This section provides an overview on the relevant literature on tax fairness perceptions, tax compliance and the determinants under investigation.
2.1 Fairness in Taxation
Taxation (or willingness to pay taxes) is a fairness issue because it involves an exchange process; the individual taxpayer wants to know what s/he receives in return for the taxes that s/he pays. However, fairness is a multi-faceted construct and does not only concern how societal resources are distributed among citizens but also how the expenditure programme is constructed in terms of the distribution across different societal spheres. The distribution aspect of fairness, that is, the distributive justice is presumably the dominant and most salient fairness aspect relevant to willingness to pay taxes.
In the field of taxation, the concept of tax equity and fairness is intertwined. Tax equity is subdivided into vertical equity and horizontal equity. While vertical equity is concerned with the approach of 'ability to pay', meaning, greater ability to pay involves greater amount of tax to pay, horizontal equity states that taxpayers, who are in a similar situation, should effect payment of the same amounts of taxes (Musgrave & Musgrave, 1989). However, the concept of tax fairness supersedes that of tax equity in the sense that it is a much broader concept and comprises many dimensions of fairness as identified by tax literature, which shall be discussed later.
Although the most obvious purpose of most taxes is to raise revenue to finance public expenditures, this is not the only rationale for taxation which may also be employed to regulate social and economic behaviour and to shape the distribution of economic resources. For this reason, the concept of tax fairness is necessarily pluralistic, depending on the particular purpose for which the tax is imposed. Not surprisingly, therefore, modern welfare states typically levy a mix of taxes, including personal and corporate income taxes, broad-based consumption taxes, excise taxes on specific goods or services, payroll taxes, property or wealth taxes, wealth transfer taxes, as well as user fees and benefit taxes.
Since the justification for any tax presumably depends on the legitimacy of the underlying purpose which it is designed to promote, the concept of fair taxation is necessarily secondary and derivative - depending on more fundamental principles concerning the fairness or justice of the public spending that taxes finance, the regulatory goals that they support, and the distribution of economic resources that they help to define.
2.2 Dimensions of Tax Fairness
There is limited literature that observes how taxpayers evaluate a fair tax system. The literatures that do observe tax fairness found it difficult to define. Christensen et al (1994) identifies four difficulties in defining tax fairness namely: the multidimensionality of fairness, 2) fairness can be defined at two levels: the individual and societal, 3) the interconnection between fairness and complexity and 4) the perception of the unfairness of a tax may entail taxpayers towards non compliant behavior. Accordingly, many researchers (e.g. Porcano, 1984; Richardson & Sawyer, 2001; and Jackson & Milliron, 1986) agree that tax fairness is a multidimensional concept.
Gerbing's (1988) factor and item analysis of the tax fairness judgments identified four underlying dimensions of fairness: (i) general fairness and distribution of the tax burden, (ii) exchange with government, (iii) attitude towards taxes of the wealthy, (iv) preferred tax rate structure and (v) self interest. This finding supports the position that fairness is a multidimensional concept.
Studies conducted by Christensen et al., (1994) and Christensen and Weihrich (1996) also documented the existence of the 5 tax fairness dimensions similar to Gerbing (1988) using the survey instrument developed by Gerbing (1988). Christensen et al. (1996) made a further investigation and the same tax fairness dimensions were found. According to them, three criteria derived from literature based on 'social justice', can be used as a measure of tax fairness: equity (whether an individual's inputs are proportional to his/her outcomes), equality (whether everyone is treated equally) and need (whether there should be special provisions).
Another study that had used the instrument developed by Gerbing was conducted by Richardson (2006) and Giligan & Richardson (2005). These studies were administered in Hong Kong. Richardson (2006) and Giligan & Richardson (2005) found that despite cultural differences that exist in Hong Kong and other western countries, similar tax fairness dimensions were found in Hong Kong. Additionally, he identified a sixth tax fairness dimension which is middle income earners, which is a dimension unique to Hong Kong.
Etzioni (1986) underlines the multidimensionality and interdisciplinary of tax fairness in his study since he identified that the aspect of fair could have been defined either from an economics or ethical perspective. This means either from the view of getting fair benefits for taxes paid or from the idea that the taxes are just and equitable. Dimensions of fairness used by Maroney et al (2002) were exchange fairness, horizontal equity, and vertical equity. Porcano (1990) made use of a set of nine factors to measure tax fairness and it was targeted to tax professionals.
Figure 1: 5 Tax Fairness Dimensions
2.3 Measures of Tax Fairness
It is generally accepted that fairness relates to the degree to which the principles of horizontal and vertical equity are achieved by the taxation system (Plimmer et al., 2000b).
