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AARHUS UNIVERSITY BUSINESS AND SOCIAL SCIENCES DEPARTMENT OF ECONOMICS How tax morale and tax ethics affect tax compliance rates in EU? Research on determinants shaping tax morale and ethics in tax resistant countries. Author Arkadiusz Slawomir Winnicki AW89815 Supervisor Anna Piil Damm 1/5/2013 Character count (excluding spaces) : 89 620

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    How tax morale and tax ethics affect tax

    compliance rates in EU? Research on determinants shaping tax morale

    and ethics in tax resistant countries.

    Author Arkadiusz Slawomir Winnicki AW89815

    Supervisor Anna Piil Damm


    Character count (excluding spaces) : 89 620

  • 2


    Many scholars have described current global society as a tax civilization. Most of the

    people in the world are being under governance of authorities that have been elected in a more or

    less democratic way. It has been done to provide more security to individuals lives and more

    welfare to the society. Tax revenues are necessary for the government to implement social and

    economic initiatives, therefore high tax compliance rates have to be maintained.

    The paper strives to examine how tax ethics and tax morale differ between members of

    EU and to highlight areas where tax compliance is significantly lower. Historical data proved

    that the CEE members, especially those that have undergone transition process represent stronger

    willingness to resist taxes. The further analysis of the troubled areas is trying to determine factors

    responsible for such situation.

    In order to provide the basis for the discussion this paper mixes social and taxation

    theories and models together with empirical data on demographical determinants of tax

    compliance and social representations on tax deterrence methods. Afterwards, five main aspects

    such as: post-socialistic history, trust, corruption, effectiveness of legislation and state authorities

    and effectiveness of redistribution, have been chosen for further research.

    Overall, there has been a correlation between chosen aspects and deterioration of tax

    ethics and morale. Post-socialistic past had very strong impact on social resistance towards

    personal income taxation in the first years on transition process. Corruptive practices and

    exhibited lack of efficiency of state authorities in tax collection and distribution led to decrease

    in social trust in governments initiatives and institutions.

    Lack of trust and transparency in governments actions seemed to be revealed as the most

    significant aspect that led to many illegal practices on both sides. The key findings are relatively

    consistent, due to further implications that come from the lack of honesty in the individual-

    government financial transactions. Western models to increase tax compliance cannot be adopted

    in CEE countries until social trust would overcome the barrier built up between both sides.

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    Table of Contents 1. Introduction ..................................................................................................................................... 4

    2. Description of historical data........................................................................................................... 8

    Between transition period and late 90s ............................................................................................. 10

    Changes in recent decade .................................................................................................................. 13

    3. Theoretical framework ................................................................................................................... 14

    The Social Contract Theory ............................................................................................................... 14

    Social representations ....................................................................................................................... 16

    Relevant pro-social behavior theories ................................................................................................ 17

    The Allingham Sandmo Model (1972) and extensions ................................................................... 18

    Yitzhakis extension (1974) ............................................................................................................ 19

    Andreonis extension (1992) .......................................................................................................... 20

    Englers tax evasion dynamics model (1999)...................................................................................... 21

    Fundamentals of tax analysis ............................................................................................................. 23

    Shadow economys estimation methods .............................................................................................. 24

    The currency demand approach ..................................................................................................... 24

    The physical input method ............................................................................................................. 26

    4. Empirical studies on tax morale and ethics .................................................................................... 27

    Demographic studies ......................................................................................................................... 28

    Social representations on tax deterrence methods .............................................................................. 31

    Fairness and institutional quality ....................................................................................................... 32

    5. Determinants of tax compliance in CEE countries ............................................................................. 33

    History .............................................................................................................................................. 34

    Trust .................................................................................................................................................. 35

    Corruption......................................................................................................................................... 36

    Efficiency of state institutions and tax regulations .............................................................................. 38

    Efficiency of tax redistribution ........................................................................................................... 40

    6.Conclusions ........................................................................................................................................ 42

    7.References .......................................................................................................................................... 45

    Appendixes ............................................................................................................................................ 50

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    1. Introduction Taxes, according to Oliver Wendell Holmes Jr. (1841-1935), are the price we pay for the

    civilization. This sentence is carved on the faade of the Internal Revenue Service building in

    Washington, DC (Block, 1997) as a memorandum to the society that current order is maintained

    thanks to their contributions from their personal incomes. It can be argued that the argument

    stating that governments could not exist without taxes is biased, due to other revenues that they

    are collecting from fees, lotteries and other voluntary contributions. Yet it has to be said, that this

    level of income would not allow the government to function at current level. The scope of the

    government would have to be seriously cut back, if tax revenues were to disappear (McGee,


    Work of many authors has proven that despite this knowledge, society does avoid

    taxation. The level of shadow economy in OECD countries has sharply increased between 1970

    and 1998 (Schneider, 2000) and so did the individuals level of risk attitude in order to avoid tax

    burden (Dynan et al., 2008). Most researchers examine individuals lack of tax compliance from

    a legal or fiscal point of view. However, some of the authors take more philosophical approach,

    focusing on taxpayers ethics and morality in order to find the cause of the problem. (McGee,


    There is no one definition of tax morale, nor just few determinants of it, which makes the

    topic interesting and worth researching. According to Torgler (2007) tax morale is an intrinsic

    motivation to pay taxes, measured as willingness to pay taxes in the light of moral obligation and

    belief that paying them contributes to society. The concept of tax morale is closely related with

    taxpayers ethics, which can be defined as the norms of behavior governing citizens as

    taxpayers in their relationships with the government (Song and Yarbrough, 1978 in Alm, 2006).

    Feld and Frey (2002), argue that tax morale is shaped by the nature of fiscal exchange between

    government and taxpayers, indicating trust as a major determinant of positive attitude towards

    taxation. They also state that the study of tax morale is, unfortunately, taken from the wrong

    perspective. Very often it is considered as individual preference, which is used to describe

    uncertainty in tax avoidance, rather than a factor determining tax compliance. What should be

    focused on is how tax morale can be raised and later on maintained in order to improve tax


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    In 2004, European Union has experienced connection between Eastern and Western

    Europe, which has been the biggest accession in the history called as Big Bang enlargement

    (Noutcheva, 2008 in Torgler, 2011). According to Baldwin (1995), the gains from such

    connection with Eastern Europe were supposed to be potentially enormous for the whole revenue

    system. What was not taken into consideration was the possibility of existence of a different tax

    subculture in post-communistic Eastern Europe with its own set of unwritten rules (Lewis, 1982,

    in Frey, 2007). It is often mentioned that in developing and transition countries, tax compliance

    is low and tax evasion is widespread and present far more serious consequences than in

    developed countries (Torgler, 2007). Rose-Ackerman (2001) points out that despite generally

    low tax morale in those countries, Central and Eastern European countries present generally

    higher tax compliance compared to Former Soviet Union countries.

    To conclude, study of tax morale and taxpayers ethics is important due to incapability of

    standard expected utility theories to explain lack of tax compliance (Spicer and Becker, 1980, in

    Frey, 2007),. In Allingham and Sandmos model (1972, in Torgler, 2011) taxpayers are people

    who are risk-averse, yet willing to maximize their net income and their willingness to evade is

    based on a net tradeoff between the possible gains and possibility of being detected and fined.

    The morality here is the matter of choice, whether or not to try to evade, which together with

    social representations presented by differing in many aspects, yet in so many ways related, EU

    countries provide a very interesting field for research to be done.

    As the debts of European Countries increase studies are required in order to assess the

    determinants of peoples lack of compliance. However, studies with economical and legal

    approach, concerning matters such as tax rates and complexities of legal frameworks, did not

    yield exhaustive conclusions, due to the fact that nearly 20% of tax compliance is being

    explained by peoples tax morale and tax ethics in their countries (McGee, 2012). Moreover, due

    to accession of Central European Countries, with different historical background and ethics

    shaped by different factors resulting in tax resisting culture (Lewis, 1982), the topic is really

    worth further researching.

    The main purpose of this paper is, first, to compare the level of tax compliance and

    tax morale between European Union member countries and, second, to investigate what

    determines cross-country differences in tax morale.

