Prof. Dr. DDr.h.c . Friedrich Schneider Department of Economics

1. Studien\TaxEvasion\2015\TaxMorale.ppt Revised Version July 7, 2015 Prof. Dr. DDr.h.c. Friedrich Schneider Department of Economics Johannes Kepler University of Linz E-mail: friedrich.schneider@jku.athttp://www.econ.jku.at/schneider The Morals of (Not) Paying Taxes and Receiving Benefits:Economic, Institutional and Psychological Factors  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

2. Content  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA • Introduction • Some Theoretical Considerations about Tax (Benefit) Morale • What Shapes the Attitudes to (Not) Paying Taxes or Receiving (Unjustified) Benefits? The Case of Austria • What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland • Local Autonomy, Tax Morale and the Shadow Economy • Summary and Conclusions

3. 1. Introduction – 1.1 Why do people pay taxes? • The puzzle of the economic theory of tax complianceis: Why do people pay taxes? Especially in the view of the low deterrence in most countries, either because of a low intensity of control or small penalties, taxpayers should evade more than they actually do, i.e. compliance is much too high.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

4. 1. Introduction – 1.1 Why do people pay taxes? Figure 1.1: “Do you justify cheating on taxes?” Results of the EVS 1990, 1999, 2008 for 5 countries in % Source: European Value Survey, longitudinal data file; May 2015.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

5. 1. Introduction – 1.1 Why do people pay taxes? Figure 1.2: “Do you justify claiming state benefits you are not entitled to?”, Results of the EVS 1990, 1999, 2008 for 5 countries in % Source: European Value Survey, longitudinal data file; May 2015.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

6. 1. Introduction – 1.1 Why do people pay taxes? • Two strands of arguments ((i) and (ii)) are put forward to close the gap between theory and facts: • On the one hand, the probability of being detected is subjective. First, individual perceptions of being caught when cheating on taxes or benefits are much higherthan objective probabilities of detection. Second, subjective probabilities of being caught exist in the sense that the individual ability to evade taxes strongly varies among subgroups of the population.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

7. 1. Introduction – 1.1 Why do people pay taxes? • On the other hand, tax morale serves as an explanation for highcompliancerates in OECD countries. Allingham and Sandmo (1972) argue that tax morale residually explains the level of tax compliance independent of tax policy and the behaviour of public authorities. This argument is consistent with the view that fundamental social norms, (like religion or civic duty) shape tax morale.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

8. 1. Introduction – 1.2 Goals of this lecture Three goals: • If tax morale is used as an explanation why tax compliance rates are so high, it is necessary to analyze what shapes tax morale. • This will be done for Austria (homogenous, mono-cultural country) in part 3 and for Belgium, Spain and Switzerland (non-homogenous, multi-cultural countries) in part 4. • In part 5 an additional analysis “explores” the relation between local autonomy, tax morale and the shadow economy.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

9. 2. Some Theoretical Considerations about Tax (Benefit) Morale – 2.1 Tax and benefit morale literature Intrinsic motivation (expressed as tax and benefit morale) is therefore a key determinant in understanding compliance behavior! • Using Canadian data Torgler (2003) shows that tax morale rises with financial satisfaction, age, patriotism, trust in government, religiosity and deteriorates with rising income. • Torgler and Schneider (2004) emphasize the influence of cultural differences in explaining tax morale and find strong evidence for interactions between culture and institutions.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

10. 2. Some Theoretical Considerations about Tax (Benefit) Morale – 2.1 Tax and benefit morale literature • Torglerand Schneider (2005) investigate tax morale in Austria. Societal variables (e.g. perceived tax evasion, patriotism, trust in legal system) are key determinants. • To my best knowledge very few investigations of the individual (taxpayer’s) decision on claiming unjustified subsidies (e.g. by underreporting income) exists so far in the economic literature; e.g. Orviska and Hudson (2003) touch upon this issue.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

