Low tax morale

Defining ‘tax morale' as citizens' social norms regarding compliance with tax responsibilities, Benno Torgler finds that older people and women exhibit higher tax morale, and that education and following news affect tax morale positively. “But political interest measured through the intensity of discussing political matters with friends affects tax morale negatively… Married persons have the highest tax morale. On the other hand, employed/self-employed persons have lower tax morale,” he writes in ‘ Tax Morale, Eastern Europe and European Enlargement ,' a recent paper from the Human Development Economics Unit of the World Bank ( www.ssrn.com ).

Analysing tax morale in ten eastern European countries that joined the European Union in 2004 or 2007, and studying tax morale differences between 1999 and 2008, the paper shows that tax morale has decreased in 7 out of 10 eastern European countries.

The author reminds that the rapid collapse of institutional structures produced a vacuum in many countries, followed by large social costs, especially in terms of worsening income inequality and poverty rates.

He underlines that, in shifting from a centrally controlled to a market economy, the fiscal system had to be reformed (e.g., income taxation). “As the population was largely unaware of taxes or had no perception of the tax burden during planned socialism, it follows that reforms might have repercussions on tax morale and tax compliance,” he postulates.

Suggesting, therefore, that there is a need to improve not only governmental quality, but also tax administrations, or government structures in which taxpayers place their trust, the author cites studies about how low government legitimacy leads to higher incentives to try to avoid taxes (Rose-Ackerman, 2004).

“Institutional arrangements which increase tax morale are necessary to stabilise individuals' tax compliance behaviour. If the taxpayers are not actively integrated in the political process, tax morale might decrease.”

A note of caution in the paper is that a decrease of tax morale can initiate a negative spiral. “The more a taxpayer believes that others have low tax morale, the lower his/her moral costs will be to behave dishonestly (Frey & Torgler, 2007).”

Wish our economists enlightened us about the state of tax morale closer home.

Legislative malapportionment

The paper by Martín Ardanaz and Carlos Scartascini from the Inter-American Development Bank ( www.iadb.org ) raises an important question: ‘Why Don't We Tax the Rich?' The authors begin by observing that personal income taxation remains relatively low in many developing countries despite recent democratic advancement and rapid economic growth – something that is hard to reconcile with standard political economy models of taxation.

Arguing that the details of political institutions help to explain these low levels of personal income taxation, they add that ‘legislative malapportionment' enables rich elite to have disproportionate political influence; and that, because over-represented districts tend to be dominated by parties aligned with the elite, these groups can block legislative attempts to introduce progressive taxes.

For instance, one learns from a pair of charts in the paper that while the average taxes on goods and services (GSS) have converged between Latin America and the OECD, personal income taxes have remained far apart.

“The ‘inertia' of personal income taxation is even more striking if one considers earlier time periods: the share of personal income taxes in total tax revenue or GDP has changed very little over the last thirty years in developing countries in general (Bird and Zolt, 2005).”

For starters, ‘legislative malapportionment' denotes a discrepancy between the share of legislative seats and the share of population held by electoral districts, serving as a tool for the elite to preserve their economic interests in a democracy by introducing bias in political representation, the authors explain.

They conclude by suggesting that looking at specific features of democratic political institutions can go a long way in explaining why some countries are successful in pursuing progressive taxation while in others the scope for redistributive policies is much more limited.

Instructive insights.

Haven choice

An increase in the average foreign non-haven tax rate of one percentage point increases the probability that a manufacturing firm invests in a tax haven by three percentage points, find Anna Gumpert, James R. Hines Jr., and Monika Schnitzer in a paper titled ‘ The Use of Tax Havens in Exemption Regimes.'

The authors observe that due to lower variable costs of profit reallocation, and possibly the greater variation in these costs between firms, manufacturing firms respond more strongly to incentives from higher tax rates in their choice of tax haven investment. In contrast, service firms' tax haven investments may not vary significantly with foreign taxation because of their higher marginal cost of profit reallocation, and relative uniformity of profit reallocation costs among service firms, the paper informs. “Nonetheless, service firms invest in tax havens because their fixed cost of doing so is lower, which may stem both from lower cost of setting up an a affiliate and from profits which service firms earn from ordinary business activities in tax haven countries.”

In the conclusion section of the paper, the authors reiterate that tax haven investment is relatively more common among service firms than among manufacturing firms, reflecting the attractiveness of tax haven locations for ordinary business activities in service industries.

They suggest, therefore, that policy measures that raise the cost of income reallocation may discourage tax haven investment. “At the same time, such policy measures may encourage firms to shift real activities to tax havens. Given the increasing share of service industries in Western economies, the tax avoidance activities of service firms, and their consequences offers a fruitful area for further research.”

For a detailed study.

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