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    The paper reflects on attitudes of people living in CEE countries, which are members of

    the EU, however still amongst developing ones, towards tax compliance and to compare them

    with their Western neighbors. The objective of this thesis is to show, how different approaches of

    EU Members towards tax collection and administration together with relation between

    taxpayers and government affect the tax morale and ethics. Much emphasis will be put on taking

    into consideration differences arising due to the history and belonging to communistic welfare

    system of majority of CEE countries.

    Moreover, in order to provide relevant answers, matters such as trust, institutional

    effectiveness, corruption, social integration, demographic traits and post-communistic tax

    attitude in CEE countries will be taken into account. They will be included in order to be able to

    indicate determinants of tax morale and possible ways of showing how it can be raised and

    maintained in the future.

    In the end, the work would like to present the governmental flaws that are being

    constantly overlooked in EU countries, which result in lowered tax compliance rates. If possible,

    some discussion will be drawn in order to provide advices on how the situation might be

    improved in the future, leading to rise in tax morale and possibly finding a way to maintain that


    This study has several delimitations, the most important one stating, that the work will

    focus mainly on the before mentioned 20% (McGee, 2012) of tax compliance which cannot be

    explained by economic and legal aspects. Thus it will not take a look at matters such as tax

    legislation itself, tax rates, individual income and the economical situation of the country. It will

    also not focus on effects of peoples willingness to pay taxes, such as tax administration and tax

    compliance costs arising due to state authorities policy to prevent tax crimes (Slemrod, 2000).

    The three most commonly recognized ways of decreasing the tax compliance rate are the

    following. Tax avoidance referring to usage of legal means in order to reduce the tax burden. Tax

    evasion which uses illegal means to reduce tax burden. Finally, tax flight, which employs means

    of relocation in order to escape taxation (Schneider, 2001). Since all methods have similar

    effects, namely a reduction of tax revenue and are based on the same motive to reduce tax

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    burden, it is suggested by economists that they should be analyzed jointly (Shaw, 1982), thus the

    work will take tax compliance rate as general, not differentiate between particular methods.

    Moreover, while discussing morality as a matter of personal choice the work will not

    justify any of the actions. It will be based on the idea that is peoples choice, based on their

    personal beliefs and ethics to answer the question whether or not to comply with taxes?

    (Uslaner, 2007). Thus it is not my objective to answer, whether or not, tax evasion can be

    justified. Nor, shall I advice any changes to legal framework that should be introduced by tax

    authorities in order to help provide such a judgment.

    My thesis are mainly based on literature review grounded on publications of academics

    and scholars within fields of taxation, economics, philosophy and ethics. Meaning that,

    secondary data is used as the main source of information and neither quantitative nor qualitative

    experiments were conducted by me in order to gather primary data.

    Programs such as Google Scholar were used in order to find documents, which had

    keywords such as tax morality, tax avoidance, tax ethics. Taking into account the way

    how Google Scholar works, papers from first two pages were taken into consideration, as the

    ones who had been searched the most and with the highest reliability rate.

    My literature search for journals, articles, books and reports used the three classic criteria

    of high-quality research, reliability, validity and generalizability (Eriksson, 2008). I selected

    sources based on the names of the authors and the institutions or journals for which they were

    prepared. First, as regard the reliability criterion, I gave priority to well-known universities,

    institutions (for ex. EU, NBER) or authors, whose books and publications have already been

    approved by academic environment. Secondly, as regard the validity criterion, the sources were

    selected based on their relevance for the problem of interest. Thus, I gave higher priority to

    studies on aspects of tax avoidance, tax morality and ethics, especially regarding EU area.

    Finally, as for the last criterion, my literature review also includes scientific studies of general

    relevance, such as ones explaining theories that could be applicable no matter where.

    After the first selection of scientific studies, I checked the lists of references of those

    studies in order to find useful journals quoted by the respective authors. Assuming that those

    academics had proper knowledge in assessing sources used in order to conduct their research,

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    only criterion of relevance to the topic of interest was applied; no further quality assessments

    from my side were made.

    In the case of empirical data, my biggest concern was relevance and reliability. Surveys

    and data gathered by governmental, economical or social research institutions such as WVS, EU

    and NBER were regarded as reliable. By relevance, I mean relevance for the topic and

    geographical area of interest.

    The next chapter will describe the current level of tax morale and tax compliance rates

    among EU countries. The idea behind it is to divide countries into culturally similar areas and

    taking one of them for analysis as a representative of given group. The purpose is to indicate

    geographical areas, where the situation is worse than average and where probability of an

    incident with a motive to decrease tax burden is higher. It shall also discuss most important

    determinants of such situation.

    The third chapter will present the theoretical framework. The fourth chapter will present

    empirical studies on the determinants of tax morale. The joint objective of chapters 3 and 4 is to

    present the concept of taxation and social theories, tax morale and tax ethics and their effects on

    the topic of interest.

    The last part will use the theoretical and empirical insights from the third and fourth

    chapter to explain the descriptive findings in the second chapter and discuss on how tax morale

    can be raised in low tax compliance countries and how those governments can maintain it

    afterwards. The last chapter will draw conclusions based on my analysis and suggest directions

    for future further research.

    2. Description of historical data

    Nobody likes paying taxes (Frey,2007) that is a fact leading to tax crimes and shadow

    economic activities all around the world. Despite all the efforts, undertaken by governments, to

    control this worldwide phenomenon through the means of education, punishment and

    prosecution the problem still occurs and cannot be ignored. Due to the lack of crucial data it is

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    very difficult to take a real estimate of the frequency and magnitude of illegal activities. Most of

    the people involved in illegal actions prefer to remain unidentified and, if possible, unnoticed,

    hence the estimation of the real scope of the problem may not be accurate. (Schneider, 2000).

    Taxation is not a new concept and over the centuries four basic views concerning the

    ethics of tax evasion have emerged (McGee, 2012). The first could be summarized in well

    known words Ask not what your country can do for you ask what you can do for your

    country (Kennedy, 1961). It states that citizens have a duty to the state to pay taxes, no matter

    how high they are and how efficiently they are going to be used by the state authorities. This

    ethic is especially seen in democracies with strong belief that the matter of the society is more

    important than the matter of an individual. The duty to contribute to the community is shown as

    the most important ethical consideration a citizen has to make, showing freeloaders as the

    negative variables in the well being of the society. The second view might be considered as

    anarchistic, while it states that taxation is unethical and the government behaves as a thief

    whenever it is taking money from its citizens. The authorities rule only because they were given

    such an opportunity by the society and they do not possess any moral authority and privilege to

    take anything from others without their approval. The third view is more moderate, seeking a

    way to achieve balance between two previous ones. It states that tax avoidance can be moral, in

    some cases, depending on how we feel about the efficiency of redistribution and the

    governments actions. It is closely related to the last view, which main point is based on the

    concept of efficiency. Government is liable to corruption, inefficient regulations and agencies,

    while private sector is more concerned about efficiency in order to not to get out of the business.

    That is why, by avoiding taxation to the inefficient state authorities, people keep the money in

    the private sector, which is more organized and result-oriented (McGee, 2012).

    Those are just basic theories, which had many more moral implications developed

    differently under different regimes, cultures and societies. For example, the morality of

    Scandinavian countries influenced by the big welfare system changed the way of thinking and

    proclaimed social ethics of taxation. In that case, the most ethical argument seems to be the one

    stating that since we receive benefits, therefore we must pay our taxes. Even though not

    everyone can agree on what those benefits should be, the society has to receive something that

    would be generally approved. Unfortunately, there is no way of giving someone something,

  • 10

    without forcing others to pay for it (Rawls,1971). It is contrary to what is seen in Eastern

    European countries, where people are not satisfied with benefits, if any are granted, thus they do

    not want to pay their taxes, especially social contributions. The reasoning behind it is that since

    people do not get what they pay for, why should they continue doing it (McGee, 2012)?

    In Economics, the differentiation between Western and Eastern Europe is due to the

    transition process, which has taken place and caused disorientation and a heavy economic burden

    (Frey, 2007). This period caused vacuum in many countries budgets and required people to give

    their financial contributions to the wellbeing of the state. This was something, inexperienced

    before by the citizens of post-socialistic regimes. Many citizens of transition countries have

    never before been subdued to personal income taxation or any other tax regulations (Kornai,

    1990). This led to a significant social resistance and had a strong influence on shaping of a new

    tax morality. Unfortunately, under those conditions it was hard to predict, whether the emerging

    tax morality will be similar to the general European level (Alm, 2006).

