Although it is commonly said that the only things certain in life are death and taxes, it is
unmistakable that taxes are in fact far from inevitable. Individuals do not like paying taxes, they
take a variety of actions to reduce their tax liabilities, and in many occasions they get away with it.
Some of these actions can be classified as tax avoidance, or the legal reduction in tax liabilities by
practices that take full advantage of the tax code, such as income splitting, postponement of taxes,
and tax arbitrage across income sources that face different treatment. Tax evasion consists of
illegal and intentional actions taken by individuals andfirms to reduce their legally due tax
obligations, by underreporting incomes, sales or wealth, by overstating deductions, exemptions or
credits, or by failing to file appropriate tax returns. For its part, government must take actions to
increase compliance with the
tax laws.
Tax evasion is notoriously difficult to measure.’ Still, there is widespread
evidence that tax evasion is extensive and commonplace in nearly all countries. For the United
States, the most reliable estimates suggest that the amount of unpaid federal individual and
corporate income taxes totaled $127 billion for 1992, with an annual growth rate of 10 percent
since 1973 (Internal Revenue Service, 19%). Evidence from a variety of methods for other and
diverse countries, such as Argentina (Herschel, 1978), the Philippines (Manasan, 1988), Jamaica
(Aim, Bahl and Murray, 1990; 1993), the Netherlands (Elffers, 1991), and Spain (de Juan et al., 1994),
indicate that tax evasion is a pervasive and extensive phenomenon.
Tax evasion is important for many reasons. The most obvious is that its presence reduces tax
collections, thereby affecting taxes that compliant
146
Institutions, paradigms and tax evasion in developing countries 147
taxpayers face and public services that citizens receive. Evasion creates misallocations in resource
use when individuals alter their behavior to lower their taxes, such as in their choices of hours to
work, occupations to enter, and investments to undertake. Its presence requires that government
expend resources to deter non-compliance, to detect its magnitude, and to penalize its
practitioners. Non-compliance alters the distribution of income in unpredictable ways. Evasion may
contribute to feelings of unfair treatment and disrespect for the law. It affects the accuracy of
macroeconomic statistics. More broadly, it is not possible to understand the true impact of taxation
without recognizing the existence of tax evasion and the economic incidence of tax evasion
(Martinez-Vazquez, 1996).
In developing and transition countries (DTCs) in particular, tax evasion is often widespread and,
indeed, systemic.2 Thus, the problem of tax evasion tends to have far more serious consequences in DTCs than in developed economies.
In this chapter we examine what we have learned from the analyses of tax evasion, which for the
most part have occurred in the context of developed countries, and what we can apply from these
lessons to the problem of tax evasion in DTCs. Specifically, we examine several key issues. First, we
present the basic analytical framework of the individual evasion decision, in order to study the
major factors that economic theory suggests motivate individuals to evade —or to pay – their taxes.
We argue that this basic framework offers some important insights but also suffersfrom some
significant limitations, limitations that arise largely because of its failure to incorporate fully or
realistically the role of societal institutions in the analytical framework. Second, then, we examine
these institutions, and we argue that the existence of a ‘social norm’ of compliance and the
presence of an effective but service-oriented tax administration are crucial, broadly defined societal
institutions that influence the magnitude of tax evasion. Indeed, these institutions are closely
linked, and jointly determine the extent of tax evasion. Such institutional factors are obviously
important in all countries but are especially decisive in DTCs, and, because these institutions are
typically so inadequate in such countries, tax evasion is typically so extensive there. Third, we
demonstrate the importance of such institutions in DTCs with three case studies: in Jamaica, to
demonstrate the important but limited role in developing countries of basic enforcement strategies
like higher audit probabilities and penalty rates; in Africa, to demonstrate the crucial role of social
norms in compliance decisions; and in Russia, to demonstrate the limited effect of administrative
innovations like tax amnesties in a country that lacks both an effective tax administration and a
social norm of compliance. We conclude with a discussion on how to improve tax compliance in
DTCs.
Source:
2003
Institutions, Paradigms, and Tax Evasion in Developing and Transition Countries
James Alm
Tulane University of Louisiana, jalm@tulane.edu
Jorge Martinez-Vazquez
Georgia State University, jorgemartinez@gsu.e
148 Public finance in developing and transitional countries
THEORETICAL FOUNDATIONS OF THE COMPLIANCE DECISION
The standard economic approach to the analysis of tax compliance has re
