- Email: [email protected]
Relationship between tax compliance internationally and selected determinants of tax morale
Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
Relationship between tax compliance internationally and selected determinants of tax morale Ahmed Riahi-Belkaoui∗ University of Illinois at Chicago, 601 S. Morgan Street, Chicago, IL 60607-7123, USA
Abstract Tax compliance has been studied by analyzing the individual decision of a representative person between planning and evading taxes. A neglected aspect of tax compliance is the impact of a social contract on tax morale. Such implicit contract between the individual and the state guaranteeing a high level of economic freedom, effective competition laws, an important equity market and high moral norms, is hypothesized to have a positive impact on tax compliance. In this paper, empirical evidence based on data from 30 countries indicate that tax compliance internationally is positively related to the level of economic freedom, the level of importance of the equity market and the effectiveness of competition laws and high moral norms. © 2004 Elsevier Inc. All rights reserved. Keywords: Tax compliance; Social contact; Tax morale; Economic freedom; Effective competition laws; Moral norms
1. Introduction Why do individuals resist total compliance with their tax commitments and why does this situation differ internationally? The question has been extensively researched from the theoretical perspectives of general deterrence theory, economic deterrence models and fiscal psychology (Cuccia, 1994a, 1994b). This study takes the view that tax morale and its determinants can best explain the phenomenon of tax compliance internationally. It shows that where countries provide their citizens with a situation of high economic freedom, important equity markets, effective competition laws and high moral norms, tax compliance ∗
Tel.: +1 312 996 4400; fax: +1 312 996 4520. E-mail address: [email protected].
1061-9518/$ – see front matter © 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.intaccaudtax.2004.09.001
136
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
will be at its highest. It argues for an implicit social contract where the government and/or the state guarantee the maintenance of this social contract and its resulting tax morale for tax compliance to be effective. Section 2 of the paper describes the relationship of tax morale and tax compliance. Section 3 describes the data. Section 4 presents the regression analysis and discussions, and Section 6 concludes.
2. Tax morale and tax compliance Various authors reviewed the tax compliance literature (e.g. Andreoni, Erard, & Feinstein, 1998; Jackson & Milliron, 1986; Kinsey, 1986; Long & Swingen, 1991). The bulk of the research views tax compliance from three theoretical perspectives: general deterrence theory, economic deterrence models, and fiscal psychology. The general implications of these theories is that tax noncompliance is deterred by sanctions (e.g. Tittle, 1980), can be modeled as a purely economic decision under uncertainty (e.g. Allingham & Sandmo, 1972), or can be the results of non-economic factors such as demographics, attitudes, and perceptions on compliance (e.g. Kinsey, 1986). But, given the likelihood that cheaters are rarely caught and penalized, and defy a strict profile description, the three theories and related findings do not provide a definite explanation of why do people pay taxes (Alm, McClelland, & Schulze, 1992, p. 22), and also over predict non-compliance (Andreoni et al., 1998, p. 855). Tax noncompliance is in fact a pervasive phenomenon in all societies. There is good evidence of a shadow economy, or black economy, internationally (for a survey, see Cowell, 1990, pp. 22–23). The crux of the problem in the shadow economy or black economy is the fact that individuals are behaving dishonestly by providing false information. Basically, it is the distortion of information that can affect the state’s problem of exercising control and authority on the economy (Cowell, 1990, p. 40). What would lead citizens to behave more honestly, provide correct information and improve the tax compliance rate? One answer to this question is the existence of an intrinsic motivation to pay taxes, which has been sometimes called, “tax morale” (Feld & Frey, 2002). For example, Graetz and Wilde conclude on the basis of the Internal Revenue Service’s Taxpayer Compliance Measurement Program (1985, p. 358) that “. . . the high compliance rate can only be explained either by taxpayer’s (. . .) commitment to the responsibilities of citizenship and respect for the law or lack of opportunity for tax evasion”. When these three factors lose importance the level of ethics suffers (Benabou, 1996). Hence, the erosion of ethics was blamed for the observed falling tax compliance (Graetz, Reinganun, & Wilde, 1985, 1986; Lewis, 1982; Roth, Scholz, & White, 1989; Schwartz & Orleans, 1967; Slemrod, 1992). The main question becomes: “What are the factors that shape the emergence and maintenance of tax morale?” This stream of research has identified strong political rights in the sense of direct decision making like referenda and initiatives as a major determinant of tax morale (Feld & Frey, 2002; Frey, 1997; Pommerehne & Weck-Hannemann, 1996). But, it is more than the strong political rights that can explain the tax morale. Social contracts consist of the exchange of security against a share of the private good, produced at a higher level of effort. The agreement specifies what the government is prepared to offer individuals in return for tax based financing of these benefits. It is a special social contract whereby individuals in a given state
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
137
