Paul Mason
Baylor University
(254) 710-6129
p_mason@baylor.edu
Steven Utke
University of Connecticut
(860) 486-2374
sutke@uconn.edu
and
Brian Williams*
Indiana University
(812) 855-5725
bw63@indiana.edu
November 2, 2020
Keywords: Tax Evasion, Tax Morale, Quality of Government, Perceived Influence, Procedural
Fairness
JEL codes: H26
Data Availability: Data used in this study are available from public sources identified in the
paper, except as otherwise specified.
*Corresponding Author: Brian Williams, Kelley School of Business, Indiana University,
Bloomington IN 47403, 812-855-5725, bw63@indiana.edu
_______________
We gratefully acknowledge the support of our respective institutions. This paper has benefited
from helpful comments from Shannon Chen (discussant), Jennifer Glenn, David Guenther, Brad
Hepfer, Jenny Luchs, Sean McGuire, Bridget Stomberg, John Robinson, Connie Weaver (editor),
Dave Weber, two anonymous reviewers, the University of Arizona Tax Readings Group, the
Texas A&M Tax Readings Group, conference participants at the 2018 American Taxation
Association Midyear meeting, and workshop participants at the University of Connecticut. The
analysis in this paper uses data from the World Bank Group’s Enterprise Surveys and was
accessed by the authors under a strict confidentiality agreement. The analysis, interpretations,
and conclusions expressed in this paper are those of the authors and do not represent official
positions of the World Bank.
2
Why Pay Our Fair Share? How Perceived Influence over Laws Affects Tax Evasion
Abstract
We examine how the relation between taxpayers and their government affects tax evasion.
Specifically, we examine how perceived influence over government policymaking affects firms’
decisions to evade tax. We argue that firms are less willing to comply with tax laws when they
perceive the influence over their government to be unfavorable to them or the result of an unfair
policymaking process. Consistent with this argument, we find that firms evade more tax when
other domestic firms have more perceived influence over domestic government policymaking.
This suggests a potential negative externality of lobbying: higher tax evasion by other firms.
However, government effectiveness or lack of corruption eliminates the positive relation
between evasion and perceived influence over policymaking. Our results suggest that limiting
domestic firms’ influence over policymaking could help governments decrease tax evasion.
1
INTRODUCTION
Tax evasion continues to gain public and governmental attention (Beck, Lin, and Ma
2014; Hanlon, Maydew, and Thornock 2015; Slemrod 2018), especially following the 2008
financial crisis and the subsequent criticism of firms not paying their “fair share” of taxes (e.g.,
Starbucks in the UK; Barford and Holt 2013). Tax evasion is particularly problematic in
developing countries, the subject of our study, and has especially negative effects in those
countries (Bearak 2016). However, tax evasion is also an issue in developed countries such as
the U.S.; the Internal Revenue Service (IRS) estimates that lost revenue from underreporting of
income (i.e., tax evasion) exceeds $350 billion annually, with a non-compliance rate of 18.3
percent.
1
That is, 18.3 percent of the tax that should be collected is not collected because of
evasion. With governments world-wide facing budgetary issues, understanding tax evasion is
particularly important due to the economic significance of the lost governmental revenue
involved.
In this study, we explore an important but understudied aspect of tax evasion: firms’
relation with the government. Specifically, we explore how firms’ perceptions of who influences
domestic government policymaking affects firms’ decisions to evade taxes.
2
We identify three
separate and distinct groups that firms can perceive as influencing policymaking: domestic firms
(including the taxpaying firm and other domestic firms), foreign firms, and international
development agencies/foreign governments. We propose that this perceived influence affects
firms’ tax compliance decisions.
3
Existing literature on non-deterrence aspects of tax compliance
1
https://www.irs.gov/PUP/newsroom/tax%20gap%20estimates%20for%202008%20through%202010.pdf, accessed
April 10, 2017.
2
Consistent with recent research (e.g., Bertrand and Schoar 2003), we acknowledge that managers, not firms, make
the firms’ decisions. Despite this, for ease of exposition throughout the paper we refer to firms’ decisions, rather
than the decisions of the firms’ managers.
3
Prior tax evasion research often focuses on individual taxpayers (e.g., Allingham and Sandmo 1972). However,
Slemrod (2018) points out that the majority of individuals’ tax evasion stems from the underreporting of business
2
often focuses on individual taxpayers’ attitudes and perceptions regarding other taxpayers
(Slemrod 2018).