    Of course, it has to be said that in every country radical argument states, that if you do

    not like the government and do not want to pay taxes you can always leave. Unfortunately, such

    option, depending on the country of individuals residence, might not present any improvement

    to the economical or social situation (McGee, 2012). Nevertheless, this chapter is not supposed

    to discuss morality behind such a choice, but to present the situation after the transition process.

    Between transition period and late 90s

    Due to lack of personal income taxation in some of the countries in the 90s, the

    comparison of tax compliance rates should be done by comparing the level of shadow economy

    in given countries. The term shadow economy includes all underground economic activities,

    both monetary and nonmonetary that aim to evade or illegally decrease the tax burden

    (Schneider, 2000).

    By the use of input method many academics tried to estimate the size of the shadow

    economy in the 90s in transition countries. Based on their study, first signs of deterioration in

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    Eastern Europes tax morale were visible already in the beginning of the post-communistic


    Table 1. Size of shadow economy in CEE members of EU that were under transition

    process in percent of GDP

    Country Average






    Bulgaria 26.1 32.7 35.0

    Czech Rep. 23.0 28.7 23.2

    Estonia 19.5 35.9 37.0

    Hungary 25.1 30.9 30.5

    Latvia 18.4 32.2 43.4

    Lithuania 19.0 38.1 47.0

    Poland 27.2 31.8 25.9

    Romania 20.9 29.0 31.3

    Slovakia 23.0 30.6 30.2

    Slovenia 26.8 28.5 24.0

    Average 22.9 31.84 32.75

    Sources: Own calculations using values from Schneider (2000, table 3, p.11)(Appendix 1)

    As shown in the table above, general level of shadow economy in those countries was on

    average more than 20% of GDP, which was an enormous expense for governments under

    financially demanding reforms. What is not surprising is the fact that as the investments and

    reforms demanded more money, therefore increasing personal tax burden in those countries, the

    social resistance became stronger. The level of shadow economy was ranging from 22,9 % of

    cumulative GDP in 1989, reaching the level of 32.75% in 1995. From ethical point of view, it is

    understandable that people who were living for a half of the century under repressive and

    corrupted regimes had a little respect and trust to their new governments. Those attitudes fueled

    their tax evasion incentives and began process of long-lasting struggles between taxpayer and tax

    authorities in CEE countries (McGee, 2012).

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    In the case of Western European countries currency demand method was used in order to

    estimate the size of illegal economic activities undergone by individuals.

    Table 2. Size of the shadow economy in Western European members of EU and OECD in

    percentage of GDP

    Country Average








    Austria 5.1 6.1 7.0 8.6

    Belgium 19.3 20.8 21.5 22.2

    Denmark 10.8 15.0 17.8 18.2

    France 9.0 13.8 14.5 14.8

    Germany 11.8 12.5 13.5 14.8

    Great Brit. 9.6 11.2 12.5 13.0

    Greece NA NA 29.6 30.1

    Ireland 11.0 14.2 15.4 16.0

    Italy 22.8 24.0 26.0 27.2

    Netherlands 11.9 12.7 13.7 13.8

    Portugal NA NA 22.1 22.8

    Spain 16.1 17.3 22.4 23.0

    Sweden 15.8 17.0 18.6 19.5

    Average 13.02 14.96 18.05 18.77

    Sources: Own calculations based on Schneider (2000, table 4, p.12 and table 7, p.14)(Appendix 1.)

    Table 2 shows that the average rate of shadow economy in Western countries is ranging

    from 13.02% of cumulative GDP in 1990 to 18.77% in 1997. Western results, even at their peak

    are still below lowest Eastern European rates. The numbers, though not alarming for developed

    countries, are still high in some of the member states. It could be argued that in the case of

    Western European countries, the ones placed in the South are having problems with keeping

    their tax compliance rates high. Both Greece and Italy show numbers that are at the same level or

    even higher as some of the Eastern European countries. The lowest rates are amongst centrally

    located countries, such as Netherlands, Germany and Austria.

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    Changes in recent decade

    Changes in regulations and efficiency of tax authorities have lead to two different

    outcomes in the case of tax morality and tax compliance rates within transition countries. Tax

    ethics researchers say that in the period between 1998 and 2008 the tax morale has decreased in

    7 out of 10 countries with Romania and Baltic States leading the deterioration scale (Torgler,

    2011). One of the mentioned reasons of such situation is increased social awareness, which made

    people more interested in governments affairs. In countries where police and courts are not able

    to control corruption and where people cannot see that their personal contributions to social

    welfare do not actually make people wealthier, there is no big reason to believe that citizens have

    faith in their government (Uslaner, 2007).

    On the good side, with the increased importance of Personal Income Taxes (PIT) in

    countries GDP, the tax compliance rates have also been pushed up. In most of mentioned

    countries, there was a general increase in compliance rates, probably due to reforms of tax

    legislations, which made it more difficult for employed individuals to avoid it. In some countries,

    such as Poland, PIT is being automatically transferred to tax authorities from income transfers

    made by employer to employees bank account (Christie, 2006). Hence it is hard to say, whether,

    in case of employee being able to choose whether to comply or evade paying taxes the results

    would be the same. Nevertheless, during given period in Eastern Europe PIT compliance rates

    varied between 45%-70% and social security charges ranged from 50% to 75% showing

    improvements of tax authorities in effectiveness of tax revenue collection (Christie, 2006).

    Countries differ in their income taxation rates; however that, by itself, does not explain

    why so many different individual approaches have been visible with different outcomes. In case

    of Czech Republic, where tax rates remained constant for the whole period, the general tax

    compliance rates have been steadily increasing. In the case of Latvia a flat personal income tax

    rate of 25% was introduced. Despite having a low tax rate for the European Standards, Latvian

    tax compliance has not followed positive trend, it has been steadily deteriorating (Christie,

    2006). Therefore the question is whether, among generally decreasing income tax rates in

    Eastern Europe, the actions taken by government and morality are not the dominant determinants

    of peoples willingness to pay.

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    As for the Western European countries, mentioned in table 2, during the whole period

    they present, comparably, higher values for tax morality and tax compliance rates. In case of

    PIT, numbers vary between 60% and 80%, and social security charges, start from 70% up to

    95% (Christie, 2006).

    This is a good reason to believe that the tax rates and the complexity of calculation of PIT

    do not affect the compliance rates in a highly dominant way. In the case of CEE countries, the

    ones with the simplest personal taxation have the lowest tax compliance and morality rates. In

    Western Europe many tax brackets and higher tax burden does not increase incentives to avoid

    or evade taxation. The reasons are more complex and are touching more personal level, but will

    be discussed further on in the work.

    3. Theoretical framework

    This chapter will focus on some of models and theories related to the researched topic in

    order to provide a lead on angle from which it has been studied.

    The Social Contract Theory

    The social contract theory, with its roots in the XVI century is probably one of the most

    important ones for the topics in the field of taxation. It shaped our current civilization and led to

    creation of governments that require tax revenues in order to survive and continue to exist. It can

    be summed up as an agreement between a group of individuals, which gathered at some time and

    created a government. They have sacrificed some of their sovereignty in order to give better

    protection to their lives, liberty and property (McGee, 2012).

    Despite the generally good idea of the theorys founding fathers, Thomas Hobbes (1588-

    1679) and John Locke (1632-1704), nowadays it might be outdated and unjustified. Although,

    the contract was generally accepted by the previous centurys philosophers, the idea that anyone

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    has ever made a written agreement where they transfer their rights to someone else seems absurd

    for nowadays lawyers (Kary, 2000).

    According to Hobbes, in a "state of nature" individuals life would be affected by human

    nature and be poor, dirty, violent and short. He defined contract as the mutual transferring of

    rights. However, the belief that an individual had a right to self-governance leads him to an idea

    that the contract is not about acquiring rights but about renouncing them. Every individual has

    rights to anything by nature, there are only obstacles that hinder him from obtaining them (Kary,

    2000). Unfortunately, in the absence of political order and law everyone would have unlimited

    natural freedoms which would result in crimes, violence and war of all against all" (bellum

    omnium contra omnes) (Hobbes, 1588-1679).