accept and trust their government in general, and comply with the tax burden in particular, if the government and/or the state provide them with conditions that enhance and protect their human dignity, trigger their morality and respect for moral norms, and assure them a piece of mind in their relations with other citizens and in the conduct of their affairs. Although not exhaustive but amply supported as sufficient and necessary, these conditions include: (a) Effective competition laws (Frey, 1994; Hermalin, 1992; Zywicki, 2002): Social contracts that promise effective competition laws allow the individual to exert a high level of effort in the provision of the private good. In exchange for the gain generated by the private good, the individual is more willing to comply with tax rules and obligations. The hypothesis is that (H1): “Effective competition laws lead to high tax compliance”. (b) High economic freedom (Ali, 1997; Alm, Jackson, & McKee, 1992; Feige, 1989): Social contacts that guarantee economic freedom creates more opportunities for individuals to be productive and in turn leads to higher tax compliance. The hypothesis is that (H2): “High economic freedom leads to high tax compliance”. (c) An important role accorded to the equity market (Beck, Ross, & Norman, 2000; Budge, 1996; Choi & Wong, 2002; La Porta, Lopez-de-Silanes, Schleifer, & Vishny, 1999; Levi, 1988; Townsend, 1979): A strong role of equity market in social contacts creates the financing opportunities for provision of private goods and a better willingness to comply with tax laws. The hypothesis is that (H3): “Important role of equity market leads to tax compliance”. (d) Moral norms (Coffee, 2001; Cuccia, 1994a, 1994b; Cullis & Lewis, 1997; Dyck and Zingales, 2001): Where moral norms are high, the security provided by the social contract ensures effective production and better tax compliance. With moral norms measured by a serious crime surrogate, the hypothesis is that (H4): “High crime rate leads to less tax compliance”. Regardless of reputation cost and/or the legal punishment tax noncompliance trigger, a citizen might chose to comply with taxes if the competition laws are effective, economic freedom is high, the equity market is important, and for moral considerations. 3. Data The determination of the sample rested on securing the necessary data on the variables of interest as specified in the main hypothesis of the paper. A total of 30 countries met this test. They are shown in Table 1. Table 2 summarizes all the variables (1) Tax compliance is measured by an assessment of the level of tax compliance index that varies from 0 to 6. Higher scores indicate higher compliance (La Porta et al., 1999). The three highest scores are for Singapore (5.05), New Zealand (5.00), and Australia (4.58). The three lowest scores are for Italy (1.77), Sweden (1.91) and Turkey (2.07). (2) Economic freedom is measured by the 1999 summary economic freedom index from Gwartney, Lawson, and Samida (2000). The summary index is based on 23 components designed to identify the consistency of institutional arrangements and policies with economic freedom in seven major areas: (a) size of government, (b) economic structure and use of markets, (c) monetary policy and price stability, (d) freedom to use alternative
138
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
Table 1 List of countries Name of country
Tax compliancea
Singapore New Zealand Australia UK Hong Kong Switzerland USA Malaysia Chile Japan Norway France Canada Denmark Austria Finland Germany Thailand Philippines Netherlands Spain Taiwan Indonesia Mexico Argentina Poland Portugal Turkey Sweden Italy
5.05 5.00 4.58 4.67 4.56 4.49 4.47 4.34 4.20 4.41 3.96 3.86 3.77 3.70 3.60 3.53 3.41 3.41 1.83 3.40 3.29 3.25 2.53 2.46 2.41 2.19 2.18 2.07 1.91 1.77
a Tax compliance is measured by an assessment of tax compliance based on a scale from 0 to 6 where high scores indicate higher compliance.
currencies, (e) legal structure and security of private ownership, (f) freedom to trade with foreigners, and (g) freedom of exchange in capital markets. Principal component analysis is used to combine the component ratings into area ratings and the area ratings into a summary rating. A high score means greater economic freedom. The three highest scores are for New Zealand (8.5), Singapore (8.2) and USA (8.0). The three lowest scores are for Brazil (2.8), Turkey (4.3) and Mexico (5.7). (3) Importance of equity market is measured by the degree that each country’s firms depend on equity financing (La Porta & Lopez-de-Silanes, 1997; Luez, Nanda, & Wysocki, 2001). The three highest scores are for the UK (36.27), Switzerland (31.50) and Australia (31.00). The three lowest scores are for Brazil (6.33), Indonesia (6.67) and Turkey (7.00). A high score measures high dependence on equity financing. (4) Violent crimes rate is used as proxy for low moral norms as suggested by Coffee (2001). It is equal to the 1993-reported number of murders, violent crimes or armed robberies per 100,000 populations, based on Interpol and Country data as reported in
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
139
Table 2 Variables Variable
Description
Source
1. Tax compliance (TC)
“Assessment of the level of tax compliance. Scale from 0 to 6 where higher scores indicate higher compliance. Data is for 1995”. Response to survey question, “Competition laws prevent unfair competition in your country”. Higher scores suggest agreement that competition laws can be effective. 1999 summary economic freedom index based on 23 components designed to identify the consistency of institutional arrangements and policies with economic freedom in seven major areas. Degree that each country’s firms depend on equity financing. This is a proxy for low moral norms suggested by Coffee (2001). It is the reported number of murders, violent crimes or armed robberies per 100,000 populations.
The Global Competitiveness Report 1996 as reported in La Porta et al. (1999)
2. Competition laws (CL)
3. Economic freedom (EF)
4. Importance of equity market (IOEM) 5. Serious crimes per 100,000 inhabitants (CP)
World Competitiveness Yearbook (1996). Institute of Management Development
Gwartney et al. (2000)
La Porta and Lopez-de-Silanes (1997); Luez et al. (2001) Interpol and Country data for 1993 as reported in World Competitiveness Yearbook (1995)
the 1995 World Competitiveness Yearbook. The three highest scores are for the USA (272.5), Hong Kong (190.8) and Sweden (169.6). The lowest scores are for Japan (2.7), Indonesia (4.6), and Argentina (8.2). (5) The effectiveness of the competition laws is measured by the answer to the survey question “Competition laws prevent unfair competition in your countries” (World Competitiveness Yearbook, 1996). Higher scores suggest agreement that competition laws can be effective. The three highest scores are the USA (5.96), Germany (5.91) and France (5.83). The three lowest scores are Indonesia (4.42), Thailand (4.77) and Portugal (4.81).
