The Determinants of Tax Morale: the Effects of Cultural Differences and Politics

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1 1 Determinants of Tax Morale in Japan and in Turkey The Determinants of Tax Morale: the Effects of Cultural Differences and Politics Recep Tekeli 1 Abstract: In this paper we analyze the tax morale in two OECD countries; Turkey and Japan, using data from the fifth wave of World Values Surveys. Using Survey data for comparative analysis we can see the differences in several factors affecting Tax Morale between Japan and Turkey We empirically test what shapes tax morale by using Ordered Probit model. We have followed the literature but used additional variables to see what determines the notion intrinsic motivation to pay taxes i.e tax morale. Most of our findings are in line with the earlier works in tax morale literature. Our findings also indicate significantly higher tax morale in Japan than in Turkey, controlling in a multivariate analysis for additional variables. Keywords: Tax morale; Tax compliance JEL classification: H26; H30 1. Introduction Why do people pay taxes? This question recently has started to be pronounced more often and attracted increased attention in the tax (non)compliance literature over the last few years. It is supposed that nobody likes to pay taxes but governments can still generate tax revenues. One possible answer among the scholars is to force people to pay their taxes by establishing a deterrence policy. In line with the economics-of-crime approach, Allingham and Sandmo s (1972) model shows that the extent of tax evasion is negatively correlated with the probability of detection and the degree of punishment. However, because of the empirical and experimental findings, their seminal model has attracted many criticisms by researchers (see, e.g., Graetz and Wilde 1985; Alm et al. 1992; Frey and Feld 2002). These deterrence models predict a comparatively high incidence of tax evasion; even in many countries, the actual level of deterrence is found to be too low to explain the high degree of tax compliance.(see Torgler, Schneider and Shaltegger, 2010:294; Torgler and Shaltegger, 2006:396) 2 1 Faculty of Economics and Administrative Sciences, Department of Public Finance, University of Adnan Menderes, Nazilli, Turkey (rtekeli@adu.edu.tr). The Research Grant by Higher Education Council of Turkey (YÖK) is greatly appreciated. I would like to thank Policy Research Institute at Ministry of Finance, Japan for granting Visiting Scholar position and Policy Research Institute staff. Also I would like to thank to participants at the workshop where this paper was presented. 2 Torgler Schneider and Shaltegger (2010:294) and Torgler and Shaltegger (2006:396) quoting from several researchers report that there is a considerable gap between the amount of risk aversion that is required to guarantee such compliance and the effectively reported degree of risk aversion. For example, in the United States and Switzerland, the estimated Arrow Pratt measure of risk aversion is between 1 and 2, but approximately a value of 30 would explain the observed compliance rate in these countries. Also, they argued that a higher level of income declaration is reported in tax compliance experiments than the expected utility model would predict. Recep Tekeli Policy Research Institute 1

2 2 Determinants of Tax Morale in Japan and in Turkey In the tax compliance literature this seemed to be a puzzle, or in other words, it is indeed an avenue to study further for the scholars. To resolve this puzzle of tax compliance, many researchers have tried to link tax morale to the high degree of tax compliance (e.g., Schwartz and Orleans 1967; Lewis 1982; Roth et al. 1989; Alm et al. 1992, 1999; Pommerehne et al. 1994; Frey 1997; Frey and Feld 2002; Feld and Tyran 2002; Torgler 2001 and Torgler and Schneider 2009). In this perspective, Torgler, (2003:290) argued that Erard and Feinstein s work (1994) demonstrates the relevance of integrating moral sentiments into the models to provide a reasonable explanation of actual compliance behavior. Also while reviewing the tax compliance, Andreoni et al. (1998:852) suggest that adding moral and social dynamics to models of tax compliance is as yet a largely undeveloped area of research (see Torgler Schneider and Shaltegger 2010:294) Following Torgler s researches into the field of tax morale, rather than treating tax morale as a black box, or a residuum, many papers have analyzed which factors shape or maintain tax morale (see Torgler and Schneider 2007; Torgler and Murphy 2004; and Torgler Schneider and Shaltegger 2010). In addition, this puzzle concerns policymakers because they need to know the driving forces of tax morale and the possibility that it influences willingness to pay taxes so that they can design efficient tax system. In the literature, tax morale is defined as a moral obligation to pay taxes, or a belief in contributing to society by paying taxes. It is also defined as the existence of an intrinsic motivation to pay taxes (Torgler 2003; Torgler 2004; Torgler and Schneider 2009; Cummings et al 2009; Torgller 2005). This is not an output variable like the size of shadow economy; it measures individual attitude not individual behavior (Torgler 2004; Torgler and Schneider 2009). Tax morale is also closely linked to the term taxpayer ethics by Alm and Torgler (2006:228) and Torgler and Schneider (2007a:10; 2007b:444) and used the definition by Song and Yarbrough (1978:443) that, the norms of behaviour governing citizens as taxpayers in their relationship with the government. Torgler and Murphy(2004:301) defines the concept as tax morale can generally be understood to describe the moral principles or values individuals hold about paying their tax 3 3 Tax morale is sometimes related to the term tax culture. Although it is not well conceptually organized yet, tax culture is defined as all residual factors that have not been considered to explain the behavior of tax compliance. In this aspect, Nerre (2008:155) defines tax culture as follows: A country-specific tax culture is the entirety of all relevant formal and informal institutions connected with the national tax system and its practical execution, which are historically embedded within the country s culture, including the dependencies and ties resulting from their ongoing interaction. Recep Tekeli Policy Research Institute 2

