Tax compliance has been a key topic in public finance for some decades already, and has been in the agenda of tax administrations for millennia. People evade taxes, totally or partially, pretty much everywhere in the world. For an economist, this is not surprising: evading tax is akin to a gamble, where you have some chances of being caught, and some changes of getting away with more money. Tax evasion is like investing in an asset before knowing whether it is going boom or bust.
It is nice to think of tax evasion as an investment decision. The enforcement system determines what happens in the bad scenario, when the cheater is caught, and the good scenario is when the taxpayer gets to use the evaded amount. But it fails to explain the variety of forms in which tax evasion takes place, let alone predict some empirical patterns that still puzzle economists to this day. One puzzling fact is simply that far too many people comply with taxes. They simply do not take the gamble, even when it seems that it would be worth it.
A popular trend of argument is to include tax morale as an ingredient to the taxpayer’s decision. Tax morale is the wish to comply with the tax system, just because. When tax morale is present people comply with taxes even when the enforcement system is not very strict. Something else is happening in the “benefit” side of tax evasion.
In a survey published in the Journal of Economic Perspectives (Vol. 28, №4, Fall 2014), Erzo Luttmer and Monica Singhal mention three things that might be going on. One, intrinsic motivation: people may simple like paying taxes. Two, reciprocity: people pay taxes when they see that they are being put to good use. Three, social influences. Smart economists have come up with ways to measure all that.
For example, in Germany the State collects money on behalf of churches. It is the “church tax”, or “Kirchensteuer”. However, enforcement of this tax is apparently zero, so people can simply not pay it and nothing happens. Still, in Bavaria 20% of Protestants pay the exact amount, with many other complying partially, according to a study cited in the survey. Similar patterns happen for Catholics.
Why would they do that, if not for tax morale reasons? Indeed, all three factors are present here. People may simply feel intrinsically motivated to pay taxes, because it is the right thing to do. (In Germany pedestrians stop at the red light even when there are no cars coming). Reciprocity: the Church provides services to the community, whose members understand that they have to contribute to keep the activities going. Social pressure: if your fellow Protestant or Catholic friends are paying, why should you be the smart one that will evade the tax?
However, things get trickier when one starts putting numbers to these things. Some experiments have been designed to understand which story is more important, but their results are typically not very encouraging. Researchers around the world have sent letters to taxpayers telling them that “paying taxes is a civic duty” and things like that, and saw no great improvement in tax declarations (examples are Dina Pomeranz’ AER paper on Chile in 2016 or the 2011 Econometrica paper on Denmark by Kleven et al).
Telling people that their taxes are used to provide for services or infrastructure also has had no effect, so the reciprocity margin is also hard to measure. The social incentives margin has been slightly more successful. A study published in 2014 on the UK, by Hallsworth, List, Metclafeand Vlaev, showed that people did increase tax declarations after being exposed to assertions such as “9 out of 10 people pay their tax on time. You are currently in the very small minority of people who have not paid us yet.” But is this due to social pressure or because the taxpayer suddenly notices that he is under the administration’s watch?
One ‘case study’ seems worth mentioning. Margaret Thatcher instituted a lump sum tax on property in the end of the 1980s, and faced enormous revolts, presumably because people thought that it was unfair to have a tax that does not depend on the individual’s capacity to pay. This activated the “reciprocity” margin, and increased tax evasion. After the tax was abolished and the property tax was based on property value, evasion rates persisted quite high, suggesting that the new “social norm” stuck in people’s behavior. At least that is the story in a 2014 paper by Tim Besley, Anders Jensen and Thorsten Persson.
Tax morale is obviously an important element to be considered in a serious analysis. Recently I had a conversation with a very good economics professor who ranted for minutes about how much he was happy paying his taxes. He said that he deeply believed that the tax system is a better way to fight inequality and poverty than, say, giving to charity. OK, I said, thinking that it is slightly odd that someone may enjoy paying taxes. James Andreoni, a great economist who worked on the issue, has even coined the term “warm glow” to describe the good feeling of fulfilling a civic duty.
Despite the obvious importance of tax morale, it is clearly hard to measure it. It is also unlikely that the “gambling” story is minor or unimportant. Most studies on tax evasion do not include tax morale features, and have been more successful in putting believable figures to evasion and its causes. It is already hard to understand the impact of audit probabilities, penalty rates and tax rates on the propensity to evade, but taxpayers clearly react to these parameters.
This is not to meant that tax morale does not matter, but we are still trying out effective ways to understand how to measure it and how to get variation that can explain different patterns of evasion. This is much easier to do with policy instruments.