4. Methods To examine the determinants of tax compliance, the following regression equation was used: TCi = α0 + α1 EFi + α2 IOEMi + α3 CPi + α4 CLi + Ui
(1)
where, TCi is tax compliance score for country i (La Porta et al., 1999); EFi is economic freedom index for country i (Gwartney et al., 2000); IOEMi is importance of equity market for country i (La Porta & Lopez-de-Silanes, 1997); CPi is serious crimes per 100,000
140
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
population for country i (World Competitiveness Yearbook, 1996); CLi is effectiveness of competition laws (World Competitiveness Yearbook, 1996); Ui is residual term. 5. Determinants of tax compliance internationally Table 3 presents the descriptive statistics for the main variables used in the study, while Table 4 presents the Pearson correlations among the same variables. Table 5 presents the results of the regression regarding the impact of the selected “tax morale” variables on tax compliance. The results and discussions are presented below: Table 3 Descriptive statisticsa Variable
Mean
Standard deviation
Minimum
Maximum
TC IOEM EF CP CL
3.410 19.959 6.447 77.853 5.219
1.010 9.420 1.292 64.051 0.388
1.770 6.330 2.800 2.700 4.420
5.050 36.670 9.00 272.50 5.960
a
Variables are defined in Table 2.
Table 4 Pearson correlationa
TC IOEM EF CP CL a
TC
IOEM
EF
CP
CL
1.000
0.692, 0.0001 1.000
0.727, 0.0001 0.607, 0.0001 1.000
−0.0169, 0.928 0.340, 0.065 0.2617, 0.154 1.000
0.583, 0.0004 0.395, 0.027 0.527, 0.001 0.386, 0.029 1.000
Variables are defined in Table 2.
Table 5 Determinants of tax compliancea Independent variable Intercept IOEM EF CP CL R2 (adjusted) F Wald test Reset F value Hausman F value Dependent variable: tax compliance (TC). a Variables are defined in Table 3. ∗ Significant at α = 0.01.
−4.455 (−2.62)∗ 0.036 (2.25)∗ 0.498 (3.38)∗ −0.006 (−3.17)∗ 0.800 (2.20)∗ 75.96% 18.70∗ 0.01 0.05 11.36
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
141
1. H1 : The impact of economic freedom on tax compliance is positive and significant (t = 3.38, p = 0.01). This is in conformity with our thesis that economic freedom creates favorable tax morale more conducive to tax compliance. 2. H2 : The impact of the importance of equity market is positive and significant (t = 2.55, p = 0.01). This is in conformity with our thesis that the importance of the equity market creates possibilities for alternative allocation of resources, and opportunities for wealth management and growth, and in the process render a certain level of fairness to tax liability. The end result is a better tax morale and tax compliance. 3. H3 : The importance of moral norms is assessed by the impact of the proxy of serious crimes per 100,000 population. As would be expected, the impact of serious crimes per 100,000 population is negative and significant (t = 3.17, p = 0.01). This is in conformity with our thesis that regardless of the reputation cost and/or legal punishment tax noncompliance trigger, a citizen might choose tax compliance for moral considerations. Therefore, the higher the serious crimes per 100,000 population, the lower will be the moral norms and the higher will be the rate of non-compliance. 4. H4 : The impact of the effectiveness of laws on competition is positive and significant (t = 2.20, p = 0.05). This is in conformity with our thesis that satisfaction with law regulating competition and business lead to a better tax morale and more tax compliance. The result of Table 5 relies on White’s (1980) adjusted standard error estimates to deal with heteroscedasticity. The Wald test for joint significance is reported in the table. In addition, there is no evidence of serious multicollinearity among the independent variables. The regression specification error test (RESET) as suggested by Ramsey (1969) and Thursby (1981, 1985) and the Hausman (1978) were used as specification tests. The results of the RESET test, used to check for omitted variables, incorrect functional form, and nonindependence of regressors, show that the model used in this study is not misspecified (see diagnostic check statistics in Table 5). 6. Conclusions This study examines the international differences in tax compliance and relates these differences to selected determinants of tax morale. The findings of the empirical investigation of data from 30 countries indicate that tax compliance is highest in countries characterized by high economic freedom, important equity market, effective competition laws and low serious crime rate. It shows that a powerful deterrent to tax evasion is the creation of a tax morale or climate where citizens are guaranteed economic rights, and safe lives. Where individuals can exercise their economic rights in terms of economic freedom, important equity market and effective competition laws, in a safe environment that improves their quality of life, they are more prone to view tax compliance as less of a burden and more of a citizenship duty. Moral considerations are highest where the tax morale is high. These results point to the need for a contingency theory of tax compliance that calls on not only economic determinants of tax compliance but also institutional and moral determinants. Both the institutional and moral climate play a major role in the tax compliance subject and need to be recognized and taken into account by the tax authorities internationally. Future research may expand the determinants to include social and religious norms in order to
142
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
build a complete contingency theory of tax compliance and contribute to an efficient public policy on the subject. The research on the subject needs more verification in terms of bigger sample of countries and a choice of different determinants of tax morale. In effect, the five variables used in this study are only some of the adequate measures of social contracts between individuals and their governments. They are included in social contracts as an exchange for the provision of private good at a high level of effort. Other conditions need to be identified and tested. This study uses tax compliance as an independent variable across countries that have different approaches to compliance enforcement (i.e., audit rates, degree of sanctions/penalties for noncompliance) and different tax laws (i.e., tax rates, tax base, income tax versus valueadded tax). Future research may need to control for these differences in compliance enforcement and tax laws. Another limitation is that the proxy data for the variables used are drawn from different years because of the unavailability of the data for the same year as the tax compliance data. It may be stated that the few years of difference do not create material differences as the tax compliance variable takes a few years before experiencing a drastic change in its value.
