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Fines and Trust in the Government Stimulate Tax Payments
A Taxpayer Game
The research, based on the principles of behavioral economics, involves six countries: Austria, Italy, Hungary, Romania, Russia, and the RSA. The economics students chosen to participate in the research were divided into 10 groups, with eight people per group; the average age of the students was 22 (19 for the Russian students). The researchers also interviewed the participants to determine their value preferences.
The participants were offered to play a game that was divided into three stages, each of which differed from the other by the structure of the institutions involved in the collection of taxes and by their control over the redistribution of those taxes in the economy. Each stage was divided into ten time periods. Each period brought a profit of 15 units, and each participant had to decide whether to pay taxes or not (at all stages), and whether to finance the foundation that controlled the spending of the taxes collected (at the third stage).
In the first stage, all eight participants were ordinary taxpayers with an income of 15 units, and in the 33% tax bracket. It was also known that the tax funds collected were used to benefit the public, with an efficiency of 0.25. With 100% payment of taxes, such efficiency is profitable for every taxpayer. There were no control and punitive mechanisms for tax evasion. The participants, who tended toward risk, were expected to evade paying taxes. Thus, their income would be 15 units, when the effective per capita income in conditions of full compliance was 20 units.
In the second stage, one of the participants of the experiment played the role of a supervisory body (state), and carried out an inspection to determine whether two of the seven remaining participants had paid taxes. In this case, a person caught evading taxes paid a fine twice as high as the tax rate. The government got all the funds (taxes and fines), which it was able to distribute on public needs or to generate rental income. It was assumed that low spending on public needs and high rental income would lower the level of trust in the government and provoke tax evasion. Data on the remaining state funds, average income, and fines was accessible to the participants.
In the third stage, another controlling body was introduced to the participants – a foundation that oversees the activities of the state and ensures the effective use of the collected taxes. The taxpayers could voluntarily contribute up to five units towards the foundation’s management. The more units invested in the controlling foundation, the more effectively the state operated.
In the RSA, People Pay Taxes; in Russia, They Don’t
The researchers concluded that, in general, tax laws are not respected unless enforced. Results in the countries varied: the highest payments were noted in the RSA, and the lowest–in Russia.
Fines had a long-lasting positive effect in Italy and in the RSA. Figure 1 shows that all the countries undergo a sudden increase in tax collection during the tenth time period.
Figure 1. The level of the tax payments and contributions to the controlling foundation
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Source: Presentation of the research ‘Tax Payments and Trust: A Cross-Country Empirical Analysis’
In some countries, the effect of fines was decreasing (Russia, Austria), and in the others, it was short-term (Hungary, Romania).
Fines Replenish the Budget
The researchers analysed the overall fund of the taxes and fines collected. They found that the imposition of fines increases the funds roughly 1.5 times, despite the reduction in the tax base. Control over the public fund (stage 3) contributes to a significant reduction in state income and an increase in public spending, but can’t make the situation as effective as the taxpayers would like it to be. At the same time, equalization occurs between different countries in terms of taxpayers’ total income.
As a result, the RSA’s government has turned out to be more public-orientated and honest than the others. Italy demonstrated that it most effectively manages the controlling foundation. The dynamics of the rates indicate mercenary behavior on the part of the state tax collectors at the beginning of the third stage in Hungary, Italy, and Romania. The situation improved by the end of that stage in Hungary, the RSA, and Russia. In general, control over government activity is minimal in the third stage.
Tax Payments Grow When Trust Exists
A particular part of the project was dedicated to researching the people’s level of trust in the government. Theoretically, a high level of trust ensures a high rate of success collecting taxes. In Austria, Italy, and the RSA, the majority of taxpayers pay taxes honestly, but they don’t invest their money in the foundation controlling the spending. In Hungary, Romania, and Russia, a large part of the population doesn’t pay taxes and doesn’t invest in controlling bodies.
A low level of trust in the government makes people self-organize. In the RSA, people trust the government, and feel that they should respect the law. In Eastern Europe, more mercenary governments require more control, and political tensions occur.
Alexey Belianin concluded that the state is potentially a more effective steward of funds. But, low contributions to the controlling foundations, caused by additional coordination expenditures, have minimized the population’s influence on the income distribution process. A high level of trust in government and punitive mechanisms contribute to an increase in tax collection. According to the research, the RSA’s government turned out to be the most honest, and Eastern European countries deviate from the general scheme.