3 3 Determinants of Tax Morale in Japan and in Turkey Why Tax Morale is Important? German scholars in the 1960s (e.g. Schmölders, 1970 and Strümpel, 1969) tried to bridge economics and social psychology by emphasizing that economic phenomena should be analyzed from a perspective larger than the traditional neoclassical point of view (e.g., Lewis, 1979, 1982) (see Torgler and Schneider 2007b:444). In this respect, Torgler and Schneider (2007a:10-11) argue that values and attitudes can affect individual behavior: Apart from sanctions, Spicer and Lundstedt (1976) argued that a set of attitudes and norms might have affect on the choice between tax compliance and evasion. Lewis (1982) points out that it could be that tax evasion is the only channel through which taxpayers can express their antipathy we can be confident in our general prediction that if tax attitudes become worse, tax evasion will increase (p. 165, 177). (excerpted from Torgler and Schneider 2007a:10-11). Therefore, we can state that values and attitudes can affect individual s behavior. Tax noncompliance is actually inevitable fact in all societies (see Cowell, 1990; Schneider and Enste (2000, 2002); Schneider 2003; Alm et al. 2004; Schneider 2005; Schneider et al 2010 ). Schneider (2005:598) argues that most societies attempt to control shadow economic activities through measures such as punishment and prosecution, or by relying on economic growth or education. Gathering statistics about who is engaged in shadow economy activities and the frequencies with which these activities occur and magnitudes, is important. Schneider (2005:600) defines the shadow economy as: The shadow economy includes all market-based legal production of goods and services that are deliberately concealed from public authorities : to avoid payment of taxes and social security contributions, to avoid having to meet certain legal labor market standards, such as minimum wages, and to avoid complying with certain administrative procedures. While the shadow economy is estimated generally it was not dealt with typical economic activities that are illegal and fit the characteristics of traditional crimes such as gambling, burglary, robbery, drug dealing, prostitution etc. The informal household economy, which consists of all household services and production, is not included either (see Schneider 2005; Schneider et al 2010). Schnieder (2005) and Schneider et al (2010) have provided estimates of the size of the shadow economies for developing, transition and highly developed OECD countries over the periods of time using the MIMIC/DYMIMIC and the currency demand approach. The first conclusion from these results is that for all countries investigated the shadow economy has Recep Tekeli Policy Research Institute 3

4 4 Determinants of Tax Morale in Japan and in Turkey reached a remarkably large size and increasing over the years. Also, the empirical results convincingly demonstrate that an increasing burden of taxation and social security payments, combined with rising state regulatory activities, are the major driving forces underlying the size and growth of the shadow economy 4. Table 1: The size of shadow economy in 26 EU countries and Turkey Size of the shadow economy (as % of GDP) EU Countries 1989/ / / Austria Belgium Bulgaria Czech Republic Denmark Estonia N.A N.A N.A 42.3 Finland France Germany Great Britain Greece Hungary Ireland Italy Latvia Lithuania Luxembourg N.A N.A N.A 10.2 Malta N.A N.A N.A 27.7 Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden Turkey Average Source: the data are obtained from Schneider (2005) and Schneider et al (2010) with the average value is our own estimate. 4 Although it is difficult to estimate the accurate size of a shadow economy, there are three methods can be found in the literature to estimate the size of the shadow economy (see Schneider 2005): 1. Direct approaches, 2. Indirect approaches [2.1. The discrepancy between national expenditure and income statistics, 2.2. The transactions approach, 2.3. The discrepancy between the official and actual labor force, 2.4. The currency demand approach, 2.5. The physical input (electricity consumption) method, The Kaufmann-Kaliberda Method, The Lacko method] and, 3. The model approach (DYMIMIC). Recep Tekeli Policy Research Institute 4

5 5 Determinants of Tax Morale in Japan and in Turkey The size and development of shadow economies of 26 EU countries is shown in Table 1. The average shadow economy size was 17.9% in 1989/90 and increased to 24.75% in In Turkey the size of shadow economy shows a significant increase. The lowest shadow economies have Austria, Luxembourg and Britain with the size of shadow economy around 10 to 13 percent in The highest shadow economies among 26 EU countries have Romania with 38.9, Bulgaria 41.2 Estonia 42.3 and Latvia 44.3 percent. These countries sizes of shadow economy are above Turkey s size in 2007 i.e 35.2% (see Graph 1). Source: see the fourth column in Table 1. Note: Graph is prepared by using shadow economy estimates of Schneider et al (2010) Recep Tekeli Policy Research Institute 5

6 6 Determinants of Tax Morale in Japan and in Turkey In Graph 2 above and Table 2 below the size of the shadow economy of 27 OECD countries are shown. The lowest shadow economies have the USA, Switzerland, and Austria with an average size of shadow economy varies from 9 to 10%. Japan also shows a low level of shadow economy with 12.1%. The countries with the highest shadow economies among these 27 OECD countries are Turkey with 35.2%, Mexico with 31.3 %, Greece with 31% and South Korea with 29.4%. Table 2: The size of shadow economy in OECD countries (including Japan) OECD Countries 2007 USA 9 Switzerland 9.1 Austria 10.1 Luxembourg 10.2 Japan 12.1 Great Britain 13.2 Netherlands 13.2 New Zealand 13.6 Australia 15 France 15.7 Ireland 16.4 Canada 16.6 Germany 16.7 Iceland 16.8 Denmark 19 Finland 19.2 Norway 20.2 Sweden 20.4 Portugal 22.5 Belgium 23.1 Spain 23.1 Italy 27.4 South Korea 29.4 Greece 31 Mexico 31.3 Turkey 35.2 Mean 18.8 The comparison of shadow economies in EU and OECD economies shows an important phenomenon for some countries to deal with. The main problem in the shadow economy, or black economy, is the fact that individuals are behaving dishonestly by providing false Recep Tekeli Policy Research Institute 6

