The Relation Between Deterrence and Tax Paying Behaviour Moderated by Tax Morale

The Relation Between Deterrence and Tax Paying Behaviour Moderated by Tax Morale


Tax Compliance

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Journal of Economic Psychology, 28, (2007), pp. 704–727

A Self-Interest Analysis of Justice and Tax Compliance: How Distributive Justice Moderates the Effect of Outcome Favorability

Peter Verboon

Marius van Dijke

Correspondence concerning this article should be addressed to Peter Verboon, Department of Psychology, Open University, P.O. 2960, 6401 DL, Heerlen, the Netherlands, Tel: *31-10 2771480, Email:


Compliance with tax authorities has been studied mainly in the fields of economics and psychology. The focus has respectively been on self-interest motives and justice concerns in tax compliance. We argue that both concerns are less divergent than is often thought. Specifically, we studied the moderating role of distributive justice on the relationship between outcome favorability and tax compliance in two cross-sectional surveys. It is generally believed that favorable outcomes increase compliance because they decrease what can be gained from non-compliance. The present research addresses the role of distributive justice in this process. Since people believe that distributive fairness guarantees their long-term outcomes, favorable present outcomes now imply favorable future outcomes and unfavorable present outcomes now imply unfavorable future outcomes. Thus, we expected fair outcomes to result in a strong relationship between outcome favorability and compliance. On the basis that unfair outcomes are believed to result from chance, outcome favorability should have a weaker relationship with compliance when outcomes are unfair. Even when controlling for other variables, this prediction was supported by both studies.

Key words: Tax compliance; distributive justice; outcome favorability; self-interest

A Self-Interest Analysis of Tax Compliance: How Distributive Justice Moderates the Effect of Outcome Favorability

In recent decades, the study of tax compliance has become increasingly important (for an overview, see Kirchler, 2007). Tax compliance refers to the willingness of people to comply with tax authorities by paying their taxes. Modern societies rely heavily on the fact that most people comply with tax laws. It is therefore important to understand why people comply with tax authorities and thereby identify mechanisms that underlie people’s decisions to be compliant or not. This knowledge may guide authorities towards the development of strategies that strengthen compliance and fight non-compliance. Attempts to understand the processes involved in tax compliance have been pursued in two lines of research. The first focuses on how people’s desire to maximize their self-interests can be aligned with, or countered by, tax systems. This approach, based on the formal economic model of Allingham and Sandmo (1972), has dominated economic analyses of tax compliance (Andreoni, Erard, & Feinstein, 1998). The second line of research utilizes psychological and sociological analyses of tax compliance. Here, the focus is on the interaction between tax authorities and citizens, on norms that guide citizens’ behavior, and on the fairness of tax systems and tax outcomes ( Kirchler & Hoelzl, 2006).

Economic and psychological approaches are often viewed at best as complementary, and at worst as mutually exclusive approaches. The present research attempts to increase our understanding of why people comply with tax authorities by showing that economic and psychological approaches are not necessarily as divergent as is often thought. More specifically, because self-interest considerations play an important role in why people care about distributive justice (e.g., Brockner & Wiesenfeld, 1996; Skitka, 2003), we argue that the degree to which tax outcomes are perceived to be fair should play an important role in a self-interest analysis of tax compliance. The present study therefore examines the moderating role of distributive justice in the relation between the favourability of tax outcomes and compliance with tax authorities. It should be noted, however, that whilst we are not the first to propose an integration of economic, psychological, and sociological analyses of tax compliance (e.g., Cullis & Lewis, 1997), our research attempts to directly test predictions derived from an explicit integration of these views.

From a theoretical perspective, the present study aims to increase our understanding of the interactive processes of two concepts in the context of tax compliance, concepts considered by many to be interchangeable (Brockner & Wiesenfeld, 1996; Skitka, Winquist, & Hutchinson, 2003). As argued below, the study may also help clarify the divergent findings of previous studies, which sometimes found support for the role of distributive justice in tax compliance, and sometimes did not. (e.g., Alm, McClelland, & Schulz,1992; Webley, Morris, & Amstutz, 1985). From a practical perspective, we also aim to emphasize that tax authorities should view outcome favorability and outcome fairness as separate constructs that both need to be considered in order to enhance compliance with decisions of tax authorities.