    What both philosophers dont agree on is the reason of getting into a contract. People

    have voluntarily submitted their rights and freedoms to a ruler, who would provide protection

    and order in their lives, but based on different reasoning. According to Hobbes, it was a rational

    choice, rather than empirical evidences that pushed people to choose one sovereign lord that will

    protect them from invaders. They have obliged themselves to contribute to the commonwealth

    and submitted their will to the ruler. A contradicting implication was the fact that people agreed

    that under the authority of the chosen one, his successors would continue to rule. They have

    voluntarily foregone their right to vote for their ruler. (Kary, 2000). Locke argued that the

    reason of such a contract was more based on historical evidences and empirical experiences. The

    need itself was dictated by the history, yet the terms of the agreement by the reasoning. Unlike

    Hobbes, he did not devote a lot of time considering what people should do in the contract and

    how to make it work. He simply accepted a main rule, that people are obliged to keep their part

    of the deal and promises. (Kary, 2000).

    Current mentality and legal frameworks make the concept outdated. The social contract

    theory was an unwritten agreement made by a, comparably, worse educated society, yet it

    continued to have its effect throughout centuries. Many lawyers consider it as not rightful

    agreement, which cannot be considered as a contract, under current regulations, and in the effect

    shaping of many regimes as unjustified (Kary, 2000). Nevertheless, the contribution of this

    theory in shaping of current political situation and governments was invaluable. Governments

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    require funding in order to provide their obligations, thus it had also big impact on the

    development of taxation.

    Social representations

    Tax ethics and morale are aspects that are being shaped collectively, meaning that society

    in which we live determines our tax compliance in the long term. That is why it is important to

    discuss social representations, as the influence of our environment, in order to closely analyze

    researched topic.

    Social representations, in literature, are defined as collective sum of shared ideas,

    attitudes and opinions in the society (Moscovici, 1981). They represent a broad concept, which

    in the same way as myths, beliefs and ideologies tries to capture the social reality of an

    individual in given place and time. The concept can be extended towards common-sense theories

    (Hewstone, 1983)

    Social representations are used by social sciences to establish coherence within groups

    and to create distinctions between them (Schneider, 2001). There are three aspects of social

    representations that affect the creation of groups and their perception of reality. The first one

    contains all the relevant opinions, evaluations and attitudes towards an object showing how

    people think about it. The second one is based on all available information, easiness to gather

    them and knowledge about given object. The last one provides all the emotional, motivational

    and cognitive factors associated by an individual with the object focusing on how people feel

    about and are affected by it (Verges, 1987)

    Social representations can also be divided based on how closely are they related to

    individuals personal opinion. Central core and peripheral system can be distinguished. Central

    core is a stable, solid and resistant to changes part of representation, carried further by the

    society. Peripheral system takes into account inter-individual differences between members of

    the group towards the subject (Abric, 1996).

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    It is important to consider the influence of social representations in researched topic, due

    to their effect on individuals behavior. They represent the influence of the society in which one

    lives and might affect individuals decisions.

    Relevant pro-social behavior theories

    Social context is a significant aspect in the field of tax compliance and it cannot be

    denied an important place in the individuals decision making process. The understanding of the

    other tax payers behavior and its effect on individual is crucial to understand tax compliance.

    Taxpayers willingness to comply with taxes might be conditional. Therefore as the society is

    being perceived as honest with its taxes, the willingness of an individual to be honest is higher.

    That is why, theories of pro-social behavior are considered as promising for further research of

    tax ethics (Torgler, 2007).

    Theory of equity points out that satisfaction and behavior are linked when taxpayer is

    being compared with other individuals. The theory applies not only for objective outcome levels

    but also for subjectively perceived ones (Tyler, 1998). Lack of equity between the taxpayers

    own tax rate and the rate of other taxpayers causes a sense of ambiguity. Higher tax rate

    stimulates anger and willingness to decrease the tax burden, while lower ones create feeling of

    guilt and willingness to comply. Awareness of those inequalities can lead to different actions,

    such as tax avoidance, in order to restore equality (Homans, 1961 in Torgler, 2007).

    The theory of reciprocity is striving to explain conditional cooperation. In the field of

    taxation, it would imply that people would follow general pattern of tax compliance. If many

    citizens showed their willingness to pay, an individual would also feel obliged to contribute and

    to comply. On the other hand, social resistance against taxes would make an individual more

    opposed to the tax burden. (Falk, 2002)

    Theory of conformity focuses on individuals willingness to comply with social norms. It

    states that a behavior of a taxpayer might be influenced by the need to fulfill social needs and to

    obey the rules. Therefore, paying taxes would be more dictated by social pressure rather than

  • 18

    personal incentives (Henrich, 2004). Some academics discuss, that conformists would contribute

    to any public good as long as others comply as well. It gives many social complications, due to

    blind obedience to a group which leads to individuals lack of interest in the public goods

    management and distributions efficiency (Bardsley, 2006).

    Conditional cooperation is also influenced by past behavior and social information. Their

    effect is especially visible among indifferent individuals. Information about other taxpayers

    actions will not affect people who have always been against or after something. Unexpectedly,

    indifferent individuals once informed about positive actions of others tend to try to make their

    own contribution more significant (Torgler, 2007). Another study showed that information about

    high compliance in a group makes each member of it more willing to comply (Heldt, 2005). The

    level of contribution has also been proven as a significant factor in measuring peoples

    willingness to pay. As the members of the society tend to give higher contributions, the higher

    the willingness of individuals to join and comply (Croson, 1998).

    The Allingham Sandmo Model (1972) and extensions

    Tax compliance literature follows many trends, one of them, the modeling approach,

    includes classical model presented by Allingham and Sandmo and its extensions discussed

    below. The basic assumption for the whole model is that taxpayer is being driven exclusively by

    the need to maximize his utility function. Moreover, his utility function depends mostly on his

    expected income net of fines. Taxpayer is modeled as risk-averse, expected net income

    maximizing agent, which has the possibility to under-report his income, but by doing so he

    increases his chances to get audited and fined. His choice is often based on the tradeoff between

    possible gains and losses (Christie, 2006).

    Equation 1: Expected utility model of a taxpayer

    All taxable income (y) is fixed, while only the taxpayers amount to report is chosen. The

    risk-averse taxpayer chooses to report (x) and decides on the amount of unreported income (y-x),

  • 19

    in order to maximize his expected utility. The von Neumann-Morgensterns utility function

    (U( ) ) represents the individuals attitude towards risk, while assuming the probability (p) of the

    payoff per dollar (t) from understatement. The model can be generally summed up as a

    gambling game, where the choice of whether and how much to evade is similar to making a bet

    (Slemrod, 2000).

    Yitzhakis extension (1974)

    The model and equation 1 created many issues, which have been discussed by other

    authors. Schlomo Yitzhaki focused on the determinant of the penalty for discovered evasion. The

    base model was dependant on the income understatement, while many countries were more

    interested in tax understatement. This was an important implication, due to its effect on the tax

    evasion gamble. The tax rate, itself, has no effect on the attitude towards taking risk, however the

    higher the rate the higher the reward from successful understatement and the cost of being

    detected (Slemrod, 2000).

    The extension also predicts that a risk-neutral taxpayers compliance would be solely

    determined by his actions expected payoff. A positive outcome for tax evasion would result in

    no tax statement, while negative in total compliance. In the case of risk-averse taxpayer,

    mentioned by the base model, the probability of detection has to be taken into account. The

    margin gain in expected value of tax evasion has to be calculated including increased risk-

    bearing and probability of detection (Slemrod, 2000).

    Equation 2: The extended model

    The expected payoff per dollar of evaded income becomes (1-p)t-p*t. Additionally,

    Yitzhaki introduces equation that takes into account audited income ) and unaudited income

    ( ) that is affecting the marginal utility of tax evasion.

