Policy Research Working Paper 5911 Tax Morale, Eastern Europe and European Enlargement Benno Torgler e World Bank Europe and Central Asia Region Human Development Economics Unit December 2011 WPS5911 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
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Policy Research Working Paper 5911
Tax Morale, Eastern Europe and European Enlargement
Benno Torgler
The World BankEurope and Central Asia RegionHuman Development Economics UnitDecember 2011
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Produced by the Research Support Team
Abstract
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.
Policy Research Working Paper 5911
This study tries to remedy the current lack of tax compliance research analyzing tax morale in 10 Eastern European countries that joined the European Union in 2004 or 2007. By exploring tax morale differences between 1999 and 2008, it shows that tax morale has decreased in 7 out of 10 Eastern European countries. This lack of sustainability may support the incentive
This paper is a product of the Human Development Economics Unit, Europe and Central Asia Region. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at [email protected].
based conditionality hypothesis that the European Union only has a limited ability to influence tax morale over time. The author observes that events and processes at the country level are crucial to understanding tax morale. Factors such as perceived government quality and trust in the justice system and the government are positively correlated with tax morale in 2008.
Tax Morale, Eastern Europe and European Enlargement
by
Benno Torgler
Benno Torgler, The School of Economics and Finance, Queensland University of Technology, GPO Box 2434,
Brisbane, QLD 4001, Australia, e-mail: [email protected]. He is also a research fellow of CREMA –
Center for Research in Economics, Management and the Arts, Switzerland and associated with CESifo in
Number of observations 14,832 13,315 12,855 12,734
Pro>chi2 0.000 0.000 0.000 0.000
Pseudo R2 0.031 0.057 0.057 0.056
Notes: Coefficients in bold, z-statistics in parentheses, and marginal effects in italics. The symbols *, **, *** represent statistical significance at the 10%, 5% and 1% levels, respectively. As can been seen, HUNGARY is
the reference group for the countries.We report the marginal effects of the highest tax morale score (3).
31
Table 3: Determinants of Tax Morale in 10 Eastern European Countries
Notes: Coefficients in bold, z-statistics in parentheses, and marginal effects in italics. The symbols *, **, *** represent statistical significance at the 10%, 5% and 1% levels, respectively. As can been seen, HUNGARY is
the reference group for the countries.We report the marginal effects of the highest tax morale score (3).
32
IV. CONCLUSIONS
Campos and Coricelli (2002) report that during the first years of the transition process output
fell, labor moved away and the physical capital stock shrank. The rapid collapse of
institutional structures produced a vacuum in many countries, followed by large social costs,
especially in terms of worsening income inequality and poverty rates. In shifting from a
centrally controlled to a market economy, the fiscal system had to be reformed (e.g., income
taxation). As the population was largely unaware of taxes or had no perception of the tax
burden during planned socialism, it follows that reforms might have repercussions on tax
morale and tax compliance. Several authors had pointed out that the EU worked as a magnet
and a catalyst for rapid tax and institutional reforms for Eastern European member countries.
The European Union “is widely credited with having brought about an alignment of the ten
post-communist countries‟ systems of governance economies and legal structures with the
West European member states and the EU‟s acquis communautaire” (Epstein and Sedelmeier
2008, p. 796). However, Mungiu-Pippidi (2007) stresses: “At the end of day, we seem to see
confirmed once again the liberal principle that incentives, as opposed to planning, can deliver
the goods. The incentive of EU accession led countries to the remarkable scores that they
achieved in the early 1990s, when great progress was made in just a few years. The EU‟s
coaching and assistance (through the Commission and twinning programs with member
countries during negotiations) did not deliver much. Enlargement is nearly miraculous as an
incentive, but quite sluggish and ineffective as an assistance process” (p. 15).
The conditionality hypothesis suggest that after the accession, the membership reward
is no longer conditional for the EU‟s new member states which leads to behavioral and
attitudinal changes: “As the incentive structure for the new members changes, post-accession
compliance with costly pre-accession demands of international institutions should
deteriorate. After all, if it had only been the external incentive of membership that drove
33
compliance, then – having won the ultimate reward – why would the newest EU members not
be tempted to roll back reforms that had been the most costly to implement?” (Epstein and
Sedelmeier, 2008; p. 797). Similarly, Mungiu-Pippidi (2007) points out: “As for the day after
accession, when conditionality has faded, the influence of the EU vanishes like a short-term
anesthetic. The political problems in these countries, especially the political elite‟s hectic
behavior and the voters‟ distrust of parties, are completely unrelated to EU accession. They
were there to start with, though they were hidden or pushed aside because of the collective
concentration on reaching the accession target. Political parties needed to behave during
accession in order to reach this highly popular objective, but once freed from these
constraints, they returned to their usual ways” (p. 16). Our results agree with this hypothesis,
and indicate that the level of tax morale has not been sustainable. In 7 out of the10 Eastern
European countries that joined the EU in 2004 or 2007 there was significant decrease in tax
morale between 1999 and 2008. Győrffy (2009) discusses the persistent lack of government‟s
trustworthiness: “Unrealistic expectations of the new system can similarly contribute to the
general disillusionment. Transformation was originally perceived as a way to close the gap in
living standards with the advanced West. As this did not materialize, disappointment was
coded into the system. In spite of the considerable increase in living standards as measured
by the availability of various consumer goods (…), nostalgia for the previous regime has
remained widespread” (p. 154).