7 7 Determinants of Tax Morale in Japan and in Turkey information. If so, what would lead citizens to behave more honestly, provide correct information and improve the tax compliance rate? Some believe that tax morale is an answer to this question (see Feld and Frey 2002). Also, Torgler and Schneider (2007b) argue that a reduction of tax morale reduces the moral costs of behaving illegally and increases the incentives to work in the black economy. According to Alm, et al (2004), a negative correlation between the size of the shadow economy, which is a measure of the extent of tax evasion, and tax morale indicates the extent to which individuals revealed actions are related to their attitudes about paying taxes (Torgler and Schneider 2009:230; Torgler and Schneider (2007b)). In this extent, a number of previous studies have investigated the simple correlation between tax morale and the size of shadow economy. For example, Alm and Torgler (2006:242) focusing on Europe and the United States find a strong negative correlation (r=-0.460). Alm, Martinez-Vazquez, and Torgler (2006) focused on transition countries and their results indicate a strong negative correlation between both variables (-0.657) (see Torgler and Schneider, 2009:230). Torgler (2005) investigates the correlation between the size of shadow economy and tax morale in Latin America, and a strong negative correlation between both variables (-0.511) has been found. Torgler and Schneider (2009) find a significant correlation between tax morale and the size of shadow economy based on data from more than fifty countries. Their empirical results strongly suggest that tax morale plays a significant role in determining the level of shadow economy: higher tax morale leads to a smaller shadow economy. Also, the beta coefficients show that its quantitative impact is comparable to other determinants. It has been argued that if tax authority places a taxman under every bed it is highly likely to achieve a high level of tax compliance rate but with high costs to the tax authority. Torgler and Shaltegger (2006:397) argues that even though taxation is enforced by law, there is a moral dimension in paying taxes for many people. For example, Slemrod (1992:7) states that methods that reinforce and encourage taxpayers devotion to their responsibilities as citizens play an important role in the tax collection process (excerpted from Torgler and Shaltegger 2006:397). If tax morale is thought to be an explanation for why tax compliance rates are so high, it would be interesting to analyze what may shape tax morale among taxpayers. Next section examines the magnitude and determinants of Tax Morale. Model and variables which are considered to be important explaining tax morale are presented as well. Section 3 gives the empirical results in Turkish and Japanese experience. Last section concludes the paper. Recep Tekeli Policy Research Institute 7

8 8 Determinants of Tax Morale in Japan and in Turkey 2. Magnitude and Determinants of Tax Morale: 2.1 Magnitude If tax morale is seen as an important factor to understand the puzzle of tax compliance and plays a significant role in determining the levels of shadow economy, then it is necessary to investigate the determinants of tax morale. Thus, this section focuses on the magnitude and determinants of tax morale in the study countries: Turkey and Japan. We define tax morale as the intrinsic motivation to pay taxes as defined by Torgler in his papers. This is not physical output variable such as tax evasion or the size of shadow economy. It measures an individual s willingness to pay taxes, in other words, the moral obligation to pay taxes or the belief that paying taxes contributes to society. Data for the tax morale variable are extracted from the World Values Survey (WVS) (see Inglehart et al., 2000). The World Value Survey is a worldwide investigation of socio-cultural and political change, which includes the case of Turkey and Japan. There are so many variables for this dataset and it covers quite a huge number of countries. They are based on representative national samples of more than 1000 individuals. In the 2005 wave of the survey, a total of 1346 Turkish citizens and 1096 Japanese citizens agreed to participate in the study. Data from these surveys can be accessed by researchers interested in how views change with time and across countries. The World Values Surveys have produced comparative data on what people value, what their beliefs are, what they want out of life and the facts of life. In the survey, our main concern is the question number 200 which is about the attitudes toward cheating on taxation. This attitude was measured with the 10 different scales, where the value of one (1) indicates that cheating on taxation is never justifiable and the value of ten (10) means it is always justifiable. This dataset has been regularly surveyed. The first one was carried out in 1981 for European Value Survey. The second wave was completed in , the third one was carried out in , the fourth one took place in , and the fifth and last one took place in 2005/2007. As the last one is the most recent one which we can access, we use the last wave for the analysis. The general question to assess the level of tax morale in World Values Survey is that: Please tell me for each of the following statements whether you think it can always be justified, never be justified, or something in between : V200. Cheating on tax if you have the chance never justified always justified Recep Tekeli Policy Research Institute 8

