Psychic cost of tax evasion

Sundday, January 22, 2017 http://daillyasianage.com m/news/456448/psychic-coost-of-tax-evasion

Psycchic cosst of taax evassion M S Sidddiqui

People probably perceive taxes more like losses or some mental category of expenses, such as bad gambles or mandated purchases.

There is a general consensus that most people dislike paying taxes, more research is needed to determine how, and to what extent, tax aversion plays a role in taxpayer behavior. Another possible manifestation of tax aversion might be increased evasion. Tax aversion refers to both

tax avoidance and tax evasion.

Tax avoidance or tax mitigation are legal, Tax evasion is not. Tax evasion is important for many reasons. The most obvious is that it reduces tax collections, thereby affecting taxes that compliant taxpayers face and public services that citizens receive.

Beyond these revenue losses, evasion creates misallocations in resource use when individuals alter their behavior to cheat on their taxes, such as in their choices of hours to work, occupations to enter, and investments to undertake.

Evasion may contribute to feelings of unjust treatment and disrespect for the law. It affects the accuracy of macroeconomic statistics. Economy becomes informal and sometimes underground.

More broadly, it is not possible to understand the true impact of taxation without recognizing the tax evasion.

A mare notion of 'businessmen don't pay tax' is not the state of affairs. Given these concerns, a natural concern is to search for alternative regulatory and administrative policies to encourage tax compliance.

Devising such policies depends critically upon understanding why individuals and firms may fail to comply fully with their legally due tax obligations, on examining the various types of evidence on noncompliance, and on pursuing regulatory policies that are consistent with these motivating factors and the associated evidence.

The basic theoretical model used in nearly all researches on tax compliance begins with the economics-of-crime model of Becker (1968), here a rational individual is viewed as maximizing the expected utility of the tax evasion gamble, weighing the benefits of successful cheating against the risky prospect of detection and punishment, and the individual pays taxes because he or she is afraid of getting caught and penalized if he or she does not report all income.

This model gives the plausible and productive result that compliance depends upon audit frequency and penalty. Indeed, the central point of this approach is that an individual pays taxes because of this fear of detection and punishment. The obvious implication for designing strategies to reduce tax evasion is to increase enforcement.

This economics-of-crime approach therefore gives the sensible result that compliance depends upon the enforcement policies of a tax administration. However, it is essential to recognize that this approach also concludes that an individual pays taxes because - and only because - of the economic consequences of detection and punishment.

It is clear to many observers that compliance cannot be explained entirely by such purely financial considerations, especially those generated by the level of regulatory enforcement.

The percentage of individual income tax returns that are subject to a thorough tax audit is generally quite small in most countries, almost always well less than 1 percent of all returns.

Similarly, the penalty on even fraudulent evasion seldom exceeds more than the amount of

unpaid taxes, and these penalties are infrequently imposed; civil penalties on non-fraudulent evasion are even smaller.

A purely economic analysis of the evasion gamble suggests that most rational individuals should either underreport income not subject to source withholding or over claim deductions not subject to independent verification because it is extremely unlikely that such cheating will be caught and penalized.

However, even in the least compliant countries evasion never rises to levels predicted by a purely economic analysis, and in fact there are often substantial numbers of individuals who apparently pay all (or most) of their taxes all (or most) of the time, regardless of the financial incentives they face from the enforcement regime.

The many extensions of this economics-of-crime approach considerably complicate the theoretical analyses, and generally render clear-cut analytical results impossible. Nevertheless, these extensions retain the basic approach and the basic result, which is, individuals focus exclusively on the financial incentives of the evasion gamble, and individuals pay taxes solely because they fear detection and punishment.

The basic model of individual compliance behavior therefore implies that rational individuals especially those whose incomes are not subject to third-party sources of information should report virtually no income. Although compliance varies significantly across countries and across taxes and is often quite low, compliance seldom falls to a level predicted by the standard economic theory of compliance.

It seems implausible that government enforcement activities alone can account for these levels of compliance; the basic model is certainly unable to explain this behavior. Indeed, the puzzle of tax compliance behavior may well be why people pay taxes, not why they evade them. This observation suggests that the compliance decision must be affected in ways not captured by the basic economics-of-crime approach.

What are the other factors may explain why people pay taxes? A number of other economic factors have been suggested and analyzed in the theoretical literature. If taxpayers receive something from government for their tax payments, and the receipt of government services has been shown to have a positive effect on compliance, that is, individuals pay taxes because they value what they get for their taxes, and they pay more in taxes the more responsive is government in providing what they value. A related aspect is that individuals may be responsive to positive rewards given to them if they find the audit process to be honest.

Let us evaluate a real life experience of everyday. An analogous contrast might be drawn between two traffic laws, one that dictates the side of the road on which people should drive, and another that limits speed on a wide, straight, uncongested thoroughfare to 40 miles per hour. The first law coordinates the sort of cooperative action in which people would engage anyway, while the second law most likely coerces behavior in which people would not otherwise engage.

It is not quite as simple as that, however, because compulsion fundamentally changes the picture.

On one hand, some people who are willing to contribute voluntarily under a given set of circumstances may resent a compulsory collection under the same set of circumstances if part of what made the contribution attractive in the first case was its voluntary nature.

On the other hand, adding elements of compulsion directed at thwarting free riders can elicit higher levels of voluntary contributions. In the latter case, the compulsion might be seen as a proxy for a social contract or other voluntary arrangement in which the group's members derive benefits from binding themselves to undertake certain obligations.

The government may improve tax compliance through employing subtle behavioral interventions that encourage more honest tax reporting by raising the level of psychological discomfort experienced from underreporting. Employing subtle behavioral interventions that encourage more honest tax reporting by raising the level of psychological discomfort experienced from underreporting.

The psychological study says that individuals tend to be more honest when they perceive that there is a victim who will be directly harmed by their dishonesty. For example, studies show that subjects cheat less when they are told that their financial payoff will reduce the payoff to counterparty in case of tax of the common citizens, as compared to when there is no counterparty.

This approach is for the increasing 'psychic cost' of tax evasion for taxpayers. An additional measure designed to increase the psychic cost of tax evasion, such as making small adjustments to the way that taxpayers fill out their tax forms, could generate much needed tax revenue.

Moreover, these measures would impose very little administrative expense to the government as compared to traditional deterrence mechanisms like audits and penalties.

A sincere professional attitude of tax officials is sufficient to extend this simple reduction of psychic cost of taxpayers. Moreover, adopting measures to increase the psychic cost of tax evasion should impose a relatively small administrative cost to the government compared to expending resources to audit more taxpayers, and should avoid the crowding out effects and other costs imposed by high penalties.

Again, this is a plausible and productive insight, with the obvious implication that the government can encourage greater tax compliance by increasing the audit and the penalty rates of its regulatory regime and reducing psychic cost for tax payers.

The writer is a legal economist Â