characterised as a type of credence good based on the fact that they lack the ability to be evaluated in the same way as search goods (which can be evaluated prior to purchase) and experience goods (which can be evaluated after consumption). A client will usually have no way of knowing whether their tax strategy was the best available or even appropriate until they have had time to observe the results, usually through audits or other regulation-related challenges, and may potentially never know.

Complexity and regulatory fragmentation are the primary forces driving this phenomenon. For example, there are currently in excess of 3,000 bilateral tax treaties throughout the world, many based on the OECD or UN Model Convention, but each with specific modifications for each respective country. In addition, tax codes are frequently updated, usually as a result of political or fiscal pressure, often at least once each year. As a result, this constant evolution increases the costs of acquiring and maintaining relevant expertise; accordingly, true cross-border competency is relatively rare.

Markets are able to develop signalling and screening mechanisms to help mitigate problems associated with information asymmetry and moral hazard between advisers and clients. Advisers are able to signal their quality through credentials (such as CPA or Chartered Tax Adviser), specialisation in international taxation, publishing articles in trusted technical journals, and affiliation with respected firms. Brand reputation, particularly in the context of large firms, allows these organisations to use their name as a proxy for service quality, thereby decreasing perceived risk for clients. Clients’ screening process includes reviewing case studies, seeking referrals, and using advisers who have experience providing tax services between specific countries.

An example of this in the real world is the market for US expatriate tax services. US tax advisers who focus specifically on US–UK taxation (or US–France taxation) can typically charge fees that are substantially higher than general advisers due to their experience and expertise. This is because they are familiar with the technical nuances involved in international tax compliance, such as Foreign Tax Credits, Article 23 of the US/UK Tax Treaty, and reporting requirements for Form 8938 and FATCA. Mistakes in these areas can result in penalties reaching tens of thousands of dollars and can make correcting prior errors extremely costly.

The risk of receiving incorrect advice reinforces the importance of signalling mechanisms and established reputations in this market.

Examples have emerged in recent times, such as boutique advisory firms that cater solely to cross-border entrepreneurs and digital nomads. Such firms differentiate themselves from other advisory firms by publishing detailed guides; maintaining an active online presence; and demonstrating expertise in very specific jurisdictional areas. As such, boutique advisory firms work to bring about transparency and perceived expertise in each of these areas through the elimination of information asymmetries.

As a further example of this phenomenon, the persistence of information asymmetries in this market also contributes to the lack of correlation between pricing and quality. High pricing is a function of both true expertise, or alternatively a strong signal of true expertise; low or no cost providers may bring in clients that do not appreciate the complexity of the client's situation only to suffer costly consequences later.

Therefore, the market for International Tax Advice exemplifies how different information problems affect pricing and competition but also affect the recognition of trust, reputation and the construction of entire professions within a given jurisdiction.