References Ali, A. M. (1997). Economic freedom, democracy and growth. Journal of Private Enterprise, 13, 1–20. Allingham, M., & Sandmo, A. (1972). Income tax evasion: A theoretical analysis. Journal of Public Economics, 1(2), 323–338. Alm, J., Jackson, B., & McKee, M. (1992). Deterrence and beyond: Toward a kinder, gentler IRS. In J. Slemrod (Ed.), Why people pay taxes: Tax compliance and enforcement. Ann Arbor: University of Michigan Press. Alm, J., McClelland, G., & Schulze, M. (1992). Why do people pay taxes? Journal of Public Economics, 48, 21–38. Andreoni, J., Erard, B., & Feinstein, J. (1998). Tax compliance. Journal of Economic Literature, 36, 818–60. Beck, T., Ross, L., & Norman, L. (2000). Finance and the sources of growth. Journal of Financial Economics, 58, 261–300. Benabou, R. (1996). Unequal societies (NBER working paper no. W5583). Budge, I. (1996). The new challenge of direct democracy. Cambridge: Policy Press. Choi, J. H., & Wong T. J. (2002). Audit markets and legal environments: An international investigation (Working paper). The Hong Kong University of Science and Technology. Coffee, J. (2001). Do norms matter? A cross-country examination of private benefits of control [Mimeo]. Columbia University Law School. Cowell, F. A. (1990). Cheating the government: The economics of evasion. Cambridge: MIT Press. Cuccia, A. D. (1994a). The economics of tax compliances: What do we know and where do we go? Journal of Accounting Literature, 13, 81–116. Cuccia, A. D. (1994b). The effects of increased sanctions on professional tax preparers: Interesting economic and psychological factors. The Journal of the American Taxation Association, 16, 41–66. Cullis, J. G., & Lewis, A. (1997). Why people pay taxes: From a conventional economic model to a model of social convention. Journal of Economic Psychology, 18, 305–321. Dyck, A., & Zingales, L. (2001). Private benefits of control: An international comparison (Working paper). Harvard University. Feige, E. L. (1989). The underground economies: Tax evasion and information distortion. Cambridge: Cambridge University Press. Feld, L. P., & Frey, B. S. (2002). Trust breeds trust: How taxpayers are treated (Working paper no. 98). Institute of Empirical Research in Economics, University of Zurich.
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
143
Frey, B. S. (1994). Direct democracy: Politico-economic lessons from Swiss experience. American Economic Review, Papers and Proceedings, 2, 338–342. Frey, B. S. (1997). A constitution for knaves crowds our civic virtues. Economic Journal, 107, 1043–1053. Graetz, M. J., Reinganum, J. F., & Wilde, L. L. (1985). The economics of tax compliance: Facts and fantasy. National Tax Journal, 38, 355–363. Graetz, M. J., Reinganum, J. F., & Wilde, L. L. (1986). The tax compliance game: Toward an interactive theory of law enforcement. Journal of Law, Economics and Organization, 2, 1–32. Gwartney, J., Lawson, R., & Samida, D. (2000). Economic freedom of the world: 2000 annual report. Vancouver: The Fraser Institute. Hausman, J. A. (1978). Specification tests in econometrics. Econometrics, 4, 1251–1270. Hermalin, B. E. (1992). The effects of competition on executive behavior. Rand Journal of Economics, 23, 350–65. Institute of Management Development. (1966). World Competitiveness Yearbook 1996. Lausanne, Switzerland. Jackson, B., & Milliron, V. (1986). Tax compliance research: Findings, problems, and prospects. Journal of Accounting Literature, 5, 125–165. Kinsey, K. (1986). Theories and models of tax cheating. Criminal Justice Abstracts, 2, 403–425. La Porta, R., & Lopez-de-Silanes, F. (1997). Legal determinants of external finance. Journal of Finance, 52, 1131–1150. La Porta, R., Lopez-de-Silanes, F., Schleifer, A., & Vishny, R. W. (1999). The quality of government. Journal of Economics, Law and Organization, 15, 222–279. Levi, M. (1988). Of rule and revenue. Berkeley: University of California Press. Lewis, A. (1982). The psychology of taxation. Oxford: Blackwell. Long, S., & Swingen, J. (1991). Taxpayer compliance: Setting new agendas for research. Law and Society Review, 3, 637–683. Luez, C., Nanda, D., & Wysocki, P. (2001). Investor protection and earnings management: An international comparison (Working paper). University of Pennsylvania. Pommerehne, W. W., & Weck-Hannemann, H. (1996). Tax rates, tax administration and income tax evasion in Switzerland. Public Choice, 88, 161–170. Ramsey, F. I. (1969). Test for specification errors in classical linear least squares regression analysis. Journal of the Royal Statistical, 31(Series B), 31. Roth, J. A., Scholz, J. T., & Witte, A. D. (Eds.). (1989). Taxpayer compliance: An agenda for research. Philadelphia: University of Pennsylvania Press. Schwartz, R. D., & Orleans, S. (1967). On legal sanctions. University of Chicago Law Review, 34, 282–300. Slemrod, J. (Ed.). (1992). Why people pay taxes: Tax compliance and enforcement. Ann Arbor: University of Michigan Press. Thursby, F. I. (1981). A test for strategy for discriminating between auto-correlation and misspecification in regression analysis. Review of Economics and Statistics, 63, 117–123. Thursby, F. I. (1985). The relationship among the specification test of Hausman, Ramsey and Chow. Journal of the American Statistical Association, 80, 926–928. Tittle, C. (1980). Sanctions and social deviance: The question of deterrence. New York: Praeger. Townsend, R. (1979). Optimal contracts and competitive markets with costly state verification. Journal of Economic Theory, 21, 265–293. White, H. A. (1980). Heteroscedasticity-consistent covariance matrix estimator and a direct test for heteroscedasticity. Econometrica, 10, 817–838. Zywicki, T. J. (2002). The rule of law, freedom and prosperity (George Mason law and economic research paper no. 02-20).