Self-Interest and Tax Compliance

The traditional economic approach of tax compliance (Allingham & Sandmo, 1972) views tax payers as rational actors who intend to maximize their profits. In this approach, it is assumed that people’s decisions to comply with tax authorities are motivated by economic self-interest. In order to counterbalance the profits that can be gained from non-compliance, authorities attempt to deter people from tax evasion with threatsof penalties and fines. The key concept in this analysis is deterrence, which is often split up into two sub-concepts: the probability that tax evasion is detected and the severity of sanctions. According to the economic model of tax compliance, it is chiefly the interaction between probability of detection and sanction severity that should affect non-compliance. Some important empirical and review studies about the effects of deterrence on compliance include: Williams and Hawkins (1986), Klepper and Nagin (1989), Paternoster (1987), Carrol (1987), Fisher, Wartwick, & Mark (1992), Hessing et al. (1992), Hasseldine (2000) and Torgler (2002) and recently Kirchler (2007). From these studies we may conclude that both the probability of detection and the severity of sanctions generally have minor positive effect on compliance. However, the uneven nature of previous findings indicates that the causal relation between deterrence and compliance has yet to be fully understood.

Perhaps the most obvious limitation of the economic self-interest analysis of tax compliance is that it cannot account for the relatively high levels of observed tax compliance (Bordignon, 1993). In other words, if deterrence (i.e., probability of detection and sanction severity) would be the most important variable in explaining compliance, rational people in most countries of the world would be non-compliant because levels of deterrence are generally low (Graetz & Wilde, 1985; Porcano, 1988; Elffers, 2000, Braithwaite, 2003). Moreover, contrary to predictions of economic models, Frey (2003) reported that deterrence can even have a negative effect on compliance. That is, people sometimes evade more when deterrence rises. Indeed, he maintains that too much deterrence may decrease the intrinsic motivation to comply (the “crowding out effect”).

Nevertheless, as argued below, self-interest motives can be important in analyses of tax compliance. Rather than focusing on the means that authorities have to counter noncompliance – i.e., deterrence  we focus here on how authorities can align tax payers’ self-interests with compliance. A relevant finding that is consistent with a self-interest view of tax compliance is that if people consider the outcomes of the decisions made by authorities as favorable, then they are generally more willing to co-operate and be compliant; conversely, unfavorable outcomes can negatively affect compliance with tax authorities (Murphy, 2004). Favorable outcomes in a taxation context usually refer to having to pay less tax than was expected. Presumably, people are more willing to comply with tax authorities when their decisions or those of the tax system are considered favorable because they expect less to gain from being noncompliant (Wenzel, 2002).

Justice and Tax Compliance

To understand the high observed levels of compliance, approaches other than purely economic ones have been proposed (i.e., Cullis & Lewis, 1997). Sociological and psychological insights have proved to be important in understanding the high levels of compliance (Scholz & Lubell, 1998; Alm, McClelland, & Schulze, 1999; Braithwaite, 2003; Wenzel, 2004a). In such analyses, concepts like trust in authorities (Murphy, 2004), perceived fairness of the tax system (e.g. Porcano, 1984; Tyler, 1990; Wenzel, 2004a), and moral considerations and norms (Frey, 2003; Wenzel, 2004b) are used to foster a more comprehensive understanding of tax compliance. For an overview, see Kirchler (2007). The present study addresses the role of justice in compliance with tax authorities by examining the effect of distributive justice in this process.

