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UNIVERSITY OF PRETORIA

Tax compliance and Behavioural response in South Africa:

an alternative investigation

Rebone Gcabo

Department of Psychology, University of Pretoria

Zurika Robinson

South African Reserve Bank

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CONTENT

• Brief South African Background

• Study Purpose

• Study Motivation

• Theories used to study tax behaviour

• Methodology

• Findings

• Discussions

• Concluding Remarks and possible future research

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Brief South African Background

World Cup- Recency Factor

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Research Question

People can have a ruler, people can have a king, but the man people have cause to fear is the taxman.

Sumerian proverb, 2000 B.C.

Research QuestionWhat is the best theory that explains

tax behaviour/ compliance – tax evasion in South Africa?

Background: South African Picture

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Motivation

• (Allingham and Sandmo ,1972):

- tax evasion was a product of the risk of detection and punishment in the form of tax penalties.

- purely economic approach based on economic rationality, defined simply as a “calculus of pleasure and pain” expressed in monetary terms.

- In its extreme form, this narrow approach does not take into account any moral or social aspects of tax evasion but regards it as a purely economic decision.

• (James et al. 2001) :

- That some people never cheat even if the risk of detection is non-existent there must, therefore, be other explanations for this behaviour.

(Sour 2001, Tyler 2001, Webley 2002):• the risk of detection is more important than the punishment

Motivation Cont.

• (Taylor 2001 a).

- The fear of experiencing feelings of guilt and the risk of social stigmatisation has a considerably greater deterrent effect.

• (Torgler,2001).

- Taxpayer morale is important for the prevalence of tax evasion.

- Equity, fairness, norms and trust in the tax authorities affect taxpayer morale

• ( Webley, 2002):- Causes of tax behaviour:, Opportunity to cheat, Equal and fair treatment , Individual

Difference, Social Norms and knowledge of taxation and tax system.

• (James et. Al, 2001).- Even if there are other factors than economic rationality that are significant, it does not

mean that economic self-interest can be completely disregarded as unimportant. Economic self-interest is important, particularly with regard to companies

The theories we believe we call facts, and the facts we disbelieve we call theories.

Anonymous

Theories

• Prospect theory •Loss and gains

- Risk and uncertainty,

Regret theory Attitudes , perception theories,

Utility theory Social Comparison Schema’s, Heuristics, Cognitive biases, selective perception

Equity theory Skill reputation Persuasion Effect

Methodology

• Participants

Sample Gender Mean Age Department

195 undergraduate students

80 males and 125 females

19-23 ages Economics, Psychology, Finance

Methodological Purpose

• To match the theory that best match the experimental tax scenarios:

Design Approach Purpose

Experimental Tax and Control Scenario

4 Framed 4 Control

( Casino Gamble)

Match the answers to scenario for relevance with: • Prospect • Social comparison, exchange equity • Expected Utility theories• Any other possible theory

Experiment Instructions

Framed Scenario (Alm et al., 1993; King & Sheffrin, 2002).

• Group A Group B

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In most countries there is disagreement on the fairness of the tax system. In South Africa, some taxpayers feel that the tax system is unfair, e.g. because unnecessary expenditure on arms places a large burden on the public. However, many feel that South Africa has a fair tax system because the tax base is wide enough so that individuals pay a fair amount of tax.

Choose between either (a) or (b) and (c) or (d) for each question by ticking the appropriate box.

Framed Questions Control Questions

Scenario Options Option Control

The SARS reports that tax evasion among

those with incomes in excess of R500 000 is at an all-time high, and the SARS does not have

the resources to investigate and punish all these evaders. Imagine that this year you have high

medical expenses that you thought would count

as allowable medical deductions. However,

when you file your return, you discover that

the expenses are not high enough to qualify for deductions. This means that your tax bill is

R1 000 higher than you expected. You are preparing your tax return.

a) Claiming an allowable tax deduction that

will save you R500 in taxes

b) Claiming a ‘non-allowable’ deduction that has an 80 per cent chance of being accepted by the SARS, and which saves you R1 000 in taxes

c) Claiming a deduction that has a 25 per cent chance of being accepted by the SARS which saves you R500 in taxes

d) Claiming a deduction that has a 20 per

cent chance of being accepted by the SARS

which saves you R1 000 in taxes

Which option would you prefer?

(a) a sure win of R500(b) an 80 per cent

chance of winning

R1 000Which option would

you prefer?(c) a 25 per cent

chance of winning R500

(d) a 20 per cent chance of winning R1 000

SCENARIO 1

Imagine you have just read a report that the SA General Accounting Office has found that the government spent R10 billion on missiles that cannot be used in South African equipment. This means that the government wasted R10 Billion. You are preparing your tax return and at filing find that you under-withheld, and owe R10 000 in taxes.

a) Not reporting cash income, which will save

you R1 500 in taxesb) Not reporting income from

defence stockdividends, which is 25 per

cent likely to notsave you any tax

Not reporting cash income, which means

you owe R8 500 in taxesd) Not reporting income

from defence stockDividends, which is 25

per cent likely to save to tax, and 75 per cent likely of making you liable for R10 000 in tax.

Suppose you already owe a casino R10 000.

You have a final opportunity to play the Following game. Which of the following

options would you choose?