9 9 Determinants of Tax Morale in Japan and in Turkey The tax morale variable is generated by recoding this ten-point scale into a four point scale (0,1,2, and 3), with the value 3 standing for never justifiable. As usual, the value of 0 is an aggregation of the last 7 scale points (4-10), which were rarely chosen (ie, 0 = always justifiable to 3 = never justifiable ; original scores of 4-10 were recoded into 0 = always justifiable ). We should point Elffers et al. (1987) that their findings indicate the differences between actual evasion assessed and evasion reported in survey responses. This result shows that subjective surveys are always prone to significant reporting errors. As argued by some researchers, tax morale is also measured with subjective survey responses in WWS, thus the measurement of tax morale is not free of bias (e.g. Torgler 2004; Torgler and Schneider 2007; Torgler et al 2010). Because the available data from surveys are based on self-reports in which respondents may tend to overstate their degree of compliance (Andreoni et al. 1998), no objective or directly observable measure of tax morale is available. However, the degree of honesty is expected to be higher because in the WWS the tax morale is defined less sensitive than directly asking whether a person has evaded taxes. Moreover, the dataset is based on wide-ranging surveys (based on more than two hundred questions) it was assumed to reduce the probability of respondent suspicion and the framing effects of other tax context questions. However, it can still be argued that a taxpayer who has evaded in the past will tend to excuse this kind of behavior and report a higher degree of tax morale in the survey. As no sanctions are involved in the survey many respondents might overstate their willingness to pay taxes or degree of honesty.( see Torgler and Schneider 2007a; Torgler and Schneider 2007b; Torgler and Shaltegger 2006) 5 On the other hand, it was further argued that the use of such a single question (single item value) has the advantage of reducing problems of index construction complexity, especially in regard to measurement procedure or low correlation between items (see Torgler and Schneider 2007a; Torgler 2004; Torgler 2003; Alm and Torgler2006). According to Torgler and Schneider (2007a:450) tax morale is a multi-dimensional concept that requires a multiitem measurement tool and the likelihood of a multi-item index being adversely affected by random errors will produce more reliable measures. However, several previous studies have found consistent results using single-item survey measurements and laboratory experiments 5 We should also indicate another disadvantage of working with survey data as argued by Alm and Torgler (2006: ) that we cannot control for such traditional factors as the audit probability (because this is not known for each individual) and the fine rate (because this is identical for all individuals in a country). Recep Tekeli Policy Research Institute 9

10 10 Determinants of Tax Morale in Japan and in Turkey (e.g., Cummings et al. 2005; Alm and Torgler 2006). Despite these criticisms our approach to measuring tax morale is consistent with the previous studies in this area (see Torgler, 2007; Torgler and Schneider 2007a; Torgler 2004; Torgler 2003; Alm and Torgler2006). Graph 3 provides a comparison of tax morale levels of 12 EU countries with the same method. It shows the frequency of response for tax cheating is never justifiable with respect to the total respondents and the EU average value for scaled response 6. The descriptive analysis reveals the percentage of individuals in each EU country stating that tax evasion is never justifiable (i.e., those with the highest level of tax morale) and the mean level of tax morale among EU countries. Turkey with 80.50% shows a higher proportion of never justifiable response than that of EU average (57%). The average score obtained for the tax morale question across all EU countries in 2005/2007 was 2.2 (out of 10). The lowest level of tax morale is observed for France and Norway. 6 Selected countries in WVS 2005 are: Bulgaria [2006], Finland [2005], France [2006], Germany [2006], Great Britain [2006], Italy [2005], Netherlands [2006], Norway [2007], Poland [2005], Romania [2005], Spain [2007], Sweden [2006] and Turkey [2007]. Recep Tekeli Policy Research Institute 10

11 11 Determinants of Tax Morale in Japan and in Turkey Graph 4 provides a comparison of Tax Morale levels of 15 Asia Pacific Economic Cooperation (APEC) Countries. It also shows that in 2005 the average number of people in Japan stating that tax cheating is never justified was 82.90%, which was far above APEC average of 61.80%. The average score obtained for the tax morale question across all APEC countries in 2005/2007 was 2.1 (out of 10). The lowest level of tax morale is observed for Malaysia and Thailand. As we can see there is a strong difference among APEC countries with the highest tax morale. 7 Table 3 shows the range of responses varied from 1.5 to 3.5. The country most opposed to tax cheating is Japan with a mean score of 1.5 followed by South Korea and Indonesia. Malaysia has the highest score at 3.5 implying that Malaysian has the least opposition to tax cheating. 7 APEC currently has 21 members, including most countries with a coastline on the Pacific Ocean. As Taiwan joined with full approval of mainland China under the name Chinese Taipei, the APEC uses the term Member Economies rather than member countries to refer to its members. Therefore we also used Member Economies rather than member countries. Selected countries/samples are Australia [2005], Canada [2006], Chile [2006], China [2007], Hong Kong, China [2005], Indonesia [2006], Japan [2005], Malaysia [2006], Mexico [2005], New Zealand [2004], Russian Federation [2006], South Korea [2005], Taiwan [2006], Thailand [2007], United States [2006], Viet Nam [2006] Recep Tekeli Policy Research Institute 11

12 12 Determinants of Tax Morale in Japan and in Turkey Table 3: Tax Morale in APEC Countries mean APEC Countries cheating never justified score Japan 82.90% 1.5 South Korea 74.20% 1.6 Indonesia 79.30% 1.6 Viet Nam 76.90% 1.7 Canada 66.10% 1.9 Chile 66.20% 1.9 Hong Kong 61.40% 1.9 Australia 63.90% 2 China 63.40% 2 Taiwan 61.90% 2 United States 63.80% 2.1 New Zealand 60.20% 2.2 Mexico 60.10% 2.6 Thailand 29.00% 2.8 Russian Federation 51.30% 3 Malaysia 26.90% 3.5 Mean 61.80% 2.1 Note: Data on tax cheating was not available for all OECD countries. Recep Tekeli Policy Research Institute 12