  • 20

    Equation 3: Marginal utility of audited and unaudited income

    Comparison to the base model shows, that in this case increases in t would proportionally

    increase the reward from successful understatement. However, the penalty increases less than

    proportionally, thus making the tax evasion more attractive (Slemrod, 2000).

    What both models agree on, is that no matter what determines the penalty, more risk-

    averse individuals will tend to evade less. In general individuals with higher income will evade

    more eagerly as long as absolute risk aversion is decreasing, however the amount of

    understatement (in the percentage of income) depends on individuals relative risk attitude

    (Slemrod, 2000).

    Andreonis extension (1992)

    The basic model can be extended to deal with other uncertainties. Given extension

    introduces a temporal nature to the tax evasion decision. It assumes that tax crime, if detected, is

    penalized after the tax saving is achieved. Moreover, due to uncertainty the amount of income

    stated by taxpayer and the shadow price of income fluctuates (Slemrod,2000).

    Provided that non-monetary penalties are high enough to force compliance in repayment

    of tax fines, Andreoni argues that tax evasion is a way of borrowing from tax authorities.

    Individuals evade taxation in order to smooth their income streams, thus state can be seen here as

    a lender. The repayment of the loan occurs when the situation of the lender gets better or after

    the fine is issued (Slemrod, 2000).

    The taxpayer decides on how much to report and how big are the fluctuations in the

    reported monthly income. Theoretically, the bigger the dispersion from the possible assessed

    mean, the lower the risk of being audited. It is due to decreased possibility of perceiving the

  • 21

    declared mean as insufficient by the tax authorities, hence increasing the marginal benefits

    (Slemrod, 2000).

    Aggregate noncompliance, is a true aggregate tax liability minus tax paid. Andreoni,

    stresses that the uncertainty does reduce aggregate noncompliance, but does not have a

    significantly strong effect on tax evasion. Some taxpayers will be trying to balance out their

    assessed mean, therefore paying more than they are obliged to. This might reduce aggregate level

    of tax evasion, but not individual level (Slemrod, 2000).

    Englers tax evasion dynamics model (1999).

    It is not possible to determine for a taxpayer, whether or not he will be audited. This

    creates an uncertainty and might influence taxpayers willingness to comply in incoming years.

    A taxpayer, who evades a lot during one year, might be more willing to comply in next year. It

    has also its reasoning in the cumulative effect of the penalty. The tax audit will take under its

    scope previous years, thus long-term evasion tends to create higher fines (Engel, 1999).

    The model of dynamics of tax evasion shows how the past events and the possibility of

    audit influence peoples choice. The model implies that increases in tax rates and income tend to

    create higher willingness to evade, as a fraction of income. On the other hand, higher intensity

    and efficiency of tax audits tend to discourage any tax crime activities. It also assumes that

    taxpayers, who have successfully managed to evade taxes, tend to be more aware of their

    liabilities, therefore more willing to comply. As a general matter, those individuals tend to evade

    less in the next years in order to remain unnoticed. Moreover, people who have been complying

    before tend to, after comparison with successful evaders, be more willing to cheat (Engel, 1999).

    Equation 4: Dynamics of tax evasion

  • 22

    In selecting the amount of income to report in one year, the individual has to be aware of

    the effect of this years evasion on all future tax liabilities. In equation 4 an individual with given

    amount of undiscovered tax liabilities ( ) for year (t-1) has an expected discounted

    present value ( ) for the period (t) for all future tax liabilities. Moreover, model involves

    interest paid ( ) on unreported period in case of audit and individuals one-period subjective

    discount factor ( (Engel, 1999).

    The model starts from denoting tax payments in given period (t) before and audit takes

    place. The second term presents expected tax payments for the next period (t+1), discounted and

    assumed not prone to be audited. The last term describes the effect of taxpayer being audited in

    given period (t), including penalties and interest on all evasion in year (t) and that all previous (t-

    1) activities must be repaid and future tax liabilities would not be subject to recent evasion.

    (Engel, 1999).

    While equation 4 shows the importance of the dynamic considerations, equation 5

    focuses on t the changes in individuals perception after being caught.

    Equation 5: Effect of audit on individuals perception towards tax evasion

    If the audit does not include previous years then the expected value ( ) becomes

    constant. The equation 5 shows that even after being caught, the tax rate and the level of income

    will not have effect on the individuals willingness to comply. The reason is that the savings and

    penalty from evading are both homogenously affected by the tax rate and income, thus the

    changes in those factors will not have effect on the individual. The level of next years evasion,

    as a fraction of income, is determined by the taxpayers risk aversion (Engel, 1999).

    The model carries a lot of implications, with the most important one stating that

    taxpayers with significant undiscovered tax evasion will tend to comply in next years to avoid

    suspicions. The function of current evasion is convex, leading to higher chances of being audited

    as levels of evasion, conditional on income, increase. Audits are assumed to be successful at

    discovering all shadow activities, however it also assumes that once audited, taxpayer will be

  • 23

    eager to comply afterwards. Results however prove that there is high incentive from an

    individual to evade, once audit is performed, since there is not much to lose in the first couple of

    years (Engel, 1999)

    Fundamentals of tax analysis

    After discussion of social theories and models of tax evasion it would be advisable to

    take a closer look on a normative analysis of taxation. The base of tax analysis is created by two

    criteria equity and efficiency. (Slemrod, 2000).

    The criterion of equity is based on the idea of horizontal and vertical equity. Horizontal

    equity states that all individuals in the same tax frame and rate should be treated in the same

    way. The assessment should be based solely on tax calculations, not determined by any other set

    of irrelevant characteristics. The vertical equity states that all taxpayers no matter of income

    should be treated in the same way, if caught evading (Slemrod, 2000). Moreover, both aspects

    imply that no matter what is the taxpayers origin, the evasion shall be treated equally by the

    state authorities.

    The criterion of tax efficiency is based on the theory of tax incidence, which is based on

    three basic principles of allocation of tax burden to individual. The first principle is grounded on

    the rule that all tax burdens must be traced back to respective individuals, meaning that every

    taxpayer should pay for what he is obliged to. The second one, states that individuals elasticity

    towards taxed goods tends to affect his willingness to comply with tax burden. The third

    principle states that in the long run, in case of levying taxes, it does not matter which party is

    obliged to pay taxes to the government. They have to be repaid, unless said otherwise (Slemrod,


    The Allingham Sandmos model together with horizontal equity produce some

    behavioral tax evasion implications. One of them is the fact that the horizontal effect is

    influenced by individuals tax aversion. The less-risk averse taxpayer will gain more from the

    gamble in comparison of individuals expected value. Moreover, the horizontal inequity is

  • 24

    determined by the honesty of each individual. Although, the idea of honesty is an artificial

    distinction between citizens, due to the fact that each of them is in the real world a utility-

    maximizer (Slemrod, 2000). Perceived honesty or dishonesty depends on the taxpayers utility

    function and willingness to achieve it. Some people are simply not interested in entering a

    gamble with tax authorities, hence are more eager to comply with their tax burden and to

    sacrifice some of their maximal utility, while others will do anything to achieve it (Steuerle,

    1985, in Slemrod,2000).

    Shadow economys estimation methods

    Academics cannot decide which of the methods of estimation is the most accurate in case

    of the shadow economy. Therefore there are many approaches used in order to get the results. In

    this work, I would like to present two of them, which created outputs used in previous chapter.

    The currency demand approach

    Philip D. Cagan (1927-2012), was the first one to develop the model of currency demand

    in the context of shadow economy. The main concept of it was the correlation of the currency

    demand and the tax pressure, which were the determinant of peoples willingness to evade tax

    burden (Schneider, 2000).

    The model has been developed in order to create a mathematical function, which would

    not be affected by biases in correlation. The extended model assumed that the most of the

    shadow transactions are done in cash, in order to remain traceless for the state authorities. Thus

    the increased demand for money would result in pumping up the correlation with the shadow

    economy. An econometric equation had to be developed in order to make the model more

    accurate (Tanzi, 1983).

