Chapter 8 Collective Cooperation: Shadow Economy and Tax Paying

Question 1

Shadow economy – broad definition

Answer 1

– those economic activities and the income derived from them that circumvent or avoid government regulation, taxation or observation

• Includes
– services within private households (e.g., washing clothes)
– income from legal sources within alternative economies (e.g., communes)
– the economy of “friends of friends”
– illegal businesses (e.g., drug dealing, selling stolen goods)

Question 2

Size of shadow economy correlated with

Answer 2

– Tax system: larger when taxation rates rise, and penalties and audit probabilities decrease
– Tax morale: negatively correlated with black labour marke

Question 3

Tax morale

Answer 3

– an intrinsic motivation arising from the moral obligation to pay taxes correctly

Question 4

Reasons for taxes

Answer 4

– equivalence of interests theory: private taxes equal the amount of service provided by the state

– insurance theory: private tax payments are a fee collected for the public protection of one´s property and person

– sacrifice theory: every citizen contributes to the fulfilment of community goals by making a sacrifice corresponding to his or her productive capacity

Question 5

Lorenz curve

Answer 5

– shows the distribution of income within a country

Question 6

Gini coefficient

Answer 6

– measures the degree of concentration in a country’s income distribution.

– measures the area between the Lorenz curve and an equal distribution line, relative to the total area under the equal distribution line

Question 7

Tax systems differ in tax rates

Answer 7

– Flat tax rates: same tax rates for all income Levels

– Progressive tax rates: higher tax rates for higher incomes

Question 8

Tax evaders may even be admired

Answer 8

– “honest taxpayers” were described as more hardworking than “tax evaders”, but also as less intelligent
– “tax evaders” were evaluated more positive than “typical taxpayers”

Question 9

Tax non-compliance

Answer 9

• Tax non-compliance
– most inclusive conceptualisation of the failure to meet tax obligations, regardless of whether the failure was intentional
• Tax avoidance
– legal attempts to reduce tax liability by taking advantage of loopholes in the law

• Tax circumvention
– attempts to reduce tax liability that are against the spirit and purpose of the law

• Tax Evasion
– illegal attempts to reduce tax liability by breaking the law

Question 10

Determinants of tax compliance ( Economic determinants )

Answer 10

– frequency of Audits
 – fines (Geldbußen)
– opportunity to avoid or evade taxes 
– marginal tax rate
 – income size

Question 11

Determinants of tax compliance (Psychological determinants )

Answer 11

– attitudes
– complexity of the tax law
– personal norms: internalized values or tendency to obey the law
– social norms: norms and values in a social setting
– societal norms: norms and values of a society as a whole
– distributive justice: outcomes
– procedural justice: process •
fairness of tax-related decision-making process
– retributive justice: fairness of form and severity of punishment

Question 12

Determinants of tax compliance (distributive justice: outcomes )

Answer 12

• horizontal fairness: tax burden in comparison to similar others
• vertical fairness: tax burden in comparison to those contributing more or less
• exchange fairness: tax burden relative to provision of public goods

Question 13

Economic theory of criminal behaviour

Answer 13

– criminal behaviour can be understood as consideration of costs and benefits
– therefore the threat of punishment has a deterrent effect if crimes are discovered and punished

Early models of tax behaviour (e.g., Allingham & Sandmo, 1972) based on this approach: assuming that tax honesty depends on audit probabilities and fines
• However, empirical findings suggest that influence is smaller than expected

Question 14

Bomb crater effect

Answer 14

– in tax experiments with several rounds, compliance often strongly drops after an Audit

• Audits as signal for lack of trust
– audits and negative sanctions contribute to mistrust and promote deliberate decision-making
– deliberate decision making can crowd out the intrinsic motivation to cooperate

Question 15

Social dilemma

Answer 15

– decision problem where individual interests are opposed to the goals of the community
– individuals can gain by acting selfishly, but
– the community (and ultimately the individual) are harmed if too many individuals act selfishly

Question 16

Tax compliance varies with opportunity

Answer 16

– self-employed as high-risk group, because they have generally higher opportunities to evade taxes than employees

Question 17

Tax compliance varies with “distance” between tax authorities and taxpayers

Answer 17

– geographical distance: e.g. lower willingness to comply with EU taxes than national taxes
– social distance: how close or distant taxpayers feel to the tax authorities

Question 18

Paradigm “Differences among taxpayers”(Motivational postures )

Answer 18

– different standpoints that taxpayers take in their interaction with the tax authorities

Five motivational postures:
– commitment: moral obligation
– capitulation: accepting necessity
– resistance: fight against authorities – disengagement: non-cooperation with authorities
– game-playing: no respect for authorities, seek advantage

• Depending on the motivational posture, different regulatory strategies should be used, ranging from self-regulation to command regulation

Question 19

Paradigm “Interaction climate”

Answer 19

• Enforcement paradigm
– refers to a view of taxpayers as potential criminals, so that tax honesty is to be achieved through audits and fines
• Service paradigm
– refers to a view that tax honesty can be achieved by easing the way, e.g., through service offers
• Trust paradigm
– refers to a view that tax honesty can be achieved by building trust between tax authorities and taxpayers

Question 20

Slippery slope framework

Answer 20

– tax behaviour is a function of trust in tax authorities and power of tax authorities

• Two determinants of tax compliance
– power of authorities: Taxpayers‘ perception of the potential of tax authorities to detect and to punish evasion
– trust in authorities: Taxpayers‘ perception of tax authorities as benevolent and working for the common good

• Two different types of power:
– legitimate power: based on positive evaluations of authorities´ power and positive attitudes towards authorities
– coercive power: based on tax authorities’ ability to enforce a law regardless of its societal acceptance

• Coercive power can undermine trust; legitimate power can have positive effects on trust

Question 21

Recommended practice

Answer 21

– simplification of tax law
– principles of behaviour instead of Plethora(Überzahl) of rules with exceptions
– efficient training for tax authorities and tax auditors
– intensive cooperation between tax authorities, legislators, judges,…
– transparent use of tax money
– promotion of social norms of correct behaviour
– achievement of distributive, procedural, and retributive justice
– segmentation of taxpayers according to needs and motivations
– audits necessary to protect honest taxpayers from free riders
– negative sanctions necessary - adequate level and proper form