13 13 Determinants of Tax Morale in Japan and in Turkey Table 4 presents a basic descriptive analysis showing the percentage of individuals in each OECD country saying that tax cheating is never justifiable (that is, those with the highest level of tax morale). Table 4 also presents the mean level of tax morale in Turkey and in Japan in relation to other OECD countries. Table 4: Tax Morale in OECD Countries OECD Countries Never justifiable Mean Scores France 47.90% 2.8 Norway 49.70% 2.3 Sweden 53.50% 2.2 Poland 55.10% 2.4 Finland 56.20% 2.1 Germany 56.60% 2.2 Great Britain 57.80% 2.3 Mexico 60.10% 2.6 New Zealand 60.20% 2.2 Netherlands 61.10% 2.3 Italy 61.50% 2.2 Switzerland 61.80% 2 United States 63.80% 2.1 Australia 63.90% 2 Spain 64.80% 2.1 Canada 66.10% 1.9 Chile 66.20% 1.9 South Korea 74.20% 1.6 Turkey 80.50% 1.3 Japan 82.90% 1.5 Mean 62.60% 2.1 First of all, it can be seen that in 2005 wave of WVS, the average number of people among all OECD countries saying that tax cheating was never justified was 62.6 per cent. Further the average score obtained for the tax morale question across all OECD countries was 2.1. When comparing the Japanese and Turkish figures to those of the rest of the OECD, it can be seen in Table 4 that both countries level of tax morale in 2005 and in 2007 (82.90 and percent respectively) was substantially well above the OECD average (62.60%). In sum, the results for the magnitude of tax morale show that Japan and Turkey rank in the highest as compared to other countries within their regions. Thus, this gives a task to explain why tax morale is very high in these two countries; what determines tax morale and are there any similarities between these two countries in the determination of tax morale level. Recep Tekeli Policy Research Institute 13

14 14 Determinants of Tax Morale in Japan and in Turkey The tax systems of the study countries Although two countries with very different cultures and a different history and politics, a comparison of tax morale and compliance between Turkey and Japan as a member of OECD constitutes a good experiment since the tax systems themselves are broadly similar. The elements of the personal income tax (PIT) systems in both countries are summarized in Table 5. For the PIT (and Corporate Income Tax, CIT), the self-assessment are similar in both countries although there are varying degrees of aggressiveness in tax enforcement. Both countries rely on some form of tax withholding at source, the stamp payment system, official assessment system and individual self-assessment and reporting of final tax liabilities. Tax evasion seemed to be treated as more serious crime in Turkey than in Japan even though general tax amnesty was conducted three times in the last decade (2003, 2008 and 2011) in Turkey. Table 5: Features of the tax system in the study countries Tax feature Turkey Japan Self reporting/assessment Yes Yes Withholding Yes Yes Stamp payment Yes Yes Official assessment Yes Yes Tax rates (%) PIT: 15, 20, 27, 35 CIT: 20 PIT: 10, 20, 30, 37 CIT: The respective computations of the PIT and CIT bases are similar. In Japan, PIT and CIT are taxed separately as in Turkey. The PIT base consists of wages and salaries as well as earnings from interest and dividends (but these are taxed at the source). The marginal rate for PIT is capped at 35 percent in Turkey, lower than the top rate in Japan (37 percent). The corporate tax rates in Japan varies from 34.5 %(30% effective) for ordinary companies with large scale to 25 %(effective 22%) for small size corporate and cooperative associations and public service corporation. However in Turkey there is a basic corporate tax rate of 20 % applied to all size corporations. Both countries have some form of administrative and judicial penalties imposed for failure to file if taxes are owed. Administrative penalties consist of interest and a penalty up to the tax owed/evaded. Judicial penalties also can be imposed for tax evasion/fraud. In Japan there is a delinquent tax fee at the rate of 14.6% per annum and substantial additional tax imposed at the rate of 35% of the tax amount as a penalty for evasion. In case of fraud additional tax is imposed at the rate of 40% of the tax amount (see Table 6). There is a judicial penalty imposed against tax crimes in connection with the assessment and collection of tax. Recep Tekeli Policy Research Institute 14