  • 25

    Equation 6: Linear regression of the currency demand approach

    Given model is a logarithm that takes under its scope the ratio of cash holdings to current

    and deposit accounts (C/ . The regression uses four variables. The weighted average tax rate

    (TW), which is used to proxy changes in the size of the shadow economy. The proportion of

    wages and salaries in national income (WS/Y), which captures changes in payment and money

    holding patterns. The interest paid on savings deposits (R), which represents the opportunity

    costs of holding cash. The last variable represents the income per capita (Y/N) (Tanzi, 1983)

    Figures for the size and development of the shadow economy can be estimated by

    comparing the difference between the development of currency, when the direct and indirect tax

    burden with government regulations are held on the lowest possible and current values. The

    same income velocity for currency used both in the shadow economy and the official one has to

    be assumed. Otherwise, the size of the shadow economy could not be computed and compared to

    GDP (Schneider, 2000).

    Despite being the most commonly used approach the model has not avoided criticism. It

    was argued that not all shadow activities involve cash (roughly 80% do) and that the role of the

    barter was not taken into consideration (Isachsen, 1980, in Schneider, 2000).Moreover, the

    regression does not focus on personal attitudes and other factors that are not directly calculated

    from official statistics (Schneider, 2000). The assumption of equal velocity of money in both

    economies has also been criticized, due to large uncertainty and lack of accuracy in estimations

    for both official and unofficial one. Therefore, it cannot be certainly assumed that they are equal

    and that produced output is significant (Klovland, 1984, in Schneider, 2000).

  • 26

    The physical input method

    The physical input approach assumes that electric-power consumption can be regarded as

    the best physical indicator of overall economic activity. The model has been appraised for its

    simplicity, however there has been a division between the academics, on how it should be

    calculated and interpreted. The two most knows are the Kaufmann-Kaliberdas (1996) and

    Lackos (1998) methods (Schneider, 2000).

    The first one argues that overall economic activity and electricity consumption have been

    observed to move in a lockstep with the elasticity (electricity/GDP) usually close to one. The

    proxy measurements for the overall economy can be used to determine the size of the unofficial

    economy. The subtraction of the estimates for the official economy from the overall result can

    create an estimate for the shadow economy (Kaufmann Kaliberda, 1996).

    This would mean that the shadow economy can be simply derived from the gross

    differences between the registered usage of electricity and the overall result. This method,

    despite its simplicity is criticized on many grounds. Most common critique is concerning the

    used determinant of the shadow economy. There are many energy sources available, not only

    electricity, that could be used to aid illegal activities and their consumption is affected by the

    technological progress. Moreover, countries differ in their electricity productions efficiency,

    therefore it is difficult to assume that the method could be used worldwide (Schneider, 2000).

    The second approach is more concerned about household usage of electricity and

    production of goods. Households might be involved in do-it-yourself production and non-

    registered activities and services. The main argument here is that, when in country the shadow

    economy is mainly associated with household activities, higher usage of electricity would also

    mean higher shadow economy (Lacko, 1998).

    Equation 7: Lackos household electricity method

  • 27

    The model starts with taking a logarithm of household electricity consumption (E) in

    given country (i). It is calculated based on five variables. The first is the real consumption of

    households per capita (C), excluding the consumption of electricity in given country in US

    dollars at purchasing power parity. The next variable is the real price of consumption of 1kwh of

    residential electricity (PR) in US dollars at purchasing power parity. The model also focuses on

    the number of months of heating needed in houses (G) and the ratio of energy sources other than

    electricity energy to all household energy consumption (Q) in given country. Lastly the model

    uses the output of the hidden economy per capita (H), which is derived as a regression of 3

    variables: the ratios of both the sum of paid indirect and direct taxes (T) and public social

    welfare expenditures (S) to GDP and the sum on number of inactive earners over 14 years, per

    100 active earners (D) (Lacko, 1998).

    Unfortunately, the model itself is not able to give concrete results on how big is the size

    of the shadow economy, due to inability to calculate how much GDP is produced from one unit

    of energy. The econometric estimation can be used to establish an ordering of the countries with

    respect to the electricity usage in their shadow economies. In order to assess the actual sizes,

    secondary data about countrys electric usage and GDP have to be calculated together with

    results of the estimation (Schneider, 2000).

    4. Empirical studies on tax morale and ethics

    To comply or not with taxes is a complex decision, determined by variety of factors

    affect by tax payers tax morale and ethics. Those aspects can be both dependable on personal

    traits and environment influencing individual both directly and indirectly. Theoretical studies are

    very often subjected to different biases, due to omitting personal opinions and attitudes of

    individuals or groups involved in the study. Following chapter will present empirical data

    gathered on demographic traits, social attitudes towards tax crimes and governments that were

    gathered in order to highlight some of the factors determining tax morale and ethics.

  • 28

    Demographic studies

    This paragraph will discuss results of analysis on demographic traits, such as gender

    (appendix 2.1), age (appendix 2.2), education level (appendix 2.3), religion (appendix 2.4),

    marital status (appendix 2.5) and income level and will try to show their effect on general tax

    compliance. Such an analysis will be based mostly on data gathered during surveys for the WVS

    on tax related topics.

    As it is generally said, women are from Venus and men are from Mars (John Gray,

    1992), hence I would like to start from analyzing genders effect on tax ethics and morality.

    What is clearly visible is the lack of one general opinion for this aspect, due to different results,

    determined by individuals belonging to different culture and different ethical questions stated.

    Women are more detail oriented than men, thus differently stated, similar question, could

    produce different thoughts and answers (McGee, 2012).

    In the studies, where women were considered as more ethical many of the researchers

    concluded that it was due to their upbringing leading to deference of authorities. In the case of

    less ethical results, it was assumed that the new way of living and liberation from traditional

    household roles created more masculine views. In other words, self-aware women are becoming

    more masculine in their way of living also in their tax compliance. And it was proven that under

    same moral and ethical conditions, men are more eager than women to avoid taxes, whenever

    legislation makes it possible (McGee, 2012).

    There are many views on how gender, especially culture and differences in upbringing of

    women and men, affect tax compliance. What most of the researchers agree on is that particular

    personal traits associated with genders have an impact on tax morale. People who possess more

    feminine characters, both men and women, are more likely to be tax compliant and to defer

    authorities. On the other hand, those who posses more masculine characters tend to have more

    risk seeking attitudes and try to defer taxes. It has also been proven that the prenatal testosterone

    levels have no significant impact on those results (Kastlunger, 2010).

    Age is another significant factor determining tax compliance. However, it is worth

    mentioning, that the age studies were mostly including students, which possess higher level of

  • 29

    education than an average individual. The effect of education will be discussed further on, yet

    studies determining age had to take this aspect into account (McGee, 2012)

    Social science studies concerning ethics and taxation do not produce one significant

    result regarding age as a tax compliance determinant. However, all things equal, it has to be said

    that older people have more respect for rules and regulations, thus are more willing to obey

    authorities. It can be concluded, after trying to disregard of differences made by education level,

    that young people tend to present less ethical attitude towards willingness to pay taxes


    One of the mentioned limitations of these studies is that most of the opinions gathered

    came from students. People, who tend to be younger, and present higher educational level than

    an average individual. Nevertheless, their opinion is of vital matter since students represent the

    voice of the countrys future opinion leaders and elites. (McGee, 2012.)

    Studies on the level of education show three significant correlations. The first of them,

    states that the higher the level of education, the more ethical attitude. It has been proven by

    comparing answers of undergraduate students with graduate ones. The study concluded that,

    graduates tend to be more ethical than their less educated colleagues. The second correlation

    shows that the higher the level of education the bigger the shift, whenever tax crime is to be

    considered, from tax evasion to tax avoidance. In other words, more educated people tend to be

    more aware of the effects of tax evasion and possibilities of legal decrease of tax burden. The

    third correlation shows that, despite general positive correlation, studies related to economical

    and business areas tend to create more tax ethical attitudes. An interesting implication was the

    fact that in all of the cases, women tended to score higher in tax ethics than men at the same level

    of education (McGee, 2012).

    Religion as a spiritual area is, in my opinion, a very interesting trait to be researched in

    the matter of tax compliance. Different views, ethics and cultures shaped by religion tend to vary

    from ultra ethical, where not to pay your taxes is to commit a mortal sin against the God (Saint

    Antoninus, 1571), to lack of concern towards taxation at all. Muslim literature was interpreted to

    say that tax evasion is ethical, whenever tax is meant to increase the price or value of the

    good(Yusuf 1971, in McGee 2012).