The vertical fairness asserts that taxpayers with different economic situations should be taxed at different rates (Erich et al., 2006). This would result in higher income earners paying tax at higher rates than low-income earners. Vertical fairness is assessed based on the ability to pay and preference for tax rate structure, either flat rate or progressive. Another component is horizontal fairness, defined as 'the equal treatment of equally circumstanced individuals' (Michael, 1978). In other words, horizontal fairness recommends that taxpayers of similar economic positions should pay the same amount of tax.
These two dimensions of fairness are derived from the Distributive Justice Theory (DJT) which asserts that for a system to be perceived as fair, it needs to treat people in similar circumstances in equivalent manner, without neglecting the individuals' needs. In other words, the theory is suggesting that a compromise has to be made between these dimensions of fairness to accomplish positive perceptions on the fairness of an income tax system.
Other dimensions of fairness include a preference for either progressive or proportional taxation (Turman, 1995), personal fairness, tax rate fairness, special provisions and general fairness (Gilligan & Richardson, 2005; Richardson, 2005a; Christensen & Weichrich, 1996; Christensen et al., 1994; Gerbing, 1988).
2.3.1 Equity Theory
Tax fairness is classically related with equity theory. First proposed by Adams (1963), Equity theory states that people make comparison of the ratio of their effort put with that of their benefits reaped and ultimately with the same ratios of others. If there is an inequality in the ratios, this may entail some troubles, resulting into a feeling of guiltiness and anger to those taxpayers receiving relatively more outputs and those receiving relatively less outputs respectively. Two specific issues are addressed by the Equity theory namely: the perception to be equitable and the action of people following their perception of equity.
Equity theory has also been expanded to include the procedural justice and the distributive justice. Thus, procedural justice combined with distributive justice is perceived as social justice by some researchers such as Christensen & Weihrich (1996) while Leventhal (1980) saw the two types of justice as characteristics that are considered by individuals when making judgments about fairness. Nevertheless, the Equity theory has been criticized by Porcano (1984) since he saw that the structure of the distributive justice theory was much sophisticated than that of the equity theory.
2.3.2
Distributive justice Theory
In the taxation context, distributive justice refers to the principle that everyone pays his fair share of tax without it being overstated or understated.
Distributive justice refers to the perceived fairness of the final shape or outcome of a resource allocation event, (e.g., a tax expenditure programme) and is typically evaluated with respect to the equity of those outcome distributions (Adams 1965; Deutsch 1985; Homans 1961). As mentioned earlier, Distributive justice theory incorporates the equity, equality and need rules for defining tax fairness. The conceptual distinctions underlying those three rules help us in describing the tax system from a distributive fairness perspective.
As such, Distributive justice in the tax arena is usually explored in relation to compliance (Bobek & Hatfield 2001). It has a significant role in the process of tax compliance (Tyler, 1997; Wenzel, 2003). Nevertheless, the outcomes of distributive justice on compliance tend to vary inconsistently, while some studies have shown positive impact, others have no impact at all.
2.4 Tax Compliance
Tax compliance is a complex term to define. According to Brown and Mazur (2003), tax compliance is multi-faceted measure and theoretically, it can be defined by considering three distinct types of compliance such as payment compliance, filing compliance, and reporting compliance. The definition given by Alm (1991) revolves around the disclosure of all incomes and payment of all taxes by adhering to the statutory provisions, rules and regulations while that of Singh (2003) pertains to a person's voluntary compliance and proper declaration of emoluments within the time frame set without having to be warned by tax authorities.
Theoretically, views of the taxpayers and tax collectors are that tax compliance means adhering to the tax laws, which are different from one country to another. The goal of tax administration is to encourage voluntary tax compliance (Silvani, 1992) and hence reduce tax gap [1] . Tax compliance, according to Cobham (2005), is a problem to many countries as measured by tax to GDP ratio although it has been improving for many countries. For example, its one-third of GDP in rich countries; Latin America and the Caribbean - 17% of GDP and low-income countries (in Sub Saharan Africa) showed less than 15% to GDP (the recommended rate). It remains a big challenge to low income countries. This has promoted radical tax reforms in countries like Bolivia, Uruguay, Colombia, Jamaica and Spain with notable success (Bird & De Jantscher, 1992).
2.5 Tax Compliance Literature
The puzzle of the economic theory of tax compliance is why people pay taxes. According to Allingham and Sandmo (1972), based on Becker's (1968) economic theory of crime, the extent of deterrence, as the product of the probability of being detected and the size of the fine imposed, determines the amount of income tax evaded. Similarly, it is of primary concern to address the debate as to whether tax compliance results from decreased tax rates and economic incentives as many economists claim or from other factors as well, specifically taxpayers' perceptions that taxes are fair.