15 15 Determinants of Tax Morale in Japan and in Turkey According to the Criminal Procedures Law, tax evasion that constitutes a crime is investigated by police or prosecutors and is examined and tried in court in Japan. 8 The Turkish penalty structure seems more severe. In addition to a delinquent tax fee at the rate of 1.40 percent per month, a tax payer or a person responsible for a tax liability required to file a return who fails to do so within the period mentioned in the law is liable to a penalty equal to the tax owed (see Table 6). In case of fraud, taxable income may be estimated and three times the amount of tax charged thereon. A tax payer is also liable to imprisonment for a period of 18 months to 3 years. However, a taxpayer who knowingly and willfully makes false statements in the return or evades or attempts to evade taxation (and any person who assists a taxpayer to do so) by providing false documents and bookkeeping is liable to a penalty equal to three times the tax owed/evaded and to imprisonment for a period of 3 to 5 years. As displayed in Table 6 the tax enforcement means differs considerably between Turkey and Japan. Table 6: Penalty structures in Japan and Turkey Japan Turkey Evasion without in case of fraud Evasion without in case of fraud intention intention Timely filing but 10-15% 35% 100% 300% underreporting Non-filing 15% 40% 100% 300% Tax Bureau, MOF (2005:210) 2.2 Determinants After having discussed the magnitude of tax morale in EU, OECD and APEC countries, the question of the determinants of tax morale in Turkey and in Japan arises. German scholars led by Günter Schmölders (1960, 1962, 1970) known as the Cologne school of tax psychology have emphasized that economic phenomena should not only be analyzed from the traditional point of view with a dominance of price- and incentive mechanisms. In their surveys, using the subjective tax burden as an indicator for the level of tax morale, they found that selfemployed people reveal lower tax morale than employees. On the other hand, in the last 15 years, with the excellent works of Torgler, the main research interest has shifted to discover the reasons why people pay taxes? At first, this question has seemed as an unorthodox research question. However, taking in account that many people pay their taxes although fines 8 It should be mentioned that in Japan Under the law, a considerable difference exists between the handling of the evasion of direct taxes and that of indirect taxes. (MOF 2005:209) Recep Tekeli Policy Research Institute 15

16 16 Determinants of Tax Morale in Japan and in Turkey and audit probability are low, the question seemed not only reasonable but also crucial for the design of a country s efficient tax system (Erard and Feinstein, 1994). (see Torgler and Shaltegger 2006) The results indicate that the high level of tax compliance cannot be explained entirely by the level of enforcement (Graetz and Wilde, 1985). It is a long way before a person becomes a tax evader. For example, Elffers (2000) sees the process of tax evasion as a staircase with three different steps. First, taxpayers have to be seized by a will not to comply. Some researchers have argued that many taxpayers do not even think of tax evasion and hence do not even search for ways to cheat at taxes. In Long and Swingen s words (1991:130) some taxpayers are simply predisposed not to evade. Some researchers findings indicate that there are individuals who always comply (Alm 1999). In a second step, Elffers (2000:187) goes on to argue that not everyone with an inclination to dodge his taxes is able to translate his intention into action, because many individuals do not have the opportunity or the knowledge and resources to evade. In the last step, you can find taxpayers that feel inclined not to comply and check for the opportunity to evade taxes. Elffers s argument is that this is the phase where standard economic theory works, where taxpayers evaluate the expected value of tax evasion. Thus, the focus has been on the lower level (willingness step) where attitudes regarding tax evasion (i.e. tax morale) play an essential role. (see Torgler 2003:290) Model and Variables The empirical analysis in this paper focuses on tax morale which is influenced by a variety of factors. In empirical analysis social, demographic and economic factors as well as national pride or religiosity play a role in determining tax morale in a society. Also, there is the institutional arrangement in which the government works. Here, the extent of democratic participation (possibilities) by taxpayers as well as the level of institutional and political trust are decisive. Tax morale is driven by the acceptance of government decisions. (see Torgler and Shaltegger (2006:397). Following discussions explain the variables and indicate the expectations of the coefficient signs. Elffers (2000), as already discussed above, argues that it is important that people remain at the lower level of the staircase to tax evasion. Thus, it might be interesting to focus on the willingness step, which means that attitudes regarding tax evasion play an essential role. Thus, the empirical analyses focus on the attitudes regarding tax evasion which is simply defined as tax morale and data on Japan and Turkey from 2005 World Values Surveys are Recep Tekeli Policy Research Institute 16

17 17 Determinants of Tax Morale in Japan and in Turkey evaluated (see Inglehart et al., 2000). Our main model for predicting tax morale in the study countries has the following structure: TM i where TM denotes the individual degree of tax morale in a respected country; Our key independent variables TRUST denotes individual s trust in authority; PRIDE denotes pride of individual; POL is individual s political and pro-democratic attitudes, HAPPY denotes individual s well being (happiness) and X is a vector of variables which denotes numerous socioeconomics and control variables such as age, gender, marital status, education, awareness, employment and occupational status. Our choice of independent variables is in line with the literature. Torgler and Shaltegger (2006) discuss the studies using the factors to explain the determinants of tax morale in various countries. In Tale 7 summary of survey studies in different regions are presented with the variables and signs. Dependent Variable 1 TRUST i 2 PRIDE POL Table 7: Literature: Determinants of Tax Morale (excerpted from Torgler and Shaltegger 2006:415) Tax Morale Regions Europe North and Latin America i Transition, Asian Countries and Australia Independent Variables Age Gender (female) Education (-/+) (+) + Married + + (+) Self-employed - (+) - Income Financial Satisfaction Church Attendance + + +(Asia) Religious + + (-/+) Trust in Government Trust in Legal System + + Trust in court/legal + system Trust in the president + Trust public officials + + Pride + + Direct democracy +(Switzerland) +USA 3 i HAPPY Pro-democratic attitudes Local autonomy + Notes: Summary of survey studies in different regions. Tendencies: +: significant positive coefficient, (+), (-), positive, respectively negative coefficient sign without being (consistently) significant, (±) positive and negative sign of the coefficient without being (consistently) significant. 3 i k k 1 X i Recep Tekeli Policy Research Institute 17