  • 30

    There were quite few studies examining religion as a demographic determining attitude

    towards tax evasion and they produced significant but not coherent results. As a significant

    factor could be taken the location of where the studies have taken place. In general, Buddhists

    were stated as the ones with the highest tax compliance, followed by Muslims, Catholics, Hindus

    and Protestants. However there is a big discrepancy in results of the studies of differences

    between Catholics and Muslims, probably, based on the location of the study. In general

    overview, Catholics are being shown as the more opposing to tax evasion. However, a German

    study that differentiates Muslims on different categories shows that especially Turkish ones are

    more opposed to tax crimes than Christians (McGee, 2009 and McGee, 2011 in McGee, 2012).

    The WVS conducted research on how marital status affects peoples willingness to

    comply with taxes in order to show its significance in the tax ethics matter. Marital status is

    likely to affect the general wealth of the household, hence it should be seen as an important

    indicator favoring married couples (McGee, 2012).

    The results showed indeed that married couples are one of the most ethical groups,

    however unexpectedly, widowed individuals seem to be the most tax compliant. It might be due

    to the fact that death of a spouse leads to many wealth transfers and tax implications, which force

    compliance. On the other side, never married single people and divorced ones are the least tax

    ethical. Nevertheless, once again there is a significant result that in all of those groups, women

    seem to be more opposed to tax crimes than men (McGee, 2012).

    The last but not the least trait taken under scope of the WVS was the level of income of

    individuals and the effect on their tax compliance. The study here had many assumptions that

    academics tried to resolve. One of them shows high incomers as less tax ethical, because of the

    feeling of being overtaxed and exploited by state authorities. On the other hand, there was also a

    thought that the same thing might happen to the poorest ones, due to their inability to pay

    (McGee, 2012).

    What the studies show, is that a general trend cannot be drawn for all countries. The

    attitudes of the groups differ, due to cultural and social reasons. Studies in Hungary showed that

    middle income people were more ethical than high and low incomers, while Portugal produced

    outcomes that were quite opposite (McGee, 2012). It might be the case that in Hungary the

  • 31

    middle class was not as developed as in Portugal, thus they did not want to be involved in any

    risk concerning taxation. However, that is merely just a speculation without any proofs.


    Social representations on tax deterrence methods

    Empirical evidence indicates that tax knowledge is significantly correlated with tax

    compliance, however there is no agreement between scholars on how exactly it does. One study

    says that in depth knowledge of taxes implies lower tax compliance (Groenland, 1983 in

    Schneider, 2001), while other states that low tax knowledge results in lower willingness to pay

    (Kirchler, 2001 in Schneider, 2001). Although, studies showed that higher tax knowledge leads

    to stricter social representations on tax crimes. Individuals considered their tax evasion as more

    serious, the tax brackets as fairer and became stricter towards other peoples tax evasion

    (Eriksen, 1996 in Schneider, 2001).

    Generally, there are three ways of reducing tax burden: tax avoidance, tax evasion and

    tax flight. Each of them uses different means but strive to achieve the same goal. The conducted

    study was supposed to show, how different ways are being perceived by individuals in order to

    show the most unethical one (appendix 3).

    Tax avoidance uses legal means, such as loopholes in regulations, in order to decrease the

    tax burden. While asked about it individuals described it as a legal intention to save taxes. It was

    often mentioned together with cleverness, good ideas and some costs to gather information. It

    was considered as a moral choice, which uses regulations in order to achieve its goal.

    Acceptance of tax reductions, allowances, searching for legal ways of reducing tax, horizontal

    justice and tax loopholes were mentioned as a way to achieve tax avoidance (Schneider, 2001).

    Tax evasion is an opposite to tax avoidance. It is not concerned about the legality of its

    means to achieve its goals. While asked for associations with it, individuals were coherent in

    their answers. It was considered as an illegal and immoral choice, which included a lot of risk in

    order to save on taxes. For many responders, it was considered as a part of shadow economy,

    involving fraud, black money, faulty tax declarations and vertical justice. Moreover, it also

  • 32

    created more repressive associations, such as audit, penalties and sanctions. It is seen as an

    opportunity for an individual to save bigger amount of money, compared to tax avoidance, but

    also considered as more unethical and risky (Schneider, 2001).

    Tax flight uses means of relocation to save on taxes. It does take into consideration

    different laws and regulations in different economical areas or countries in order to achieve its

    goal. Surprisingly, individuals when asked for their opinion about it said that it is indeed legal

    but immoral thing to do. On the one hand people consider it as a clever thing, because of ability

    to use tax agreements, other tax regimes and tax havens to save money. On the other hand, it

    requires many bureaucratic activities, involves relocation costs and very often can be

    unprofitable and lead to problems for the company. What was, probably, considered as the most

    immoral was the fact that it is an open critique of the tax system of the home country. Moreover,

    leaving a country decreases tax revenues and general wealth of the society (Schneider, 2001).

    In the statistical experiments based on gathered data, the highest moral value was given

    to tax avoidance followed by tax flight and tax evasion. Moreover, higher tax knowledge, related

    to the profession of the responder, also affected general fairness of the three tax deterrence

    methods. The higher the knowledge, the higher was the perceived fairness of tax avoidance and

    the lower the knowledge the higher was perceived fairness of tax evasion. Stating that more

    educated people in the field of taxation tend to be more aware of the distinction between an

    illegal and a legal mean to decrease tax burden (Schneider, 2001).

    Fairness and institutional quality

    There is a strong argument, stating that tax ethics is shaped by the perception of quality

    and fairness of the state authorities. Whenever they are considered as fraudulent or not working

    in the interest of the nation, tax evasion could even be considered as an ethical way to show

    social disapproval (Cummings, 2005).

    In the study striving to expose the correlation between fairness and quality of state

    authorities with tax compliance, researchers wanted to prove its effect on shaping of tax ethics in

  • 33

    society. Study had to take into consideration enforcement resources available to the government,

    which does affect the results and shows that tax compliance rates might be inconsistent with

    rational behavior. The role of uncertainty in auditing plays a substantive role, due to subjectivity

    of its probability for each individual. State is not obliged, nor has the incentive, to reveal the

    entire auditing mechanism or identities of observed taxpayers (Alm, 1988).

    It is hard to generally say what determines fairness and high quality of state authorities,

    however the study produced some common associations. Individuals believe that tax system that

    treats everyone equally, implementing horizontal justice is considered as fair. While the quality

    comes when people can see that tax revenues are used to provide valuable goods and services in

    an efficient way. They would also be more eager to contribute to a government that is willing to

    spend their money in a proper way, increasing the welfare of the society (Cummings, 2005).

    Individuals should consider the government as trustworthy, taxes as fair and clear, fiscal

    exchange between taxpayer and authorities as beneficial and trust should be seen on both sides.

    The results demonstrate that those aspects have stronger effect on individual, than enforcement

    methods used by governments. The individuals positive perceptions about the government and

    tax system are very important determinant of tax compliance. It can be argued that, indeed,

    increased enforcement leads to higher tax revenues, but the perception that paying taxes is

    beneficial for the society is more important in creation of tax ethics.

    5. Determinants of tax compliance in CEE countries

    Tax morale and ethics in CEE countries is a very interesting example, which cannot be

    easily discussed based solely on demographic studies. In general, they represent a group of

    sometimes contradicting characteristics, due to their different demographics compared to

    Western Europe.

    In general, Eastern Europe has lower average age of an individual and score higher in

    Hofstedes masculinity index than Western Europe. It also has higher proportion of students

    among younger population and illiterates among older than their western neighbors. Due to their

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    higher commitment to religion and traditional family lifestyle, there is higher probability of long-

    lasting marriage. At the same time, in comparison with Western countries, a couple achieves on

    average lower mutual income (Tamas, 2007).

    After chapter 4, it cannot be said with 100 percent certainty, that demographics can be a

    significant determinant of tax compliance in CEE countries. Other determinants, such as history,

    trust, efficiency of state authorities in different aspects have to be included to take a closer look

    on why the average tax compliance rate in CEE is lower than in Western Europe.