In relation to taxation, taxpayers' attitudes may be defined as positive or negative views of tax compliance behaviour. The outcome of positive views is tax compliance and negative views are tax non compliance. These views may be explained by Psychology-based theories which reveal that taxpayers' attitude may be influenced by the following factors which eventually influence taxpayers' behavior.
Roth et al. (1989) and Yankelovich et al. (1984) found significant support for the relations between perceptions of fairness and compliance, exchange equity and compliance, and also compliance and commitment when tested for tax noncompliance using concepts such as tax underreporting and dishonesty.
Jackson and Milliron (1986) carry out a comprehensive review of the tax compliance literature and identify 14 key factors that have been studied by researcher on tax compliance. Fischer et al. (1992) proposed a model of taxpayer compliance with four dimensions based on those 14 factors. The first one is the demographic dimension which includes age, gender and education of taxpayers. The second dimension is the non-compliance opportunity which captures, income level, income source and occupation of taxpayers. The third one is the attitude and perceptions dimension which covers taxpayers' attitudes towards fairness of tax system and peer influence. The last dimension is the tax system or structure which deals with complexity of the tax system, contact with tax authorities, probability of detection and penalties and tax rates. Thus Fisher model of tax compliance incorporates economic, sociological and psychological factors into a comprehensive one.
This model has been empirically tested by Chan et al. (2000) using a structural equations approach with sample data collected from taxpayers in Hong Kong and the USA. It was reported that there is no direct connection between demographic factors like income level, age and gender and tax compliance.
There are, however, different researchers that have cited factors such as demographic, income, compliance cost, and tax agents as having an influence on tax compliance (Mohani, 2003) besides factors pertaining to moral or ethical.
Other researchers (Sour, 2002; Keller, 1997; Trivedi, 1997; Hamm, 1995; Chang et al., 1987) listed enforcement element factors like penalty, audit, and tax rates as having a great influence on tax compliance behaviours. Tax compliance behaviours of a taxpayer usually differ from the compliance behaviours estimated in economics models. Taxpayers are greatly influenced by other taxpayers. Besides, the rate and quality of audit will also influence tax compliance behaviours of a taxpayer (Trivedi, 1997).
Tax compliance has always been an area of concern to the tax administrators and policy makers. This is due to the fact that it affects revenue collection as well as the ability of the government to achieve its fiscal and social goals (Tan & Sawyer, 2003). However, tax compliance research conducted so far is mainly focused on developed countries. In view of the inadequacies in the institutional framework and insufficient expertise and resources to monitor the intricacies of the tax compliance problems, developing countries are particularly vulnerable to tax noncompliance. There is an urgent need for more empirical and institutional research on the tax compliance behaviors in developing countries.
2.6 Explaining Tax Non-Compliance: Deterrence or attitudes?
In explaining taxpayers' compliance behaviour, that is, the reasons why taxpayers comply and do not comply, there are broadly two classes of theories - economic based theories, which emphasize incentives, and psychology-based theories which emphasize attitude (Trivedi & Shehata, 2005).
2.6.1 Deterrence Theory
The reason behind non compliance of taxpayers' towards their tax obligations is of particular concern to most revenue authorities around the world. According to the some of the early research based on the examination of the tax compliance behaviour and taxpayers' propensity towards tax evasion or avoidance, the use of a deterrence theory framework was much favoured (Jackson & Milliron, 1986; Roth, Scholz & Witte, 1989).
Deterrence theories are rooted in economics and portray people as 'amoral profit-seekers whose actions are motivated wholly by rational calculation of costs and opportunities' (Kagan & Scholz, 1984, p. 69; Kirchler & Maciejovsky, 2001). According to the deterrence view, people carefully assess opportunities and risks, and disobey the law when the anticipated fine and probability of being caught are small in relation to the profits to be made through non-compliance (Kagan & Scholz, 1984). Carroll (1987, 1992) argued that the deterrence theory is consistent with the classical expected utility theory and hence taxpayers are expected to make compliance decisions to maximize their utilities. Under expected utility theory, taxpayers are viewed as a utility maximizing individual who choose to evade tax whenever the expected gain exceeds the cost (Allingham & Sadmo, 1972).