11. 2. Some Theoretical Considerations about Tax (Benefit) Morale – 2.1 Tax and benefit morale literature • From a theoretical point of view a subsidy is a negative tax, but in empirical applications a separate investigation is necessary, since • the theoretical determinants (e.g. probability of detection) can differ, and • individuals may have different ‘opportunities’; some may not have the opportunity to avoid/evade taxes, but it may be feasible for them to claim unjustified subsidies.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

12. 2. Some Theoretical Considerations about Tax (Benefit) Morale – 2.2 Key factors influencing tax and benefit morale Fourdifferent types of (reciprocity)norms,which depend on government policies, tax authorities’ behaviour and state institutions, influence tax and benefit morale: • First, citizens pay their taxes if their fellow citizens contribute their fair share. In that respect traditional deterrence policy is rather delicate, because the tax office can mistakenly forget to audit tax cheaters (who additionally tell their friends and relatives about it).  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

13. 2. Some Theoretical Considerations about Tax (Benefit) Morale – 2.2 Key factors influencing tax and benefit morale Fourdifferent types of reciprocitynorms (cont.): Also, continued public discussion about the decline of tax morale serves the same purpose: honest taxpayersget the impression that they are the last to remain(so stupid)to comply with the tax code. • Second, the government provides public services to citizens in exchange for their tax payments. If the fiscal balance between public goods and tax prices is violated by setting the tax prices too high, citizens think they have a justification for evading taxes.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

14. 2. Some Theoretical Considerations about Tax (Benefit) Morale – 2.2 Key factors influencing tax and benefit morale Fourdifferent types of reciprocitynorms (cont.): • Third, citizens perceive their tax payments as contributions to the ‘bonum commune’. Hence, they are willing to honestly declare their income even if they do not receive a full public good equivalent to their tax payments (e.g. they are net contributors to the welfare state). • Fourth, the way the tax office treats taxpayers in auditing processes plays a crucial role.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

15. 2. Some Theoretical Considerations about Tax (Benefit) Morale – 2.2 Key factors influencing tax and benefit morale (ad iv) Feld and Frey (2005) argue that taxpayersand tax authorities are engaged in a psychological tax contract. This contract about fiscal exchange (tax revenues for the delivery of goods and services) assumes that taxpayers and the tax authoritytreat each other as partnersof a contract, i.e. with mutual respect and honesty. If tax administrations instead treat taxpayers as inferiors(or servants) in a hierarchical relationship, this tax contract is violated and citizens have good reason not to stick to their contract and to evade taxes.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

16. 3. What Shapes the Attitudes to (Not) Paying Taxes or Receiving (Unjustified) Benefits? The Case of Austria – 3.1 Introduction: Three research questions • Determinants of benefit morale?  Taxpayers’/citizens’ attitude toward claiming unjustified government benefits/subsidies. • Determinants of tax morale?  Taxpayer’s attitude toward avoiding/evading taxes. • Which impact do benefit and tax morale have on actual behaviour (income)?  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

17. 3. What Shapes the Attitudes to (Not) Paying Taxes or Receiving (Unjustified) Benefits? The Case of Austria – 3.2 Data • Austrian data from the European Values Survey (1990 & 1999). • Respondents were asked to evaluate on a ten-point scale: • ‘cheating on tax if you have the chance’ (…) ‘can always be justified, never be justified, or something in between.’  tax morale (1=none, 10=highest) • ‘claiming state benefits which you are not entitled to’ (…) ‘can always be justified, never be justified, or something in between’.  benefit morale (1=none, 10=highest) • N = 2,982  After cleaning data: N = 1,887 (N1990= 835, N1999= 1,052).  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