Relationship between tax compliance internationally and selected determinants of tax morale Ahmed Riahi-Belkaoui∗ University of Illinois at Chicago, 601 S. Morgan Street, Chicago, IL 60607-7123, USA
Abstract Tax compliance has been studied by analyzing the individual decision of a representative person between planning and evading taxes. A neglected aspect of tax compliance is the impact of a social contract on tax morale. Such implicit contract between the individual and the state guaranteeing a high level of economic freedom, effective competition laws, an important equity market and high moral norms, is hypothesized to have a positive impact on tax compliance. In this paper, empirical evidence based on data from 30 countries indicate that tax compliance internationally is positively related to the level of economic freedom, the level of importance of the equity market and the effectiveness of competition laws and high moral norms. © 2004 Elsevier Inc. All rights reserved. Keywords: Tax compliance; Social contact; Tax morale; Economic freedom; Effective competition laws; Moral norms
1. Introduction Why do individuals resist total compliance with their tax commitments and why does this situation differ internationally? The question has been extensively researched from the theoretical perspectives of general deterrence theory, economic deterrence models and fiscal psychology (Cuccia, 1994a, 1994b). This study takes the view that tax morale and its determinants can best explain the phenomenon of tax compliance internationally. It shows that where countries provide their citizens with a situation of high economic freedom, important equity markets, effective competition laws and high moral norms, tax compliance ∗
Tel.: +1 312 996 4400; fax: +1 312 996 4520. E-mail address: [email protected].
1061-9518/$ – see front matter © 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.intaccaudtax.2004.09.001
136
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
will be at its highest. It argues for an implicit social contract where the government and/or the state guarantee the maintenance of this social contract and its resulting tax morale for tax compliance to be effective. Section 2 of the paper describes the relationship of tax morale and tax compliance. Section 3 describes the data. Section 4 presents the regression analysis and discussions, and Section 6 concludes.
2. Tax morale and tax compliance Various authors reviewed the tax compliance literature (e.g. Andreoni, Erard, & Feinstein, 1998; Jackson & Milliron, 1986; Kinsey, 1986; Long & Swingen, 1991). The bulk of the research views tax compliance from three theoretical perspectives: general deterrence theory, economic deterrence models, and fiscal psychology. The general implications of these theories is that tax noncompliance is deterred by sanctions (e.g. Tittle, 1980), can be modeled as a purely economic decision under uncertainty (e.g. Allingham & Sandmo, 1972), or can be the results of non-economic factors such as demographics, attitudes, and perceptions on compliance (e.g. Kinsey, 1986). But, given the likelihood that cheaters are rarely caught and penalized, and defy a strict profile description, the three theories and related findings do not provide a definite explanation of why do people pay taxes (Alm, McClelland, & Schulze, 1992, p. 22), and also over predict non-compliance (Andreoni et al., 1998, p. 855). Tax noncompliance is in fact a pervasive phenomenon in all societies. There is good evidence of a shadow economy, or black economy, internationally (for a survey, see Cowell, 1990, pp. 22–23). The crux of the problem in the shadow economy or black economy is the fact that individuals are behaving dishonestly by providing false information. Basically, it is the distortion of information that can affect the state’s problem of exercising control and authority on the economy (Cowell, 1990, p. 40). What would lead citizens to behave more honestly, provide correct information and improve the tax compliance rate? One answer to this question is the existence of an intrinsic motivation to pay taxes, which has been sometimes called, “tax morale” (Feld & Frey, 2002). For example, Graetz and Wilde conclude on the basis of the Internal Revenue Service’s Taxpayer Compliance Measurement Program (1985, p. 358) that “. . . the high compliance rate can only be explained either by taxpayer’s (. . .) commitment to the responsibilities of citizenship and respect for the law or lack of opportunity for tax evasion”. When these three factors lose importance the level of ethics suffers (Benabou, 1996). Hence, the erosion of ethics was blamed for the observed falling tax compliance (Graetz, Reinganun, & Wilde, 1985, 1986; Lewis, 1982; Roth, Scholz, & White, 1989; Schwartz & Orleans, 1967; Slemrod, 1992). The main question becomes: “What are the factors that shape the emergence and maintenance of tax morale?” This stream of research has identified strong political rights in the sense of direct decision making like referenda and initiatives as a major determinant of tax morale (Feld & Frey, 2002; Frey, 1997; Pommerehne & Weck-Hannemann, 1996). But, it is more than the strong political rights that can explain the tax morale. Social contracts consist of the exchange of security against a share of the private good, produced at a higher level of effort. The agreement specifies what the government is prepared to offer individuals in return for tax based financing of these benefits. It is a special social contract whereby individuals in a given state
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
137