18 18 Determinants of Tax Morale in Japan and in Turkey Dependent Variable The dependent variable in our study is Tax Morale (TMi). The general question to assess level of tax morale from the World Values Survey 2005 and for which has been used in several previous research studies is already described above. The WVS has been broadly used by researchers and the applied econometric method is Ordered Probit models. The tax morale variable is scaled dependent variable and hence the ordered probit models help to analyze the ranking information of this variable (Torgler 2006). Following Cummings et al (2009: ) answers of don t know and missing values were not coded and were dropped from the sample. In the model the estimated equation has a nonlinear form and only the sign of the coefficient can be directly interpreted, not its coefficient as in ordinary regression equation. Calculating the marginal effects is therefore a method to find the quantitative effect of independent variable has on tax morale 9. The marginal effect indicates the change in the share of taxpayers (or the probability of) belonging to a specific tax morale level (i.e. 0,1,2,3) when the independent variable increases by exactly one unit. We will present only the marginal effects for the highest value - i.e. tax evasion is never justifiedfrom the ordered probit estimation. 10 Table 8: Tax Morale Country Justifiable: cheating on taxes Japan (2005) Turkey (2007) Never justifiable 82.90% 80.50% % 12.50% % 4.00% % 1.10% % 1.10% % 0.20% % 0.20% % 0.10% % 0.10% Always justifiable 0.90% 0.30% Total (100%) (100%) Mean Standard Deviation Bruin (2006) offers the margin command to find the marginal effect of a specific variable in the regression. 10 The empirical results on the tax morale can be given on request from the author. Recep Tekeli Policy Research Institute 18

19 19 Determinants of Tax Morale in Japan and in Turkey Table 8 shows the frequency of response for tax cheating is never justifiable with respect to the total respondents, the average value and standard deviation for scaled response. Japan shows a higher proportion of never justifiable response than that of Turkey. Although mean response in Japan is slightly higher than that in Turkey, the mean scores appeared to be basically the same; 1.5 for Japan and 1.3 for Turkey. On a scale from 1 to 10, it does not seem like much of a difference. The Japanese sample had the highest percentage (82.90%) response for that position but both countries had responses for the never justifiable position above eighty percent. Independent Variables Our independent variables are described below. TRUST: There is no doubt that the socio-demographic and the socio-economic background of individuals affect tax morale. Torgler (2001) argued that there were a number of key factors that seemed to be important for understanding tax morale. Two of these factors included the relationship taxpayers had with their Government (ie, whether they trusted them or not), and taxpayers moral rules and sentiments. Torgler (2005) confirmed that these concepts predicted levels of tax morale in Latin America as well as in other countries (see also Torgler and Murphy 2004). In order to see whether these variables were important in understanding tax morale in the study countries, three questions that most closely measured these concepts were chosen from the World Values Survey and used as predictors of tax morale: trust in the government, trust in the legal system and trust in the parliament. Trust in the government has been measured as follows: Could you tell me how much confidence you have in the government in your capital: is it a great deal of confidence, quite a lot of confidence, not very much confidence or none at all? (1= a great deal to 4= none at all ). The other variables used to explore the relationship taxpayers had with authority are trust in the legal system and trust in the parliament. Trust in the legal system was measured in the World Values Survey as follows: Could you tell me how much confidence you have in the legal system: is it a great deal of confidence, quite a lot of confidence, not very much confidence or none at all? (1= a great deal to 4= none at all ). Trust in the parliament was measured in the World Values Survey as follows: Could you tell me how much confidence you have in the Parliament: is it a great deal of confidence, quite a lot of confidence, not very much confidence or none Recep Tekeli Policy Research Institute 19

20 20 Determinants of Tax Morale in Japan and in Turkey at all? (1= a great deal to 4= none at all ). These three variables allow us to analyze trust at the constitutional level, thereby focusing on how the relationship between the State and its citizens is established, and also allow us to analyze trust more closely at the current politico-economic level (see Alm and Torgler 2006:236). Torgler and Murphy (2004:309) see the relationship between taxpayers and the State as a relational contract or psychological contract, which involves strong emotional ties and loyalties. If citizens/taxpayers trust their government, representatives and justice system, because the State is seen to be acting in a trustworthy manner, taxpayers/citizens might be more willing to comply with their tax obligations. The tax authority cannot achieve compliance rate completely; they would have to place a taxman under every bed. In this respect, trust especially plays an important role where detection and punishment are achieved by high cost. This might indicate that trust is an important institution, which influences citizens incentive to commit themselves to obedience. The findings by Scholz and Lubell (1998) from America and by Murphy (2004) from Australian experience have led Torgler and Murphy (2004:310) to indicate that trust is an important institution, which influences citizens incentives to commit themselves to obedience. If this is indeed the case, one would therefore expect that those who have more trust in the legal system, government and/or in Parliament might also have higher levels of tax morale. Furthermore, Torgler and Shaltegger (2006:410) assert that trust is not an attitude that can be demanded by the government, taxpayers bestow trust on their government or they don t. In similar arguments, Torgler (2004:243) points out that trust can only be created if the government acts in line with citizens needs and desires. In the lights of above arguments, the following hypothesis is going to be tested: Hypothesis 1. The more extensive the citizens trust in the government, in the parliament and the legal system (justice or the court), the higher the tax morale. We expect that trust in the government, the legal system and the parliament has a strong impact on tax morale. In other words the willingness to pay taxes is highly influenced by the positive treatments of taxpayers by the authorities. Table 9 shows the frequency of response for confidence in Justice System with respect to the total respondents. In Japan participants have higher confidence in justice system than in Turkey. In Turkey 24.3% of respondents are not confident with justice system while 18% of respondents are not confident with their justice system in Japan. Recep Tekeli Policy Research Institute 20

