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Wednesday, March 14, 2012

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?


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Anonymous said...

In a small tax prep firm where our employees are paid very well but pay higher tax rates than many of the very wealthy clients whose taxes we prepare, I can see where our nice employees could be a little demoralized.
The only reason the low tax rates for the wealthy are tolerable in our office is that it is way easier to project their taxes to extend them, as they can easily afford a huge cushion!

Corey C said...

Being a tax payer with only a W-2 makes it very easy to comply with the tax rules because the government already has access to the W-2 information making it less costly to see if an individual is in compliance. On the other hand those who earn most of their income based off of capital gains do not have all their information, such as cost basis, reported to the IRS. I agree that checking to see if these individuals are in compliance is more costly because first more records have to be obtained then there is the time factor of checking to make sure amounts were reported correctly.

John L. said...

I can certainly understand how it is more cost effective to increase tax rates on those who are intrinsically more willing to pay taxes. Not only are they less likely object to tax increases, but they are more likely to pay the increased tax in a timely manner.

That being said, I don’t understand why a government would specifically target a certain demographic solely on “tax morale.” Ultimately the goal of tax policy is to raise revenue for the government. While raising revenue may be most efficient if done against those with “tax morale” the tax base of that demographic, such as wage earners, may not be a large percentage of the total tax base.

Consider how income is earned by the top 400 individual income taxpayers. A breakdown can be found here: . In 2008 merely 8.18 percent of total AGI came from wages and salary. The income distribution of the top 400 is likely similar to that of the rest of the top 1% of individual income taxpayers. Statistics show that over 36% of income tax collected came from the top 1%, and further over 70% came from the top 10%. You can find statistics on the income tax burden here:

In short, analysis should show that those who pay the largest burden of the total income tax base have a disproportionately low percentage of income derived from wages and salaries, an indicator of “tax morale.” As such it does not seem ideal from a revenue generating standpoint to target this demographic.

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