Relation between tax evasion and Hofstede's model.

• Author: Rethi, Gabor

1. INTRODUCTION

   Nobody likes paying taxes. The most popular instrument to "force" people to pay their taxes is deterrence policy. In line with the economics of crime approach, based on the expected utility maximization calculus, Allingham and Sandmo (1972) presented a formal model, showing that the extent of tax evasion is negatively correlated with the probability of detection and the degree of punishment. However, this groundbreaking model has many shortcomings. People who exhibit empirically observed levels of risk aversion normally pay their taxes, although there is a low probability of getting caught and being penalized. Thus, people are more honest than deterrence models would predict. There is a wide gap between the risk aversion that would guarantee such a high compliance and the much lower individual risk aversion observed in reality (Graetz & Wilde, 1985; Alm, McClelland, & Schulze, 1999; Frey & Feld, 2002). Tax compliance experiments also indicate that individuals report a higher level of income than the expected utility model would predict (Alm, 1999; Torgler, 2002). Many years ago, Baldry (1987, old.: 377) pointed out: "Rather than question the experimental method, these results suggest that it is perhaps the theory which needs revision (...)".

   Similarly, the high co-operation observed is not specific to the tax compliance literature. Ultimatum experiments have shown that, in many of the experiments, the modal offer is (50,50), the mean offer somewhere around (40,60), and that the smaller the offer, the higher the probability that the offer is rejected (Ochs & Roth, 1989; Roth, 1995). Public good experiments indicate that, on average, subjects contribute between 40 and 60 percent of their endowment to a public good (Davis & Holt, 1993; Ledyard, 1995).

   Traditional models also have the disadvantage that they treat taxation as an isolated case. However, recent studies indicate that subjects do not act as isolated individuals playing a "game against nature" (Alm, McClelland, & Schulze, 1992; Wenzel & Taylor, 2004). In this paper, I emphasize the relevance that tax compliance takes place in a social context. The behavior of other taxpayers is of great importance in understanding taxpayers' compliance. As a consequence, theories on pro-social behavior, that take the behavior of others into account, may be a promising concept. Taxpayers are willing to pay their taxes conditionally, depending on the pro-social behavior of other taxpayers; the more other taxpayers are perceived to be honest, the more willing individuals are to pay their own taxes. The extent to which others also contribute triggers more or less cooperation and systematically influences the willingness to contribute. I use survey data to test whether "conditional cooperation" can be identified.

   Tax evasion (1) is a widespread phenomenon and continues to be a problem for many countries. For example, Greece's underground economy is estimated to equal approximately 40% of GDP--the largest in the European Union (Athens, 1997). Italian tax authorities estimate that 15% of all economic activity goes unreported (Rome, 1997). (2) In the United States, estimates of lost tax revenues for 2001 were as high as $353 billion. Of this $353 billion, intentional underreporting of income represented anywhere from $250 to $292 billion (IRS, 2005).

   Some form of penalty usually is used as a means to control tax evasion within countries. The penalties most commonly used in the United States include fines and imprisonment. Even though penalties and audits exist, tax evasion continues to pose a significant threat to countries' economies by placing a strain on a country's budget through lost revenues. Many studies have examined the effects of varying penalties, audit rates, and other variables on tax evasion (Porcano, 1988); fewer empirical studies have examined tax compliance levels from an international perspective (Riahi-Belkaoui, 2004; Richardson, 2006). Only Alm and Torgler (2006) investigates the relation of culture to tax morale for a "large" number (16) of countries.

   This study further explores the role that national culture might play in explaining countries' tax evasion behavior. Culture is a multivariate concept, and this is the first study to use Hofstede's (1980) cultural framework as an explanator of international tax compliance diversity; that is, it uses Hofstede's four cultural dimensions as measures of culture and analyzes their relation to tax evasion for 50 countries in various geographic areas.