There is still a need to improve not only governmental quality, but also tax
administrations, or government structures in which taxpayers place their trust. Poorer
governance outcomes can facilitate corruption. Low government legitimacy leads to higher
incentives to try to avoid taxes (Rose-Ackerman, 2004). Our empirical findings indicate that
increasing individuals‟ trust in the government, the justice system and the governance quality
has a significant positive influence on tax morale. Thus, for these 10 European Union
members, further opportunities to build new trustworthy institutions should be evaluated and
34
attention should be given to developing credibility so that taxpayers feel comfortable with
paying taxes. Our results indicate that tax administrations and governments are forced to
drastically change their structures and their relationship with taxpayers. It seems that
transition countries have to work on that goal, as new institutional conditions are not created
in a few years. The rapid increase in governance quality before joining the European Union is
followed by governance quality stagnation. The local role of the state is a key determinant in
the development of tax morale. Thus, more reforms are needed concerning the political
institutions and the quality of the tax administration. More direct democratic participation
might be a key instrument for increasing tax morale. It raises trust and honesty, improves
social outcomes (Frey, 2002) and reduces corruption (Levin & Satarov, 2000). Institutional
arrangements which increase tax morale are necessary to stabilize individuals‟ tax compliance
behavior. If the taxpayers are not actively integrated in the political process, tax morale might
decrease. A decrease of tax morale can initiate a negative spiral. The more a taxpayer believes
that others have low tax morale, the lower his/her moral costs will be to behave dishonestly
(Frey & Torgler, 2007). Thus, tax morale erodes. In sum, the analysis of tax morale
development over time indicates that the EU enlargement cannot be seen as the ticket to
sustainable tax morale. Local activities at the country level exert a significant influence over
tax morale, and therefore one hopes that in the future efficient rules of the game also emerge
spontaneously within the countries.
35
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APPENDIX
Table A1: Tax Policies in Bulgaria
The National Revenue Agency has improved the services provided to the citizens and companies,
strengthened the control and the compulsory collection mechanisms as a tool for protecting revenues
from violations and fraud by:
- improving the maintenance, integration and unification of the electronic services provided to
the National Revenue Agency clients, as well as developing new electronic services;
-developing new and improving the existing methodologies for revisions and inspections in
specific areas (by types of taxes, branches, groups of liable persons) and enhancing the quality
of the selection made (through an automated annual risk assessment of all liable persons);
-using the information from the VAT information exchange system and other information
received through the administrative co-operation with EU Member States for making
selections in the course of exercising tax control in connection with intra-community supplies
and acquisitions;
-introducing electronic revisions and strengthening the role of current control;
-improving the interaction and co-ordination of activities between the revenue authorities in
the National Revenue Agency and the law enforcement authorities – the Interior Ministry and
the Prosecutors Office, for the purpose of speeding up the trials against the perpetrators of tax
and social security fraud.
A restructuring of the National Revenue Agency was already launched. It consists of the
following:
-In 5 of the currently existing territorial directorates the functions of control and
collection will be focused. These will be the new Regional Directorates Sofia, Plovdiv, Varna,
Burgas and Veliko Turnovo. In addition a “Large Taxpayers and Insurers” Directorate with
national coverage will be elaborated. The remaining 23 current territorial directorates will
retain the functions of providing services to clients.
- Within the five large territorial directorates special units will be set up for the so called
“medium-size taxpayers and insurers” - companies which form a large share of the revenues in
the region. Part of the reform constitutes also the updating of the criteria for large taxpayers
and insurers. As a result the large and medium-size taxpayers in Bulgaria - about 6 500
companies, will provide about 70% of the revenue administered by the National Revenue
Agency.
- At the same time a total of 638 people (8%) of the staff at the tax authority will be laid off in
all territorial directorates of the National Revenue Agency, including 90 positions in the
Central Division in Sofia.
The well targeted reforms will bring significant benefit to taxpayers, business and state:
-Increase in the collection rate as a result of the stronger control. Updating the criteria for
medium-size taxpayers and insurers and large taxpayers and insurers for the purpose of
increasing their share in the overall budget revenue.
-Increase in the efficiency of the tax and insurance control, since in the new regional
41
directorates the selection will cover the persons and entities in the whole region, which in turn
will lead to selecting only the cases of regional significance.
-Flexibility in the allocation of the resources available among the offices of one regional
directorate of the National Revenue Agency, and increase in the functional specialisation of
the expert staff both in the general and in the specialised administration.
For the clients:
– faster recovery of VAT as a result of the optimised process of selection;
– the possibility for filling documents and getting services in all currently existing offices of
the National Revenue Agency is kept;
– services of higher quality for a larger number of large taxpayers and insurers and medium-
size taxpayers and insurers;
– improved implementation of the uniform standards in the control activity, the provision of
services to clients and receivables collection.
Notes: Document of the Convergence Program 2009-2012, pp. 56-57.