18. 3. What Shapes the Attitudes to (Not) Paying Taxes or Receiving (Unjustified) Benefits? The Case of Austria – 3.3 Estimation of the determinants of tax & benefit morale (i) A system of two equations is applied: Tax morale = α1 + β11 * benefit morale + β11 * income + Γ1 * Χ1 + ε1 (1) Benefit morale = α2 + β21 * tax morale + β22 * income + Γ2 * Χ2 + ε2 (2) • If stated attitudes are translated in actual behavior, income is endogenous too, as simultaneity prevails. • Hallaand Schneider (2005) instrument income with chief wage earners sex & job rank and the socio-economic status of the household.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

19. Table 3.1: 2SLS Estimation of Tax and Benefit Morale – Part 1  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

20. Table 3.1: 2SLS Estimation of Tax and Benefit Morale – Part 2

21. 3. What Shapes the Attitudes to (Not) Paying Taxes or Receiving (Unjustified) Benefits? The Case of Austria – 3.4 Estimation of impact on actual behavior Income = α3 + β31*taxmorale + β32*benefitmorale +Γ3*Χ3 + ε3 (3) • A negative significant coefficient of tax morale indicates actual noncompliance behavior. • A negative significant coefficient of benefit morale shows actual claims of unjustified subsidies. • In both cases a higher net wage is, ceteris paribus, expected!  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

22. 3. What Shapes the Attitudes to (Not) Paying Taxes or Receiving (Unjustified) Benefits? The Case of Austria – 3.4 Estimation of impact on actual behavior • Durbin-Wu-Hausman-Test for endogeneity of tax- & benefit morale: P-value = 0.01 •  Endogeneity prevails; we instrument for tax- and benefit morale. • Instruments are: Confidence in the legal system, voluntary labor & children. • Test(s) for over-identifying restrictions confirm the instruments (e.g. P-value of Basmann‘s test = 0.62).  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

23. Table 3.2: 2SLS Estimation on Income Source: Martin Halla & Friedrich G. Schneider (2014).  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

24. 3. What Shapes the Attitudes to (Not) Paying Taxes or Receiving (Unjustified) Benefits? The Case of Austria – 3.5 Results of the 2SLS estimation on income • No statistically significant impact of tax morale on household income! • Statistically significant impact of benefit morale on household income! One point higher benefit morale reduces household income by 292 € p.m. • Households with female chief wage earners have about 341 € lower income p.m. • A higher socio-economic status (self reported, measured on four-point scale) is associated with 438 € more income p.m.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

25. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland– 4.1 Introduction The focus lies on institutional differences within countries rather than between countries. • Switzerland has direct democratic institutions and three main ethnic groups: German, French and Italian speaking individuals. • Belgium has two main linguistic regions (Flanders and Wallonia). • Spain is used to control for regions with a strong identity such as the Basque Country, Catalonia, Galicia, and Navarre.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

26. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland– 4.2 Empirical model & the dependent variable TMi (tax morale of individual i) (1) Demographic independent variables (DEMi): • AGE (four groups are built, 16-29 (reference group), 30-49, 50-64, 65+) (+); • GENDER (WOMAN, in the reference group man) (+); • EDUCATION (+/-); • MARITAL STATUS (+); • EMPLOYMENT STATUS (-); and • RELIGIOSITY(RELi):CHURCH ATTENDANCE (+).  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

27. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland– 4.2 Empirical model & the dependent variable TMi (tax morale of individual i) (2) Economic and institutional independent variables: • Properties of the tax system (TSi): individual tax rate, audit probability and fine rate (the last two variables only for Switzerland)) and economic variablesECONi(income, financial satisfaction) → signs ambiguous! • The effects of the TAX RATE and the INCOME on tax evasion are difficult to determine theoretically. They depend on the individual’s risk preference and the progression of the income tax schedule.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

28. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland– 4.2 Empirical model & the dependent variable TMi (tax morale of individual i) (2) Economic and institutional independent variables: (iii) A higher marginal tax rate makes tax evasion marginally more profitable, but a contrary effect works depending on the risk aversion of taxpayers. The results are influenced by the tax schedule and penalty structure → sign ambiguous! (3) Political institution (INSTi) independent variables: Direct democracy (+): The referendum is a strong restriction for the politicians or the legislature to act in their selfish interest; hence tax revenues are spent more in accordance with the preferences of the taxpayers, which increases tax morale, ceteris paribus.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

29. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland– 4.2 Empirical model & the dependent variable TMi (tax morale of individual i) (4) Social/informal institutions and other socio-psychological independent variables (SOCINSTi): national pride (+) and trust in public institutions (+). (5) Culture/languagedifferences(CULTi) independent variables: • If language acts as a restriction influencing an individual’s probability set, one can investigate whether it also influences individuals’ attitudes towards paying taxes (+); • Separatists tendencies such as observed in Spain may have a negative impact on the willingness to cooperate.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

30. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland– 4.3 Empirical Results • Individual data analysis, world and European value surveys: • Belgium (EUS): 1999, • Spain (WUS): 1995, and • Switzerland (WVS): 1996  between 1000-1300 observations per country. • Regression technique: Weighted ordered probitmodel to analyse the ranking information of the scaled dependent variable „Tax Morale“ TMi,j of individual i in country j.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

31. Table 4.1: Overview of the empirical results; dependent variable: tax morale  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

32. Table 4.1: Overview of the empirical results; dependent variable: tax morale (cont.)  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA Notes: +: significant positive coefficient, (+), (-), positive, respectively negative coefficient sign without being significant, (±) positive and negative sign of the coefficient without being statistically significant. n.a. = not available.

33. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland – 4.3 Empirical Results • Switzerland • Higher direct democracy leads to higher tax morale. • However one observes this effect only in the German speaking part of Switzerland, in the French and Italian the interaction variable (Dir.dem*Latin) is statistically significant with a negative sign!! • Trust in gov. highly significant positive effect on tax morale. • Deterrence factors no direct impact, coefficient of the fine rate negative and statistically significant → higher punishment crowds and tax morale.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

34. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland – 4.3 Empirical Results • Switzerland (cont.) • Women have higher tax morale than men. • Old citizens (between 50 and 64) have a higher tax morale than young. • Married people have a higher one than singles. • Religiosity has a significantly positive effect on tax morale.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

35. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland – 4.3 Empirical Results • Belgium • No statistically significant difference among the cultural groups (Flemish and Francophone) with respect to tax morale. • Pride and trust have a positive influence on tax morale. • Aged, women, and married people have a high tax morale. • Like in Switzerland church attendance leads to high tax morale.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

36. 4. What Shapes the Attitude to (Not) Paying Taxes? Evidence form the Multicultural European Countries Belgium, Spain and Switzerland – 4.3 Empirical Results • Spain • Like in Belgium, no statistically significant influence of the different cultural regions, even not the Basque one, on tax morale. • Opposite to Switzerland: higher autonomy does not lead to a higher tax morale in Navarre. • Similar to Switzerland and Belgium, pride and trust lead to higher tax morale. • Contrary to the findings in Switzerland and Belgium, church attendance and marriage has no effect on tax morale in Spain.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

37. 5. Local Autonomy, Tax Morale and the Shadow Economy – 5.1 Theoretical considerations / hypothesis The basic idea is to analyze the effects of institutions on tax morale. Specifically, the impact of federalism on tax morale and on the size of the shadow economy was investigated. Key hypothesis: The more extensive the local autonomy, the higher, ceteris paribus, tax morale and the lower the size of the shadow economy. The model:  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

38. 5. Local Autonomy, Tax Morale and the Shadow Economy– 5.1 Theoretical considerations / hypothesis The question for the dependent variable tax morale for the year 1999: “Do you fell it is wrong or not wrong if a taxpayer does not report all of his or her income in order to pay less income taxes?” Possible answers: 1 = not wrong, 2 = a bit wrong, 3 = wrong, 4 = seriously wrong.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