    Some of the historical facts have been already mentioned in previous chapters. Therefore,

    here I would like to simply present the most important implications of the socialistic past of CEE

    countries, which have affected their tax compliance rates and low tax morale.

    Before the transition period most of the citizens of socialistic countries were not aware of

    individual tax burden. In most of the cases the state revenues were from government owned

    companies, which had unlimited access to credit facilities. In 1980, the Polish budget estimated

    that approximately 97.5% of its revenues would come from those enterprises. Therefore, proving

    how insignificant was personal tax income (Owsiak, 2007). Most of the individuals were not

    under any taxation and were not aware of their personal contribution to the commonwealth

    (Torgler, 2007).

    The post-socialistic history is especially important, due to the fact that the transition

    period started in early 90s, thus majority of nowadays taxpayers have somehow been influenced

    by that period. People in their 20s and more have experienced at least slightly the socialist

    administration and might have developed already, common to post-socialistic societies, weak

    voluntary compliance (Torgler, 2011). In such circumstances introduction of personal taxes and

    creation of a tax based civilization is especially difficult.

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    Morality exists where there is a possibility of making a choice. Whenever there is a

    choice that includes two individuals, who are not aware of their actions, honesty is in price

    (McGee, 2012). Creation of trust is based on exhibition of honesty and goodwill from the other

    involved party.

    There are very good reasons for a correlation between trust both in the government-

    taxpayer and inter-taxpayers relations and tax compliance rates (Uslaner, 2007) (Appendix 4.1).

    First of all, we do not pay taxes to our society, we pay them to the government. The willingness

    to comply with taxes is a proof of social trust in authorities. It is the belief, that what they are

    doing is honest and benefits us, the taxpayers. The social trust reflects social solidarity, due to

    redistributive function of the taxes. A trustworthy government, which supports economic and

    social programs, will receive support allowing it to operate (Uslaner, 2007).

    Moralistic trust is a term describing moral commandment to treat people as if they were

    trustworthy. The main point is the belief that most people share fundamental moral values,

    therefore the majority will share similar views and will remain honest to each other (Uslaner,

    2007). When others share our basic set of values and ideas, there is lower risk when agreements

    including trust, relying on individuals goodwill, are being agreed upon (Selingman, 1997 in

    Uslaner, 2007). Moralistic trust is a determinant of strong solidarity community. In general,

    people belonging to those groups are willing to trust others and to participate in actions tending

    to improve the welfare of the group (Lindenberg, 1988 in Janky 2007). In the tax matter, they

    would be more willing to comply to support the redistributive function of taxes. This type of

    solidarity is observed in Western European societies. The opposite, weak solidarity, is more of a

    characteristic of CEE members of EU (Janky, 2007).

    In the EU a collision of social solidarity is easily visible. The West shows concern about

    collectivist norms and equality of the citizens, while the East, very often disappointed with

    socialistic times, strives for the goals and career of an individual. The lack of solidarity can be

    shown by an anecdote on how, in 1997, a Russian civil servant asked a Swedish political

    scientist how is it possible that almost all Swedes are honest with their taxes, while in Russia it

  • 36

    was a common practice to cheat (Rothstein, 2001 in Uslaner, 2007). Russians represent here the

    attitude of many post-socialist countries, where lack of moralistic trust undermines tax revenues.

    In the recent case of Polish media-tax, social resistance towards the public TV and lack of belief

    in the honesty of other taxpayers led to critically low tax compliance rate. The lack of trust and

    belief that the money will not be spent properly, together with relatively low compliance rates

    empowered other individuals to avoid taxation as well (Uslaner, 2007).

    Post-socialistic countries, despite the social resistance towards taxation, low tax ethics

    and morale and general lack of trust in government of the citizens, are an interesting case, where

    governmental coercion keeps tax compliance on an acceptable level. The use of coercion, in

    democratic states might be a presentation of institutional quality, while in post-socialistic states it

    very often undermines general governmental trust (Uslaner, 2007). In a state where every single

    citizen is treated as a tax offender and tax authorities have enormous power, the taxpayer will be

    more resistant to comply and trust will not be achieved (Owsiak, 2007). Trust is an important

    matter, determining positive financial interactions between taxpayers and their governments.

    Nevertheless it cannot be achieved overnight and in order to establish it both sides need to show

    their honest intentions and willingness to comply.


    There have been many studies on the correlation between corruption and tax evasion

    (appendix 4.2). Many studies have shown that as the corruption in the government spreads, the

    feeling of moral duty to pay taxes among individuals decreases (McGee, 2012). People comply

    with taxes believing that their money will be redistributed to increase overall wealth of the

    society. When money is not used in the promised way and ends up on private accounts,

    compliance rates drop as a social response (Uslaner, 2007).

    The study of corruption experienced a huge increase in interest once the transformation

    process of CEE countries began. The lack of the rule of the law, accountability of the

    government and good management led to an outbreak of many corruptive activities (Torgler,

    2007). There were situations in which administrational weaknesses lead to bribery, which in

  • 37

    some branches reach significant amounts of money. High complexity of tax law, frequent

    meetings between taxpayers and tax authorities, low wages of tax administrators and their

    relatively high influence on tax decisions are amongst the most common ones (Tanzi, 2002 in

    Torgler, 2007).

    There is a correlation between trust and corruption, which is one of the determinants of

    the level of inequality in a country. Countries with high levels of trust have low levels of

    corruption and are more likely to be influenced by, if any, economical inequalities. Corruptive

    actions tend to increase inequalities, which in organized societies are more visible and tend to

    have a stronger negative impact on the trust to government. This leads to a so called inequality

    trap, because a decrease in trust leads to more corruption, hence more inequality. Moreover, the

    inequality trap is a two-sided game. For more equal, high trusting societies (mostly Scandinavia

    and Western Europe) the game would end up in low corruption and high level of tax compliance.

    Otherwise, (for most of the CEE countries) inequalities will affect negatively trust, increase

    corruption and decrease tax compliance rates (Uslaner, 2007).

    The great power involves great responsibility (Franklin D. Roosevelt, 1882-1945), which

    is often the case in transition countries, where the power of authorities is often higher than in

    other countries. Behavior and norms that come from informal sectors tend to disturb the way the

    formal ones work (Ott, 2007). Corrupt bureaucracy does not strive for efficiency, but supports

    initiatives that are in some, material or non-material, way connected to the authorities. Therefore,

    it increases the costs and time delays of the investments, which, if noticed, have negative impact

    on tax morale (Torgler, 2007).

    Corruption was and still is a great obstacle for transition countries, which stops

    economical growth and increases the size of the informal sector. Lack of transparency,

    accountability and the feeling of impunity erode social trust to the government and the quality of

    the institutions (Ott, 2007). In many CEE countries, corrupt politicians are not being sentenced in

    a way appropriate to their crimes. This, if noticed by citizens, decreases the motivation to comply

    with taxes, since they do not provide the wealth that they are supposed to. The tax ethics and

    morale decrease, creating more incentives to decrease tax burden (Torgler, 2007).

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    Efficiency of state institutions and tax regulations

    Tax regulations are being developed to make the unpleasant duty of taxpaying as easy

    and transparent as possible, while the state institutions are supposed to ensure proper collection

    and usage of tax revenues. However, it might happen that the regulations are not clear or tax

    authorities waste the money instead of using it to increase commonwealth. Does it allow

    taxpayers to chose lesser evil, evade taxation, in order to shorten the inefficient actions? (McGee,


    In order to ensure proper tax structure, the state has to ensure that fundamental rules of

    tax civilization are applied. The most important are: the stability of the tax system, efficient

    operation of democratic institutions, accurate tax laws, a simple tax system, efficient collection

    and penalizing mechanisms and transparency in tax operations (Owsiak, 2007). A well-ordered

    tax structure increases the trust in the government, decreasing the incentives to get involved in

    illegal tax activities. The confidence in the state and willingness to comply increases as the

    perception of a strong judiciary system is more common. People are more willing to comply

    when they are treated equally by the tax law and state authorities (Uslaner, 2001).

    Stability of the tax system and its simplicity are one of the most important determinants

    of tax compliance (appendix 4.3). Frequent changes in the regulations have a negative impact on

    the creation of tax ethics, tax com