4
However, tax compliance may also be a function of firms’ attitudes towards the
government and the perceived fairness of the tax system (e.g., Levi 1989; Alm, Jackson, and
McKee 1992a; Bordignon 1993; Braithwaite and Levi 1998). Thus, we extend this literature to
incorporate the role of perceived influence over government policymaking on tax evasion.
Consistent with Tyler (1997, 2006) and Levi (1998), we conjecture that taxpayers are less
likely to pay tax when they view government policymaking as legitimate, trustworthy, and
following a fair process (i.e., procedural fairness). If procedural fairness decreases (or increases)
due to other parties’ influence on policymaking, we should observe an effect on tax evasion.
Perceived influence on government policymaking includes influence over tax policies as well as
non-tax policies such as those regarding expenditures of tax revenue, with influence over either
type of policy potentially affecting the procedural fairness of policymaking and thus tax evasion
decisions. Moreover, the perceived influence over government policymaking and its effect on tax
evasion may vary depending on the source of the influence. That is, whether firms perceive the
influence to have a positive or negative effect may depend on who influences the government.
5
How perceptions of influence over government policymaking affect tax evasion presents an
important open empirical question, especially considering that the overall effect of the perceived
income in small businesses, which are the focus of our study. Thus, we refer to survey respondents in our sample as
firms rather than individuals. Importantly, our sample contains a significant number of closely held firms (>60
percent of sample firms) where the survey respondent is likely the firm’s majority (controlling) owner. Furthermore,
even when a firm is not closely held, the manager’s survey response reflects the manager’s attitude towards tax
evasion and the manager’s personal tax evasion decisions, which are reflected in firm behaviors (Johnson,
Kaufmann, McMillan and Woodruff 2000; Joulfaian 2000; Chyz 2013). See also Cen and Doukas (2018).
4
Non-deterrence aspects of tax compliance include “behavioral” considerations such as intrinsic willingness to pay
tax (see Slemrod (2018) and Alm (2019) for reviews) whereas deterrence aspects include items such as audits,
penalties, and the probability of detection (Allingham and Sandmo 1972). Perceived influence over policymaking, as
we study in this paper, is a non-deterrence aspect of tax compliance. The next section provides a more detailed
discussion of both non-deterrence and deterrence models of tax compliance. Note that tax compliance and tax
evasion are inverses (i.e., evasion equals non-compliance), and we use both terms in this paper.
5
Frumin (2015), Helderman, Hsu, and Hamburger (2016), Kalla and Broockman (2016), and Brown and Huang
(2017) show that government policy is subject to influence.
3
fairness of the tax system on tax evasion is ambiguous (see Cowell 1990 for a review).
As is common in the tax evasion literature (e.g., Andreoni, Erard, and Feinstein 1998),
we explore this question using a survey. Specifically, we obtain survey data covering 37
developing countries from the World Bank Private Enterprise Survey for years 2002 through
2004 (similar data is used, for example, in Beck et al. [2014]). Using this data, we measure
firms’ tax evasion as a function of the perceived influence over government policymaking by
various separate and distinct groups including the taxpaying firm, other domestic firms, foreign
firms, and international development agencies or foreign governments. This data enables us to
understand the association, if any, between tax evasion decisions and perceived influence over
government policymaking. Our sample consists of developing countries, which are most likely to
suffer negative consequences from tax evasion (e.g., Bearak 2016).
6
However, understanding the
behavioral responses to perceived influence on policymaking, especially the influence of foreign
entities, is increasingly important across all countries as globalization continues (see, e.g.,
Swanson [2016] for an example unrelated to tax evasion).
We acknowledge that survey data on tax evasion is often subject to self-reporting bias
(Slemrod 2007). However, our survey has an advantage over some prior surveys in that, rather
than asking about the firm’s own (potentially incriminating) evasion, the survey asks about the
firm’s perception of the tax evasion of other local businesses in the industry to elicit more
truthful responses. Prior literature suggests that one’s perception of others’ evasion is linked to
one’s own evasion (e.g., Sandmo 2005) and therefore generally uses this perception to proxy for
6
For example, Brazilian firms created a large ‘informal economy’ to evade tax. The informal economy harms
development by discouraging legitimate business while encouraging organized crime (Rapoza 2004). Further, the
loss of governmental revenue leads to higher taxes, and thus more evasion, creating the need to devote significant
portions of scarce government resources to combating evasion (Rapoza 2004; Soto 2012).