(a) a sure gain of R1 500(b) a 25 per cent chance

of gaining R10 000and 75 per cent chance

of nothing Which of the following options would you

choose?(c) not reporting cash

income, meaning you

owe R8 500 in taxes(d) not reporting income

from defencestock dividends, which

has a 25 per centprobability of reducing

your taxes and75 per cent probability of

making youliable to paying R10 000

in taxes

Scenario: 2

a) Cheating on your taxesb) Cheating on your taxes under certaincircumstancesc) Never considering cheating on your taxes

Scenario 3

SCENARIO 4Imagine that your co-worker

informs you that he has been claiming a non-allowable deduction on his taxes and has never been caught. He further informs you that his brother in-law, who works for the SARS, has been claiming the same deduction for years without a penalty. He says the probability of an audit is 10 per cent.

a) Claim your usual deductions, which saves

you R1 000 in taxesb) Claim the ‘non-

allowable’ deduction your

colleague has described, which has a 33 per

cent probability of a tax saving of R4 000 and

66 per cent probability of not saving you any

tax

Claim your usual deductions so that you owe

R4 000 in taxesd) Claim the ‘non-

allowable’ deduction, which

means you have a 33 per cent probability

of owing R1 000 in taxes and 66 per cent

probability of owing R5 000 in taxes?

Suppose you already owe a casino R10 000.

You have a final opportunity to play the

following game. Which of the following

options would you choose?

(a) a sure gain of R1 500(b) a 25 per cent chance

of gaining R10 000and 75 per cent chance

of nothingWhich of the following

options would youchoose?(c) claiming your usual

deductions so thatyou owe R4 000 in taxes(d) claiming the ‘non-

allowable’ deduction,

which means you have a 33 per cent

probability of owing R1 000 in taxes and

66 per cent probability of owing R5 000

in taxes

SCENARIO 5

Suppose that in 2004 the government proposed

to spend R10 billion on education. However, instead of voting for the education bill, Parliament

voted for a bill that would prop up tobacco farms in KwaZulu-Natal. The newspapers report that

heavy lobbying by the tobacco industry swayed the vote.

Claim a tuition tax credit, which saves you

R5 000 in taxb) Claim tuition fees as a

business expense,which has a 50 per cent

chance of savingyou R15 000 and a 50

per cent chance ofnot saving you anything

Claim a tuition tax credit, which saves you

R5 000 in taxb) Claim tuition fees as a

business expense,which has a 50 per cent

chance of savingyou R15 000 and a 50

per cent chance ofnot saving you anything

Which of the following options do you

prefer?(a) a sure win of R5

000(b) a 50 per cent

chance of winning R15 000

and a 50 per cent chance of winning

nothingWhich of the

following options do you

prefer?(c) a 20 per cent

chance of winning R5 000

(d) a 10 per cent chance of winning R15 000

and a 10 per cent chance of winning

nothing

Results cont.

No. Aim Explanation Theory

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investigates the certainty effect andsocial comparison

options c) & d) are similar to a) & b) but exaggerated by 25 per cent.

Prospect theory ( a and d) vs Equity Theory b) & d)

2investigates loss aversion and

exchange equity.

Choices a) and b) are identical to c) and d), except that a) and b) are framed as gains and c) and d) as losses

Not Consistent with Prospect theory ( a and d) ( Irrationality?) Risk taking and restores equity

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also investigates loss aversion andsocial comparison theory.

options a) and b) are framed as gains and options c) and d) as losses.

selected a) & c) Consistent with Equity theory

4investigates the certainty effect

and exchange equity.

will choose a) and d) because they are more averse to losses that are certain than to losses that are probable,

Consistent with expected utility theory

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investigates the participant’sgeneral disposition towards tax evasion.

Only a small % indicated that they may cheat on their taxed

social comparison, social norms, motivational postures?

Results Cont.

Discussion

• The paper’s results show a generally consistent response to the framing scenarios, reflecting in terms of economic factors the assumptions of the expected utility theory than prospect theory

• Expected utility theory also explains 50 per cent of the responses to the control questions

• The remaining 50 per cent are explained by prospect theory.

• The responses to the control questions therefore conflict with those to the real questions, in that the control responses correspond with prospect theory. Option c) and d) differ significantly at the 1 % per cent confidence level.

• the only difference between the experimental/framed questions and the control questions are the inclusion of a frame depicting an inequitable situation.

• Therefore, the inequity frame alters how the participant responds to questions.

Practical Interpretation of Results

• South Africa has a tax-paying culture, unlike many other developing nations.

• The country does not suffer from tax revolts and protests

• South Africa tax collectors benefit from a compliant culture built up over many years

• The question is : is this a true picture?

Limitation of the Study

• motivation towards a specific behaviour, did not explore the participants’ decisions in any depth

• Another limitation is that the participants were students, and so not necessarily experienced in tax practices.

• Generalisability of results may not be realised

• This was just a one phase game and more repeated games/experiment may be critical for improved reliability of data

• Cost- Benefit Analysis of behavioural research, all about the bottom line?

Conclusion

- Economic theory alone cannot be used as the only determinants of tax behaviour

- More research needs to be done on other theoretical contributions to tax behaviour

- There is a need to collaborate closely with the tax authorities to test the consistency of self declared behaviour vs. the actual behaviour of tax-payers

Acknowledgements

• Zuricka Robinson - Reserve Bank of South Africa•South African Revenue Services

•Psychology Department, University of Pretoria •Statistics Department, University of Pretoria

•Prof van Tonder- Economics Department, University of Pretoria•Participants – Economics Students