Evading the Taxman: The Effects of Perceived Influence

Death may be unavoidable, but taxes? Not so much. An estimated $430 billion per year evades capture from tax collecting regimes worldwide. Developing countries are disproportionately harmed by tax evasion, with individual country losses equal to about half of their public health budgets.

Generally speaking, tax evasion is any deliberate behavior to avoid paying taxes. Tax evasion schemes run the gamut from exaggerating expenses to foreign trust schemes, in which earnings flow through “tax haven” countries outside the jurisdiction of the tax collector. For example, in the United States, the Internal Revenue Service estimates a tax non-compliance rate of 18.3%, meaning that almost a fifth of taxable income goes untaxed.

Tax evasion is prevalent throughout the world, though the rates vary considerably. For instance, one World Bank survey of developing countries found that Sri Lanka had a non-compliance rate of 7.3% while Senegal had a compliance rate of 79.3%. Devoid of tax revenue, developing countries become stuck in a coordination trap. The government cannot provide public goods and infrastructure without tax revenue, and the taxpayers are not providing tax revenue because they do not receive public goods. Without credible commitment, neither side will budge from this stalemate, resulting in a vicious cycle that hinders economic development.

A study published in the Journal of the American Taxation Association established a link between evasive tax behavior and a business’ perceived level of influence over its government. Using data from a World Bank 37-country survey, the authors suggest that firms are more likely to evade taxes if they believe that their domestic competitors have undue influence over public policy.

The World Bank anonymously interviewed thousands of owners and managers of local businesses in developing countries to understand the business landscape. To measure their tax evasiveness, the World Bank asked: “Recognizing the difficulties many enterprises face in fully complying with taxes and regulations, what percentage of total sales would you estimate the typical establishment in your area of activity reports for tax purposes?” If the respondent indicated that other businesses were underreporting their earnings, it was assumed that the respondent was also underreporting their earnings by a similar amount. Because survey respondents are unlikely to report their illegal activity accurately, this indirect questioning is less susceptible to self-reporting bias and is still indicative of the respondent’s behavior.

Participants then assessed their own policymaking influence along with the influence of other domestic firms, foreign firms, international development agencies, and foreign governments. The World Bank asked, “How much influence do you think the following groups … had on recently enacted national laws and regulations that have a substantial impact on your business?” Respondents scored firms as either having no (0), minor (1), moderate (2), major (3), or decisive influence (4). These results were used to draw a comparison to responses to the previous question. Ultimately, only one of the variables proved significant: Firms who believed that their domestic competition had undue influence over government policy were more likely to engage in tax evasion.

Like other observational studies, this study has its limitations. Alone, surveys like this one cannot prove a causal relationship between tax evasion and policy influence. It stands to reason that firms would not feel compelled to pay their share in a system in which they felt little control.

Additionally, researchers admit that “endogeneity” may affect the survey data. In other words, a firm’s influence affects tax policies, which then affects the level of a firm’s influence. Consequently, the results may not be as pronounced or valid in policy applications. 

Nonetheless, the study demonstrates how a system’s perceived fairness may be as crucial as actual policy . A premium should be placed on the appearance of equity. For example, countries should corral unethical lobbying practices, which give business owners the impression that their competitors have unfair influence over the government. This sort of reform can accompany traditional efforts to clamp down on tax evasion. Together, the revenue generated by these reforms can provide life-sustaining public goods and services and the infrastructure to support economic growth and activity.

The results also point out an interesting dichotomy between tax evasion in developed and undeveloped countries. In undeveloped countries, privilege incentivizes firms to pay taxes. Meanwhile, in developed countries like the U.S. firms use privilege to get out of paying taxes. Not only do behemoths like Amazon not pay taxes — they receive billions of dollars in tax rebates. If you can afford the legal fees, plead ignorance and buy justice. If you do not like the law, hire a lobbyist and change it. As the U.S. backslides into inequality, when do small businesses become fed up with paying taxes?

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Mason, Paul D., Steven Utke, and Brian M. Williams. 2020. “Why Pay Our Fair Share? How Perceived Influence over Laws Affects Tax Evasion.” Journal of the American Taxation Association 42 p. 133-156. https://doi.org/10.2308/atax-52598.