Distributive justicerefers to perceptions of the extent to which outcomes match implicit norms, such as equality or equity. Equity theory (Adams, 1965) states that in exchange relations, people compare the ratio of their contributions (e.g., effort) and compensation (e.g., money) with others’ contribution/compensation ratio. Thus, when people apply the equity norm, they may think it fair that others earn more than they do when these others work harder. When contribution/compensation ratios are unequal, people are dissatisfied and attempt to equalize them, for instance by decreasing their effort (Walster, Walster, & Berscheid, 1978). In the taxation context, distributive justice refers to the feeling that everyone pays his fair share of taxes, and that one does not pay too much (or too little). If society does not offer enough (tax funded) resources compared to the amount of tax one must pay, this may lead to feelings of distributive injustice (exchange inequity). Comparison of one’s own tax burden to that of others who pay less can also cause feelings of distributive injustice (horizontal inequity; Dean, Keenan, & Kennedy, 1980).

A general explanation of why people care about distributive justice is that it ensures optimal personal outcomes in the long run (e.g., van Avermaet, McClintock, & Moskowitz, 1978; Brockner & Wiesenfeld, 1996; Walster, Walster, & Berscheid, 1978; see Skitka, 2003, for a theoretical account; see Tyler, Boeckman, Smith, & Huo, 1997, for an overview of empirical research; see Wenzel, 2002, for a somewhat different view; we return to this in the discussion). Fairly distributed outcomes make people believe that their outcomes are guaranteed in the long run (i.e., they expect to share in the societal provisions that are paid for taxes ). Unfair outcomes, on the other hand, are believed to result from unstable and unpredictable forces, giving people no reason to support the distribution rules or the authorities responsible for these rules. Consequently, it is often more profitable to let one’s behavior guided by the fairness of outcomes (i.e., by complying with authorities) rather than by short-term personal profits because fair outcomes guarantee long term profit. In sum, as this analysis elucidates, self-interest is a guiding principle which explains why people value fair outcomes.

Distributive justice is considered to play an important role in the process of tax compliance (Tyler, 1997; Wenzel, 2003). Nevertheless, the reported effects of distributive justice on compliance are not always consistent. Whilst positive effects are found in some studies, others report none. In an experimental study, Spicer and Becker (1980) showed that an unfair ratio of one’s own tax burden with that of others can lead to tax non-compliance. However, the validity of this study is questionable because the participants were explicitly instructed to maximize their own profit, thereby framing the study as a (short term) self-interest situation. An experiment by Alm, McClelland, and Schulz (1992) further supported the negative effect of inequity on compliance. Equity principles were also experimentally tested by Moser, Evans, and Kim (1995) and Kim, Evans, and Moser (2005) within an economic self-interest framework. In these studies it was shown that justice and economic considerations are both of importance in explaining the amount of reported income (under-reporting thus implicating tax evasion). These studies were laboratory experiments designed to mimic a real life taxation context. Another form of distributive justice, the effect of changes in taxation on peoples’ reported compliance, was investigated by Calderwood and Webley (1992). They found that people who felt that they had unjustifiably paid more than before negatively affected their compliance. A similar result was reported by Porcano (1988), who found that the perceived exchange inequity likewise negatively affects compliance. Finally, these findings are corroborated by Maroney, Rupert, and Anderson (1998) who concluded that the perceived injustice of taxing a particular income type may even affect the compliance on other income types.

However, in a study by Webley, Morris, and Amstutz (1985), the equity effect on tax evasion was not found although this might have attributable to flaws in the experimental design (Webley et al., 1991). Having said that, Mason and Calvin (1978) found no relation between exchange and horizontal equity perceptions and self-reported compliance either. Furthermore, in a comparison of convicted tax evaders and non evaders, Wallschutsky (1984) likewise found no differences in exchange equity perceptions. However, this may have resulted from flaws in the procedure because subsequent interviews with the respondents revealed that exchange equity was an important factor in evasion decisions.

In conclusion, although some studies failed to reveal distributive justice effects on tax compliance, there remains strong evidence that the various forms of distributive justice play an important role in establishing tax compliance. Whilst this general observation provides the staring point for the present study, it adopts a different approach. Below , we develop the argument that distributive justice is important for understanding tax compliance, not only because it directly affects compliance, but also because it affects how other variables are implicated .

