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Tax Morale and Compliance

The other day I received an email from Dr. Andreas Peichl, Senior Research Associate with IZA (Institute for the study of labor) in Germany. Dr. Peichl directed me to a recent co-authored study - "Nice Guys Finish Last: Are People with Higher Tax Morale Taxed More Heavily?" (Jan. 2012).

"Tax morale" is the "intrinsic motivation to pay taxes" and is influenced by "a cultural aspect" and "national pride" as well as the administrative structure and its enforcement approach (Torgler and Schaltegger, "Tax Morale and Fiscal Policy").

In the Peichl paper, the authors conclude that evidence exists "of efficient taxation of groups with heterogeneous levels of ‘tax morale’." They used a model "where high tax morale implies
a high subjective cost of evading taxes. The model predicts that ‘nice guys finish last’: groups
with higher tax morale will be taxed more heavily, simply because taxing them is less costly.
... Income groups with high tax morale systematically face higher average and marginal tax rates."

You'll find their 38-page paper here.

In the US, we have a $450 billion annual tax gap much of which is from small businesses. Wage-earners are most compliant with the W-2 reporting form and paycheck withholding helping to give this group high tax morale. That tax morale is bolstered by the W-2 form they receive. Perhaps these folks are also the "nice guys" in the US since the tax on labor is higher today than the tax on investment since 2003 when the rate on qualified dividends dropped from a high of 39.6% to 15% and capital gains from 20% to 15%. Plus, for most workers, all of their wage income is subject to payroll tax of 7.65% paid by them and another 7.65% paid by the employer (total of 15.3%).

What do you think?



J.G. Collins
Title: Managing Director
Company: The Stuyvesant Square Consultancy
(Managing Director, The Stuyvesant Square Consultancy) |

From the definition of "Tax Gap" you cited, (i.e., the amount of tax liability faced by taxpayers that is not paid on time.) the rate differential between wage income and dividends and capital gains is irrelevant. A "tax liability" can only be imposed at the legal rate of tax.

I'm not sure how you determined that the tax gap is "from small businesses." Most small businesses are partnerships, LLC's or Subchapter S entities that also report partners', members, or shareholders' income both to the shareholder and the federal (and most state) tax authorities on Schedules K-1. The businesses compile those schedules from their financial statements that they submit to any lenders under penalty of perjury and fraud and the tax return is similarly signed by the managing partner/director/shareholder.

Larger companies -- and wealthier individuals -- to the contrary, have an array of means to defer the payment of tax and, in many instances, to legally avoid them altogether. It is only when these arrangements fail IRS scrutiny -- after years of scrutiny and litigation -- that the resulting liability results in a tax "not paid on time." Very few of these arrangements have the kind of "hard-number" required reporting one finds in a K-1 or a W-2 sent to the IRS and traceable to Page One of a tax return. While they are disclosed in the tax returns of the companies to some degree in M-3 schedules, they're not really discernible until their actually scrutinized when they go under examination.

Were the IRS to release the "gap" figures by income percentile (say, in 10% gradients) and by tax gap as a percentage of originally reported income, I think you would find some very interesting results. I'm sure such a compilation would be possible. I'm surprised its not already done as it would help IRS deploy its examination and litigation assets more efficiently.