accept and trust their government in general, and comply with the tax burden in particular, if the government and/or the state provide them with conditions that enhance and protect their human dignity, trigger their morality and respect for moral norms, and assure them a piece of mind in their relations with other citizens and in the conduct of their affairs. Although not exhaustive but amply supported as sufficient and necessary, these conditions include: (a) Effective competition laws (Frey, 1994; Hermalin, 1992; Zywicki, 2002): Social contracts that promise effective competition laws allow the individual to exert a high level of effort in the provision of the private good. In exchange for the gain generated by the private good, the individual is more willing to comply with tax rules and obligations. The hypothesis is that (H1): “Effective competition laws lead to high tax compliance”. (b) High economic freedom (Ali, 1997; Alm, Jackson, & McKee, 1992; Feige, 1989): Social contacts that guarantee economic freedom creates more opportunities for individuals to be productive and in turn leads to higher tax compliance. The hypothesis is that (H2): “High economic freedom leads to high tax compliance”. (c) An important role accorded to the equity market (Beck, Ross, & Norman, 2000; Budge, 1996; Choi & Wong, 2002; La Porta, Lopez-de-Silanes, Schleifer, & Vishny, 1999; Levi, 1988; Townsend, 1979): A strong role of equity market in social contacts creates the financing opportunities for provision of private goods and a better willingness to comply with tax laws. The hypothesis is that (H3): “Important role of equity market leads to tax compliance”. (d) Moral norms (Coffee, 2001; Cuccia, 1994a, 1994b; Cullis & Lewis, 1997; Dyck and Zingales, 2001): Where moral norms are high, the security provided by the social contract ensures effective production and better tax compliance. With moral norms measured by a serious crime surrogate, the hypothesis is that (H4): “High crime rate leads to less tax compliance”. Regardless of reputation cost and/or the legal punishment tax noncompliance trigger, a citizen might chose to comply with taxes if the competition laws are effective, economic freedom is high, the equity market is important, and for moral considerations. 3. Data The determination of the sample rested on securing the necessary data on the variables of interest as specified in the main hypothesis of the paper. A total of 30 countries met this test. They are shown in Table 1. Table 2 summarizes all the variables (1) Tax compliance is measured by an assessment of the level of tax compliance index that varies from 0 to 6. Higher scores indicate higher compliance (La Porta et al., 1999). The three highest scores are for Singapore (5.05), New Zealand (5.00), and Australia (4.58). The three lowest scores are for Italy (1.77), Sweden (1.91) and Turkey (2.07). (2) Economic freedom is measured by the 1999 summary economic freedom index from Gwartney, Lawson, and Samida (2000). The summary index is based on 23 components designed to identify the consistency of institutional arrangements and policies with economic freedom in seven major areas: (a) size of government, (b) economic structure and use of markets, (c) monetary policy and price stability, (d) freedom to use alternative
138
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
Table 1 List of countries Name of country
Tax compliancea
Singapore New Zealand Australia UK Hong Kong Switzerland USA Malaysia Chile Japan Norway France Canada Denmark Austria Finland Germany Thailand Philippines Netherlands Spain Taiwan Indonesia Mexico Argentina Poland Portugal Turkey Sweden Italy
5.05 5.00 4.58 4.67 4.56 4.49 4.47 4.34 4.20 4.41 3.96 3.86 3.77 3.70 3.60 3.53 3.41 3.41 1.83 3.40 3.29 3.25 2.53 2.46 2.41 2.19 2.18 2.07 1.91 1.77
a Tax compliance is measured by an assessment of tax compliance based on a scale from 0 to 6 where high scores indicate higher compliance.
currencies, (e) legal structure and security of private ownership, (f) freedom to trade with foreigners, and (g) freedom of exchange in capital markets. Principal component analysis is used to combine the component ratings into area ratings and the area ratings into a summary rating. A high score means greater economic freedom. The three highest scores are for New Zealand (8.5), Singapore (8.2) and USA (8.0). The three lowest scores are for Brazil (2.8), Turkey (4.3) and Mexico (5.7). (3) Importance of equity market is measured by the degree that each country’s firms depend on equity financing (La Porta & Lopez-de-Silanes, 1997; Luez, Nanda, & Wysocki, 2001). The three highest scores are for the UK (36.27), Switzerland (31.50) and Australia (31.00). The three lowest scores are for Brazil (6.33), Indonesia (6.67) and Turkey (7.00). A high score measures high dependence on equity financing. (4) Violent crimes rate is used as proxy for low moral norms as suggested by Coffee (2001). It is equal to the 1993-reported number of murders, violent crimes or armed robberies per 100,000 populations, based on Interpol and Country data as reported in
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
139
Table 2 Variables Variable
Description
Source
1. Tax compliance (TC)
“Assessment of the level of tax compliance. Scale from 0 to 6 where higher scores indicate higher compliance. Data is for 1995”. Response to survey question, “Competition laws prevent unfair competition in your country”. Higher scores suggest agreement that competition laws can be effective. 1999 summary economic freedom index based on 23 components designed to identify the consistency of institutional arrangements and policies with economic freedom in seven major areas. Degree that each country’s firms depend on equity financing. This is a proxy for low moral norms suggested by Coffee (2001). It is the reported number of murders, violent crimes or armed robberies per 100,000 populations.
The Global Competitiveness Report 1996 as reported in La Porta et al. (1999)
2. Competition laws (CL)
3. Economic freedom (EF)
4. Importance of equity market (IOEM) 5. Serious crimes per 100,000 inhabitants (CP)
World Competitiveness Yearbook (1996). Institute of Management Development
Gwartney et al. (2000)
La Porta and Lopez-de-Silanes (1997); Luez et al. (2001) Interpol and Country data for 1993 as reported in World Competitiveness Yearbook (1995)
the 1995 World Competitiveness Yearbook. The three highest scores are for the USA (272.5), Hong Kong (190.8) and Sweden (169.6). The lowest scores are for Japan (2.7), Indonesia (4.6), and Argentina (8.2). (5) The effectiveness of the competition laws is measured by the answer to the survey question “Competition laws prevent unfair competition in your countries” (World Competitiveness Yearbook, 1996). Higher scores suggest agreement that competition laws can be effective. The three highest scores are the USA (5.96), Germany (5.91) and France (5.83). The three lowest scores are Indonesia (4.42), Thailand (4.77) and Portugal (4.81).