   Therefore, the purpose of this study is to explore the extent to which international differences in tax evasion can be explained by differences in national culture, as proposed by Hofstede (1980). Hofstede identifies four cultural dimensions, which identify core values that attempt to explain general similarities and differences in cultures around the world. These four cultural dimensions are uncertainty avoidance, individualism, masculinity, and power distance. This paper links Hofstede's (1980; 2001) notion of culture with tax compliance levels across countries. Later, two more dimensions were added: long-/short-term orientation, and indulgence vs. restraint.

   The results suggest that Hofstede's cultural dimensions appear to be relevant in explaining international tax evasion levels. Specifically, higher (lower) uncertainty avoidance and power distance are associated with higher (lower) tax evasion levels across countries. Researchers also find support for higher (lower) individualism being associated with lower (higher) tax evasion across countries. We also find that higher masculinity is associated with lower tax evasion levels across countries.

2. CULTURE AND CULTURAL DIMENSIONS

   Culture has been defined in several different ways. Some of the commonly used definitions of culture are presented in this section. Some defines culture as a set of values that an individual grows up with. They add that it is a combination of the personal values and morals as well as the society's influence on the individual in his/her growing years. Hence, it is the shared way groups of people understand and interpret the world. They conclude that culture influences the ways in which a person perceives and reacts to certain situations.

   The anthropological term designates those aspects of the total human environment, tangible and intangible, which have been created by men. A "culture" refers to the distinctive way of life of a group of people, their complete "design for a living". Culture seems to be the master concept of American anthropologists.

   Most anthropologists would basically agree with Herskovits's propositions on the theory of culture:

1. Culture is learned.

2. Culture is derives from the biological, environmental, psychological, and historical components of human existence.

3. Culture is structured.

4. Culture is divided into aspects.

5. Culture is dynamic.

6. Culture is variable.

7. Culture exhibits regularities that permit its analysis by the method of science.

8. Culture is the instrument whereby the individual adjust to his total setting, and gains the means for the creative expression.

   Kroeber and Kluckhohn (1952) suggested an other definition:

   Culture consists of patterns, explicit and implicit of and for behaviour acquired and transmitted by symbols, constituting the distinctive achievement of human groups, including their embodiment in artifacts; the essential core of culture consists of traditional (i. e., historically derived and selected) ideas and especially their attached values; culture systems may, on the one hand, be considered as products of action, on the other, as conditioning elements in a future action.

   Hofstede (1980) defines culture as: "the collective programming of the mind which distinguishes the members of one human group from another." Based on an attitude survey of IBM employees in 66 countries throughout the 1970s, Hofstede (1980) developed country-based scores corresponding to four (later two more) dimensions of culture for each country surveyed: power distance, individualism, uncertainty avoidance, masculinity, long term orientation, and indulgence vs restraint. Hofstede's (1980) four primary cultural dimensions, and the additional dimensions (Hofstede, Hofstede, & Minkov, 2010) are summarized as follows (3):

   * Power distance (PD): This dimension focuses on the degree of equality or inequality between people in a country. A high power distance ranking indicates that inequalities of power and wealth have been allowed to grow within the country. These countries generally follow a class system that does not allow significant upward mobility of its citizens. A low power distance ranking indicates the country de-emphasizes the differences between citizens' power and wealth. In such countries, equality and opportunity for everyone is stressed.

   * Individualism (IND): This dimension focuses on the degree to which a country supports individual or collective achievement and interpersonal relationships. A high individualism ranking indicates that individuality and individual rights are dominant within the country. Individuals in such countries tend to form a larger number of looser relationships. A low individualism ranking indicates countries of a more collectivist nature with close ties between individuals. Such countries reinforce extended families and collectives in which everyone takes responsibility for fellow members of their group.

   * Uncertainty avoidance (UA): This dimension focuses on the level of tolerance for uncertainty and ambiguity within a country. A high uncertainty avoidance ranking indicates that a country has a low tolerance for uncertainty and ambiguity. This creates a rule-oriented country that institutes laws, rules, and regulations to reduce the amount of uncertainty. A low uncertainty avoidance ranking indicates that a country has less concern about ambiguity and uncertainty and has more tolerance for different...