pub01 - Trust Breeds Trust: How Taxpayers Are Treated Lars...

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Trust Breeds Trust: How Taxpayers Are Treated Lars P. Feld University of St. Gallen and Bruno S. Frey University of Zurich Abstract Tax compliance has been studied in economics by analysing the individual decision of a representative person between paying and evading taxes. A neglected aspect of tax compliance is the interaction of taxpayers and tax authorities. The relationship between the two actors can be understood as an implicit or "psychological" contract. Studies on tax evasion in Switzerland show that the more strongly the political participation rights are developed, the more important this contract is, and the higher tax morale is. In this paper, empirical evidence based on a survey of tax authorities of the 26 Swiss states (cantons) is presented, indicating that the differences in the treatment of taxpayers by tax authorities can be explained by differences in political participation rights as well. Keywords: Tax Evasion, Tax Authority, Tax Compliance, Direct Democracy. JEL Classification: H26, H73, D73, D78. We would like to thank R ETO C ASSERINI (University of St. Gallen) for valuable research assistance and two anonymous referees for valuable suggestions and comments.
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I. A Neglected Aspect Tax compliance has been studied in economics by analysing the individual decision of a representative person between paying and evading taxes. The literature has been shaped by the pathbreaking contribution by A LLINGHAM and S ANDMO (1972), with the consequent extensions by, among others, K OLM (1973) and S RINIVASAN (1973). They are all a specific, and particularly important, application of B ECKER ' S (1968) economic theory of crime. The present state of the art has been summarised and critically discussed by A NDREONI , E RARD and F EINSTEIN (1998) in their extensive survey on "Tax Compliance". 1 The approach is, however, faced with various problems, even when the models are extended to include endogenous labour supply, or consider the repeated nature of the reporting decision: ". .. complex and confounding effects are not limited to complicated models – even within the simple approach . .. we cannot predict the effects of all policy parameters. Moreover, when such predictions can be obtained, they often depend on the thin reed of the third derivative of utility functions and on inelastic labor supply" (A NDREONI ET AL . 1998: 824). In particular, an increase in the tax rate has a theoretically ambiguous effect in most models (but see Y ITZHAKI 1974), yet both experimental, as well as econometric, research consistently finds that higher tax rates are associated with greater evasion. Even more importantly, an increase in fines discourages evasion. 2 This corresponds to the thrust of the economics of crime and offers an important avenue for tax policy. But this effect becomes theoretically ambiguous with elastic labour supply. Empirically, studies find that expected punishment is rarely statistically significant and, if it is, the effect is of quite a small
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pub01 - Trust Breeds Trust: How Taxpayers Are Treated Lars...

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