4. Methods To examine the determinants of tax compliance, the following regression equation was used: TCi = α0 + α1 EFi + α2 IOEMi + α3 CPi + α4 CLi + Ui
(1)
where, TCi is tax compliance score for country i (La Porta et al., 1999); EFi is economic freedom index for country i (Gwartney et al., 2000); IOEMi is importance of equity market for country i (La Porta & Lopez-de-Silanes, 1997); CPi is serious crimes per 100,000
140
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
population for country i (World Competitiveness Yearbook, 1996); CLi is effectiveness of competition laws (World Competitiveness Yearbook, 1996); Ui is residual term. 5. Determinants of tax compliance internationally Table 3 presents the descriptive statistics for the main variables used in the study, while Table 4 presents the Pearson correlations among the same variables. Table 5 presents the results of the regression regarding the impact of the selected “tax morale” variables on tax compliance. The results and discussions are presented below: Table 3 Descriptive statisticsa Variable
Mean
Standard deviation
Minimum
Maximum
TC IOEM EF CP CL
3.410 19.959 6.447 77.853 5.219
1.010 9.420 1.292 64.051 0.388
1.770 6.330 2.800 2.700 4.420
5.050 36.670 9.00 272.50 5.960
a
Variables are defined in Table 2.
Table 4 Pearson correlationa
TC IOEM EF CP CL a
TC
IOEM
EF
CP
CL
1.000
0.692, 0.0001 1.000
0.727, 0.0001 0.607, 0.0001 1.000
−0.0169, 0.928 0.340, 0.065 0.2617, 0.154 1.000
0.583, 0.0004 0.395, 0.027 0.527, 0.001 0.386, 0.029 1.000
Variables are defined in Table 2.
Table 5 Determinants of tax compliancea Independent variable Intercept IOEM EF CP CL R2 (adjusted) F Wald test Reset F value Hausman F value Dependent variable: tax compliance (TC). a Variables are defined in Table 3. ∗ Significant at α = 0.01.
−4.455 (−2.62)∗ 0.036 (2.25)∗ 0.498 (3.38)∗ −0.006 (−3.17)∗ 0.800 (2.20)∗ 75.96% 18.70∗ 0.01 0.05 11.36
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
141
1. H1 : The impact of economic freedom on tax compliance is positive and significant (t = 3.38, p = 0.01). This is in conformity with our thesis that economic freedom creates favorable tax morale more conducive to tax compliance. 2. H2 : The impact of the importance of equity market is positive and significant (t = 2.55, p = 0.01). This is in conformity with our thesis that the importance of the equity market creates possibilities for alternative allocation of resources, and opportunities for wealth management and growth, and in the process render a certain level of fairness to tax liability. The end result is a better tax morale and tax compliance. 3. H3 : The importance of moral norms is assessed by the impact of the proxy of serious crimes per 100,000 population. As would be expected, the impact of serious crimes per 100,000 population is negative and significant (t = 3.17, p = 0.01). This is in conformity with our thesis that regardless of the reputation cost and/or legal punishment tax noncompliance trigger, a citizen might choose tax compliance for moral considerations. Therefore, the higher the serious crimes per 100,000 population, the lower will be the moral norms and the higher will be the rate of non-compliance. 4. H4 : The impact of the effectiveness of laws on competition is positive and significant (t = 2.20, p = 0.05). This is in conformity with our thesis that satisfaction with law regulating competition and business lead to a better tax morale and more tax compliance. The result of Table 5 relies on White’s (1980) adjusted standard error estimates to deal with heteroscedasticity. The Wald test for joint significance is reported in the table. In addition, there is no evidence of serious multicollinearity among the independent variables. The regression specification error test (RESET) as suggested by Ramsey (1969) and Thursby (1981, 1985) and the Hausman (1978) were used as specification tests. The results of the RESET test, used to check for omitted variables, incorrect functional form, and nonindependence of regressors, show that the model used in this study is not misspecified (see diagnostic check statistics in Table 5). 6. Conclusions This study examines the international differences in tax compliance and relates these differences to selected determinants of tax morale. The findings of the empirical investigation of data from 30 countries indicate that tax compliance is highest in countries characterized by high economic freedom, important equity market, effective competition laws and low serious crime rate. It shows that a powerful deterrent to tax evasion is the creation of a tax morale or climate where citizens are guaranteed economic rights, and safe lives. Where individuals can exercise their economic rights in terms of economic freedom, important equity market and effective competition laws, in a safe environment that improves their quality of life, they are more prone to view tax compliance as less of a burden and more of a citizenship duty. Moral considerations are highest where the tax morale is high. These results point to the need for a contingency theory of tax compliance that calls on not only economic determinants of tax compliance but also institutional and moral determinants. Both the institutional and moral climate play a major role in the tax compliance subject and need to be recognized and taken into account by the tax authorities internationally. Future research may expand the determinants to include social and religious norms in order to
142
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
build a complete contingency theory of tax compliance and contribute to an efficient public policy on the subject. The research on the subject needs more verification in terms of bigger sample of countries and a choice of different determinants of tax morale. In effect, the five variables used in this study are only some of the adequate measures of social contracts between individuals and their governments. They are included in social contracts as an exchange for the provision of private good at a high level of effort. Other conditions need to be identified and tested. This study uses tax compliance as an independent variable across countries that have different approaches to compliance enforcement (i.e., audit rates, degree of sanctions/penalties for noncompliance) and different tax laws (i.e., tax rates, tax base, income tax versus valueadded tax). Future research may need to control for these differences in compliance enforcement and tax laws. Another limitation is that the proxy data for the variables used are drawn from different years because of the unavailability of the data for the same year as the tax compliance data. It may be stated that the few years of difference do not create material differences as the tax compliance variable takes a few years before experiencing a drastic change in its value.