The Role of Self-Interest in Social Justice

In line with previous research, we expect that distributive justice will have a positive effect on tax compliance (Hypothesis 1). On the basis of other studies (e.g., Murphy, 2004; Wenzel, 2002), we also expect outcome favorability to positively affect tax compliance (Hypothesis 2). Note that although distributive justice is related to outcome favorability, social scientists often substitute one construct for another (e.g., Brockner & Wiesenfeld, 1996) despite the fact that each has a distinct conceptual meaning (Skitka, Winquist & Hutchinson, 2003). Outcomes can be favorable without being fair. To illustrate this difference in the context of taxation , receiving a tax refund because of tax deduction related to a mortgage is probably viewed as a favorable outcome. Nevertheless, this outcome may be considered unfair if one discovers that the neighbor received a larger refund for owning a bigger house with a larger mortgage.

Most importantly, we expect that the relationship between outcome favorability and compliance with tax authorities is contingent on the extent to which tax outcomes are considered distributively fair. As noted above, the more taxpayers consider outcomes of tax decisions as favorable to themselves, the less they should expect further gains from tax noncompliance; as such, they can be expected to be more compliant to the tax office. However, we expect that this effect is stronger when outcomes are also viewed as fair. Specifically, a fair distribution of outcomes makes people expect that outcomes are guaranteed in the long run. It should therefore follow that outcome favorability has a positive effect on tax compliance when outcomes are also considered to be fair because favorable present outcomes imply favorable future outcomes. Unfavorable outcomes should result in relatively low levels of compliance because the unfavorable present outcome suggests unfavorable future outcomes. However, when tax outcomes are considered distributively unfair, people believe that the favorability of their outcomes is unpredictable. The tax office may in the future make favorable or unfavorable decisions, but this is hard to tell. In this situation, we expect a weaker relation between outcome favorability and compliance because the outcome of the taxpayer’s contribution is unpredictable and there is no reason to support the taxation system.

Study overview

In sum, we expect that distributive justice and outcome favorability positively affect compliance (Hypothesis 1 and 2, respectively), and, more importantly, that the positive effect of outcome favorability on compliance is particularly strong if people experience relatively high levels of distributive justice. If distributive justice is considered to be low, we expect the effect of outcome favourability to be weaker. In other, words we expect that distributive justice moderates the positive effect of outcome favorability on compliance (hypothesis 3).

Our hypotheses were tested with two cross sectional surveys. The first survey consists of data that are annually collected by the Dutch tax office across a representative sample of Dutch private tax payers. The second survey was designed to address some shortcomings in the first study. Here we collected data from a representative sample of Dutch employees. We decided to use the survey method because the causal effects of distributive justice and of outcome favorability on tax compliance appear clear. An advantage of using a representative sample of the population is that conclusions can be generalized to the relevant population, while controlling for a host of other relevant variables. In addition to controlling for demographic variables, we controlled for the effects of self-interest other than outcome favorability. Thus, the deterrence concepts probability of detection and severity of sanctions are also taken into account. Furthermore, perhaps the most important factor in explaining tax compliance is people’s personal tax norm (also referred to as personal tax ethics or personal tax morale, see Torgler, 2002; Wenzel, 2004a; 2004b; 2005).

Tax morale is usually defined as the intrinsic motivation to comply. Most studies, like ours, take personal norm or tax morale as an explanatory variable for predicting the the level of compliance. One of the earliest studies by Schwartz and Orleans (1967) showed that moral appeals were more effective than deterrence in increasing compliance. Research, primarily by Torgler, has highlighted those factors that may be important for increasing tax morale (e.g. Torgler, 2003; Torgler & Murphy, 2005). Important factors that positively influence tax morale are trust in the authorities and religiosity. In some situations, sanctions may also increase personal norm, provided that the authority exercising the sanction is trusted (Mulder, Verboon, de Cremer, 2007). Although personal norm is not necessary affected by self-interest considerations, the results may be seriously biased if the effect of this variable is not controlled. Therefore, personal norms are also taken into account.