21 21 Determinants of Tax Morale in Japan and in Turkey Table 9: Trust Justice System Confidence in Country Justice System Japan Turkey A great deal 17.20% 36.80% Quite a lot 64.80% 38.90% Not very much 15.50% 16.30% None at all 2.50% 8.00% Total 1031 (100%) 1313 (100%) Table 10 shows the frequency of response for confidence in parliament with respect to the total respondents. In Turkey higher percentage of participants responded for a great deal and quite a lot category than that of Japan. Japanese participants are appeared to be unconfident with the political system especially for the parliament. Table 10: Trust Parliament Confidence in Country Parliament Japan Turkey A great deal 1.20% 22.70% Quite a lot 22.00% 38.80% Not very much 55.40% 24.00% None at all 21.30% 14.60% Total 1012 (100%) 1277 (100%) Table 11 shows the frequency of response for confidence in the government with respect to the total respondents. In the table Japanese participants seem to be less confident with their government than Turkish participants. It is also consistent with the result for the confidence in Parliament. In Turkey it is quite likely that people who are confident with the parliament they also indicate higher confidence in the government. We can say that both countries quite differ in politics. Table 11: Trust The Government Confidence in Country The Government Japan Turkey A great deal 1.60% 27.60% Quite a lot 29.50% 36.00% Not very much 50.20% 21.80% None at all 18.80% 14.50% Total 1028 (100%) 1304 (100%) Recep Tekeli Policy Research Institute 21

22 22 Determinants of Tax Morale in Japan and in Turkey PRIDE: Although pride is a widespread phenomenon, pride and its effect on tax cheating or tax evasion have not been discussed very much in economic literature. However, many results are provided in recent literature. Boulding (1992:93) states that The dynamics which governs the creation, destruction, and distribution of various forms of pride and shame in society are very little understood, yet nothing perhaps is more crucial to the understanding of the overall dynamics of a particular society than the marked differences which exist among societies in this regard (excerpted from Torgler 2004:243 also see Torgler and Shaltegger 2006:412). Everybody could be proud of own country. Pride produces a sense of group identification which can be found in international games such as the FIFA/FIBA World Cup. Tyler (2000) argues that pride influences people s behaviour in groups, organizations and societies. It gives a basis for encouraging cooperative behavior (see Torgler 2004:243; Torgler and Shaltegger 2006:412). To analyze the effects of pride on tax cheating (or tax morale) it can be hypothesized that people who are proud to be citizens of their country are more loyal, better identified with the state and have thus a higher tax morale. The question that measures national pride is: How proud are you to be...? (specific nationality, e.g., Japanese, Turkish, Korean, Dutch etc. ) (1 = very proud, 4 =not at all proud). Hypothesis 2. The greater the citizens national pride, the higher the tax morale. Table 12 shows the frequency of response for how proud of nationality with respect to the total respondents. Turkey shows a higher proportion of very proud response than that of Japan. Almost 40 percent of participants in the survey are responded not proud of Japan, while only 3.5 percent of participants responded for not proud of own country in Turkey. Table 12: Pride. How proud of Country nationality Japan Turkey Very proud 22.20% 81.30% Quite proud 38.80% 15.10% Not very proud 35.10% 2.90% Not at all proud 3.80% 0.60% Total 1030 (100%) 1264 (100%) POLITICAL ATTITUDES: Because of political attitudes (both partisan and ideological positions) and/ or a general distrust of political institutions and a lack of confidence in their own country s institutions, tax payers might less comply with their own country s taxes. For Recep Tekeli Policy Research Institute 22

23 23 Determinants of Tax Morale in Japan and in Turkey example, Penas and Penas (2008:3) argued that Individuals who defend the limitation of government s revenues and hence a protection of parts of their own income and wealth from taxation are probably more likely to cheat on their taxes. Although political disaffection and lack of confidence in the political process, politicians, and democratic institutions (Montero and Torcal 2006:6) might affect tax morale, there are other political attitudes which affect tax morale i.e. ideological biases (being left or right in politics). (see Penas and Penas 2008) We test political attitudes by a variable ideology, which is the self-placement in a left-right ideological scale from 1 (left) to 10 (right). It was measured as follows: How would you place yourself in a political scale? (1=extreme left, 10=extreme right) We do not expect a priori sign on the coefficient of this variable. Table 13 shows the frequency of response for self positioning in political scale with respect to the total respondents. In Japan, participants answer is indicating the center in political scale(52.7%) but in Turkey participants are appeared to be skewed to the centre right in politics (see the mean score is 6.2) as many people are conservatives and traditional values are still highly respected. Self positioning in Table 13: Ideology Country political scale Japan Turkey Left 2.40% 7.90% % 3.90% % 7.00% % 6.00% % 12.90% % 18.80% % 7.70% % 13.50% % 6.60% Right 2.00% 15.70% Total 863 (100%) Mean (100%) It might also be interesting to analyze whether a pro democratic attitude has a positive effect (if any) on tax morale. In general, democracy offers citizens the possibility to express their preferences. In a democratic countries citizens are able to better monitor and control politicians and thus to reduce the asymmetry of information between them and their Recep Tekeli Policy Research Institute 23