References Ali, A. M. (1997). Economic freedom, democracy and growth. Journal of Private Enterprise, 13, 1–20. Allingham, M., & Sandmo, A. (1972). Income tax evasion: A theoretical analysis. Journal of Public Economics, 1(2), 323–338. Alm, J., Jackson, B., & McKee, M. (1992). Deterrence and beyond: Toward a kinder, gentler IRS. In J. Slemrod (Ed.), Why people pay taxes: Tax compliance and enforcement. Ann Arbor: University of Michigan Press. Alm, J., McClelland, G., & Schulze, M. (1992). Why do people pay taxes? Journal of Public Economics, 48, 21–38. Andreoni, J., Erard, B., & Feinstein, J. (1998). Tax compliance. Journal of Economic Literature, 36, 818–60. Beck, T., Ross, L., & Norman, L. (2000). Finance and the sources of growth. Journal of Financial Economics, 58, 261–300. Benabou, R. (1996). Unequal societies (NBER working paper no. W5583). Budge, I. (1996). The new challenge of direct democracy. Cambridge: Policy Press. Choi, J. H., & Wong T. J. (2002). Audit markets and legal environments: An international investigation (Working paper). The Hong Kong University of Science and Technology. Coffee, J. (2001). Do norms matter? A cross-country examination of private benefits of control [Mimeo]. Columbia University Law School. Cowell, F. A. (1990). Cheating the government: The economics of evasion. Cambridge: MIT Press. Cuccia, A. D. (1994a). The economics of tax compliances: What do we know and where do we go? Journal of Accounting Literature, 13, 81–116. Cuccia, A. D. (1994b). The effects of increased sanctions on professional tax preparers: Interesting economic and psychological factors. The Journal of the American Taxation Association, 16, 41–66. Cullis, J. G., & Lewis, A. (1997). Why people pay taxes: From a conventional economic model to a model of social convention. Journal of Economic Psychology, 18, 305–321. Dyck, A., & Zingales, L. (2001). Private benefits of control: An international comparison (Working paper). Harvard University. Feige, E. L. (1989). The underground economies: Tax evasion and information distortion. Cambridge: Cambridge University Press. Feld, L. P., & Frey, B. S. (2002). Trust breeds trust: How taxpayers are treated (Working paper no. 98). Institute of Empirical Research in Economics, University of Zurich.
A. Riahi-Belkaoui / Journal of International Accounting, Auditing and Taxation 13 (2004) 135–143
143
Frey, B. S. (1994). Direct democracy: Politico-economic lessons from Swiss experience. American Economic Review, Papers and Proceedings, 2, 338–342. Frey, B. S. (1997). A constitution for knaves crowds our civic virtues. Economic Journal, 107, 1043–1053. Graetz, M. J., Reinganum, J. F., & Wilde, L. L. (1985). The economics of tax compliance: Facts and fantasy. National Tax Journal, 38, 355–363. Graetz, M. J., Reinganum, J. F., & Wilde, L. L. (1986). The tax compliance game: Toward an interactive theory of law enforcement. Journal of Law, Economics and Organization, 2, 1–32. Gwartney, J., Lawson, R., & Samida, D. (2000). Economic freedom of the world: 2000 annual report. Vancouver: The Fraser Institute. Hausman, J. A. (1978). Specification tests in econometrics. Econometrics, 4, 1251–1270. Hermalin, B. E. (1992). The effects of competition on executive behavior. Rand Journal of Economics, 23, 350–65. Institute of Management Development. (1966). World Competitiveness Yearbook 1996. Lausanne, Switzerland. Jackson, B., & Milliron, V. (1986). Tax compliance research: Findings, problems, and prospects. Journal of Accounting Literature, 5, 125–165. Kinsey, K. (1986). Theories and models of tax cheating. Criminal Justice Abstracts, 2, 403–425. La Porta, R., & Lopez-de-Silanes, F. (1997). Legal determinants of external finance. Journal of Finance, 52, 1131–1150. La Porta, R., Lopez-de-Silanes, F., Schleifer, A., & Vishny, R. W. (1999). The quality of government. Journal of Economics, Law and Organization, 15, 222–279. Levi, M. (1988). Of rule and revenue. Berkeley: University of California Press. Lewis, A. (1982). The psychology of taxation. Oxford: Blackwell. Long, S., & Swingen, J. (1991). Taxpayer compliance: Setting new agendas for research. Law and Society Review, 3, 637–683. Luez, C., Nanda, D., & Wysocki, P. (2001). Investor protection and earnings management: An international comparison (Working paper). University of Pennsylvania. Pommerehne, W. W., & Weck-Hannemann, H. (1996). Tax rates, tax administration and income tax evasion in Switzerland. Public Choice, 88, 161–170. Ramsey, F. I. (1969). Test for specification errors in classical linear least squares regression analysis. Journal of the Royal Statistical, 31(Series B), 31. Roth, J. A., Scholz, J. T., & Witte, A. D. (Eds.). (1989). Taxpayer compliance: An agenda for research. Philadelphia: University of Pennsylvania Press. Schwartz, R. D., & Orleans, S. (1967). On legal sanctions. University of Chicago Law Review, 34, 282–300. Slemrod, J. (Ed.). (1992). Why people pay taxes: Tax compliance and enforcement. Ann Arbor: University of Michigan Press. Thursby, F. I. (1981). A test for strategy for discriminating between auto-correlation and misspecification in regression analysis. Review of Economics and Statistics, 63, 117–123. Thursby, F. I. (1985). The relationship among the specification test of Hausman, Ramsey and Chow. Journal of the American Statistical Association, 80, 926–928. Tittle, C. (1980). Sanctions and social deviance: The question of deterrence. New York: Praeger. Townsend, R. (1979). Optimal contracts and competitive markets with costly state verification. Journal of Economic Theory, 21, 265–293. White, H. A. (1980). Heteroscedasticity-consistent covariance matrix estimator and a direct test for heteroscedasticity. Econometrica, 10, 817–838. Zywicki, T. J. (2002). The rule of law, freedom and prosperity (George Mason law and economic research paper no. 02-20).