39. 5. Local Autonomy, Tax Morale and the Shadow Economy– 5.2 Data information and key independent variables DDC: The degree of direct democracy – six-point scale index (1 = lowest and 6 highest degree of democratic participation at the cantonal level) LAC: local autonomy – 10 point scale (1= no autonomy and 10= very high autonomy; index by Ladner (1994) Ti: Individual tax rate Yi: the individuals’ household income Tri: measures, using the ISSP data set, the confidence in the courts and the legal system  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

40. Table 5.1: Tax morale and local autonomy

41. Table 5.1: Tax morale and local autonomy (cont.) Notes: In the reference group are Ages 16–29, Man, Single, Full Time Employed. Marginal effect = highest tax morale score (4). Standard errors adjusted to clustering in 26 cantons *Significance level 0.05<p<0.10; **Significance level 0.01<p<0.05; ***Significance level p <0.01

42. 5. Local Autonomy, Tax Morale and the Shadow Economy– 5.3 Main Findings • The results indicate that local autonomy and direct democracy are highly relevant to an understanding of why people cooperate with societies’ rules. Institutions that respect the preferences of the citizens will have more support from the people than a state that acts as a Leviathan. • High levels of local autonomy and direct democracy allow the expression of one’s own preferences and enhances identification with a state’s institutions. This counteracts the tendency to be active in the shadow economy and increases the willingness to pay taxes. • Results for the shadow economy: DD and LA are not statistically significant.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

43. 6. Summary and Conclusions • The goal was to investigate what shapes individuals’ attitudes towards paying taxes in the countries Austria, Belgium, Switzerland and Spain. • For Austria societal variables (age, gender, marital status) have a strong impact on tax morale as well as “perceived tax evasion” and “pride”. From an institutional standpoint “trust in the legal system” has a strong impact on tax morale, too.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

44. 6. Summary and Conclusions • In Switzerland, a multicultural country, a strong interaction between culture and institutions (here direct democracy) and tax morale is observed. • In Belgium, also a multicultural country, only small or no differences in tax morale between Flemish inhabitants and Walloons can be observed. • In Spain, the lowest tax morale has been found in Navarre and not in the Basque Country.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

45. 6. Summary and Conclusions • Direct democracy has a strong positive impact on tax morale in Switzerland. Also pro democratic attitudes in Belgium and Spain have a positive effect on tax morale. • National pride and trust (in the legal system, the government and the parliament) have a consistent positive effect on tax morale in all four countries! • Trust at the constitutional (trust in the legal system)and the current politico-economic process level (trust in the government and the parliament) areessential to a well-functioning taxpayer society.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

46. 6. Summary and Conclusions • Finally to conclude: • There are first and promising results to explain what shapes tax morale. Hence the puzzle, why people pay taxes, is partly solved. • Moreover, these results demonstrate that there are several factors (e.g. trust in the legal system, direct democracy, federalism) despite deterrence that could help to improve citizens’ willingness to pay taxes. • To sum up: the investigation of tax morale in these European countries brought new insights of the importance of institutional, sociological and societal variables.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

47. Thank you very much for your attention!  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

48. Appendix A1: Data Table A.1: Descriptive Statistics of the Austrian data 1990 and 1999 *Tenisthehighest tax- & benefitmorale. ** Income isgiven on a householdbasis (tenranges). Toaccountforinflationweassignthelowerboundofeachrange. Source: Martin Halla & Friedrich G. Schneider (2005).  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

49. Appendix A2:Further results of the European Value Survey Figure A.1: “Do you justify cheating on taxes?”, Results of the EVS 2008/09 for Austria, Belgium, Spain and Switzerland in % Source: European Value Survey, longitudinal data file; May 2015.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA

50. Appendix A2:Further results of the European Value Survey Figure A.2: “Do you justify claiming state benefits you are not entitled to?”, Results of the EVS 2008/09 for Austria, Belgium, Spain and Switzerland in % Source: European Value Survey, longitudinal data file; May 2015.  Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA