ABSTRACT
Tax evasion is an endemic problem in Russia – and most other transition countries – especially in comparison with the West. Easter (2007: 234-9), Hanousek and Palda (2007: 332), Ott (2007: 292-3), and Owsiak (2007) detail the extent of tax evasion in Russia, the Czech Republic, Croatia, and Poland, respectively, and the figures are distressingly high – often as great as 40 percent of the total economy. Tax evasion is part of a more general syndrome of corruption, impotent legal systems, shaky economies, and, especially, inefficient governments that fail to provide essential services. New democratic institutions did not ensure smoothly functioning states and reduced corruption. Parliamentary elections and promises of the rule of law did not turn Romania or Russia into Sweden (Uslaner and Badescu, 2004). When people believe that public officials steal their tax payments – and especially when they believe that they don’t receive high quality services for their taxes (Hanousek and Palda, 2004) – they are more likely to evade paying their taxes. Tax compliance is thus a social contract between ordinary citizens and the government rather than a contract among people based upon trust, as Rothstein
(2001) argued. Scholz (2007) and Smith (1992) argue that there is a basic expectation of reciprocity: if you don’t believe that others will pay their taxes, then you too will withhold your tax payments. Yet an explanation based upon reciprocity – you pay your taxes because you believe that others will also pay theirs – doesn’t explain why others pay their taxes (Uslaner, 2007). People obey the law – generally and, more specifically, by paying their taxes – when they believe that they will be treated fairly and equitably. A fair judicial system is more important than an efficient one (Tyler, 1990; Uslaner, 2008: Chs 2, 4). Throughout transition countries, people believe that the law is not fair, and that the rich and powerful can get away with corruption and tax evasion (Uslaner, 2008: Ch. 4). Wealthy people can pay off the courts and avoid prosecution. If they are nevertheless indicted, they can pay off the judges to fix their trials. If they are somehow convicted, they can appeal and ensure that they never serve time in jail. In 2003, the Russian government of Vladimir Putin arrested billionaire Mikhail Khodorkovsky for tax evasion and extortion and argued that no one, no matter how rich, was above the law (even though most viewed Khodorkovsky’s arrest and ultimate jailing as a move to quash his political aspirations). I argue, with Hanousek and Palda (2004), that the quality of government services is a key factor in tax compliance. Corruption also matters. When people believe that their taxes will go toward public services, and not into the pockets of politicians, they will be more likely to pay their fair share. Where there is widespread corruption and an unfair (as well as weak) legal system, tax compliance will be lower. Belief in the honesty of officials is a key component of why people trust the government in both Western and transition countries (Uslaner, 2008: Ch. 5). Performance, however, is just as critical. In the West, evaluation of how well the government manages the economy is the key to understanding why people trust that government (Citrin, 1974). In transition countries, the provision of basic services seems to be more critical than simple economic performance (Uslaner, 2008: Ch. 5). This is not such a critical concern in the West, where routine services are routinely provided. Trust in government is a key factor in explaining tax compliance in Romania (Uslaner, 2007), but the surveys of businesspeople (described below) that I employ have no direct question regarding trust in government. I can only establish a direct linkage from the quality of services to tax compliance, rather than a causal chain from service provision to trust in government to paying taxes. There is mixed support for the claim that enforcement matters. Beron et al. (1992), Smith (1992), and Scholz (2007) find that the likelihood of detection is a key factor in tax compliance in the United States, while Hanousek and Palda (2004) find it to be insignificant in the Czech Republic, as do Feld and Frey (2007) in Switzerland. I provide support for the claims that tax compliance in transition countries reflects perceptions of the quality of services and the level of corruption, both in the tax administration offices and throughout government and society, using the 2002 and 2005 surveys of business people, the BEEPS (Business Enterprise and
Environment Performance Surveys), conducted for the World Bank and the European Bank for Reconstruction and Development. BEEPS 2002 and 2005 encompassed 28 and 27 transition countries, respectively. Turkmenistan was not included in the 2005 survey, and I excluded respondents from Turkey (which is not a transition country) in both years. The BEEPS surveys do not tell us anything about compliance by ordinary citizens. However, they contain an excellent set of questions both on tax compliance and on levels of corruption (as reflected in gift payments to officials), the fairness of the legal system, the structure of firms, and expectations of audits. Approximately 7,500 respondents were surveyed in 2002 and 9,500 in 2005, with samples stratified by location, sector, size, whether the firms were exporters, and locus of control (domestic versus foreign). Business people are different from ordinary citizens. They are considerably less likely to see corruption and unfairness than the mass public (Uslaner, 2008: Chs 5, 6). Thus, the results I present here may even underestimate the importance of corruption and the quality of services. This may be less of an issue than it first seems, since businesses depend even more than the mass public on government services. In countries with unfair legal systems and many “grabbing hands”, business people are more likely to be personally affected by corruption than are ordinary citizens. The 2002 BEEPS survey involved respondents from 6,667 firms and the 2005 survey involved respondents from 9,655 firms, in 27 nations – including Turkey. Both surveys included respondents from Turkey.2 As my focus is on formerly Communist nations, I have excluded the Turkish respondents. I have used the surveys to estimate models of: (i) the perceived share of income reported by firms for tax purposes for the 2002 BEEPS; (ii) gift payments to tax collectors in the 2005 BEEPS; (iii) taxes reported in the 2005 BEEPS; (iv) reported taxes in the 2005 BEEPS, with gift payments to tax collectors as endogenous using instrumental variables; and (v) income reported for taxes across the countries in the 2005 BEEPS (in an aggregate model). Overall, I have found strong support for the claim that the quality of government services and the level of corruption matter greatly. Clearly, other factors also matter, including the size and ownership of the firm, the fairness of the legal system, the level of competition, the tax rate, the quality of the bureaucracy, and the expectation of audits. The quality of services and the level of corruption stand out as critical factors shaping tax compliance.