The Deterrence Theory primarily emphasizes employment of threat, coercion, and extrinsic material incentives. According to this line of thinking, the tools that the tax agency can use to regulate citizen behavior are tax rates, perceived probability of detection in case of evasion, legal consequences, and severity of these legal consequences. However, a system that is largely based on surveillance and sanctions is likely to be too costly. Moreover, it does not always result in detecting evasion and may, in addition, produce psychological reactance. Thus, such a system may lead to opposite and retaliatory behaviours, if it is perceived as illegitimate (Brehm & Brehm, 1981).
The economic deterrence model of tax compliance introduced by Becker in 1968 has from thereon, been adopted by nearly all economic approaches to tax compliance and there have been some important empirical studies on the likely consequences of deterrence on compliance namely: Williams and Hawkins (1986), Fisher, Wartwick, & Mark (1992), Hasseldine (2000), Torgler (2002) and recently Kirchler (2007). Conclusion reached from analysis, demonstrate that both the likelihood of being detected and the sternness of sanctions generally have insignificant positive effect on compliance.
2.6.2 Psychology Theory
Given the fact that the Deterrence research undertaken in the context of tax has reported continuous inconsistent results, many tax researchers have questioned the deterrence theory framework as the most appropriate model for explaining taxpayer behaviour. These researchers, instead, suggest that taxpayer attitudes towards the tax system and paying tax need to be incorporated into theoretical accounts of non-compliance. The findings of studies conducted about attitudes toward, and beliefs about, taxation and its evasion suggest that taxpayer attitudes towards the tax system, and the way taxpayers feel treated by a tax authority are important in explaining taxpayer non-compliance.
Instead of focusing on the problem of tax non-compliance, modern social and behavioral scientific theorizing stresses the role of norms, trust, justice, and morality in enhancing tax compliance which is a more positive focus (e.g., Cullis & Lewis, 1997; Falkinger, 1995; Kinsey, Grasmick, & Smith, 1991; Scholz & Lubell, 1998; Wenzel, 2002).
In general, according to this line of research, there is an alternative approach, called the attitudinal or intrinsic approach to tax compliance and tax evasion. Tax payers are viewed as 'voluntarily' complying with their tax duties as a function of intrinsic motivation, i.e., internalized norms of conduct (e.g., reciprocity - taxpayers behave fairly toward the system if they are treated fairly). 'Voluntarily' in this context means that the citizens pay taxes without surveillance or threat of sanctions. Perceived fairness of the tax system is assumed to play a paramount role in producing genuine acceptance of tax obligations and regulations.
Psychology theories of tax compliance assume that psychological factors - including moral and ethical concerns are also important to taxpayers and so taxpayers may comply even where the risk of audit is low. Psychology theories de-emphasize audits and penalties and instead focus on changing individual attitudes towards tax system. Trivedi and Shehata (2005) concluded that some taxpayers' behaviour may follow economic theories while others may follow the psychological theories and a mixture of the two is also possible. Graetz and Wilde (1986) noted that compliance cannot be explained entirely by the economics factors. The authors argue that the individuals' behaviors and psychological factors may have a significant impact on taxpayers' compliance behaviors. Behavioral approach assumes that individuals are not simply independent, selfish utility maximisers but they interact according to differing attitudes, beliefs, norms and roles (Elffers, 1991). Studies from the behavioural perspective suggest that demographic factors, such as age, gender, ethnicity and education (Hasseldine and Hite 2003; Hite 1997; Rothengatter 2005), and social norms such as perceived fairness, peer influence, ethics and tax morale (Alm, Sanchez, and Juan 1995) have a significant effect on tax compliance.
2.7 Relationship between tax fairness perceptions and tax compliance
Numerous studies have been published on the relationship between tax fairness perceptions and tax compliance. Tax research has documented that there is a link between perceptions of tax fairness and compliance. Specifically, several analysts have pointed out the likelihood of the taxpayers complying with the tax provision if there is a belief that the latter is fair.
Christensen et al (1994) has compiled literature that had observed the association between tax fairness and tax compliance. The literature showed inconsistent findings. Likewise, literature such as Vogel (1974) and Porcano (1988) found no relationship between tax fairness and tax evasion.
Other studies (as reviewed by Richardson and Sawyer 2001) have explored the relationship between taxpayers' perceptions of fairness and their compliance, with inconclusive results. Some of which they attribute to uncertainty as a result of the multidimensional nature of fairness as a compliance variable. Conversely, they suggest that whether or not perceptions of fairness influence compliant behaviour, it is preferable for taxpayers to have a favourable perception of the fairness of the tax system.
However, studies such as Spicer (1974) and Hite & Roberts (1992) found that tax fairness is associated with tax evasion. Surveys conducted by Scott and Grasmick (1982) and Spicer and Lundstedt (1976) indicate that respondents who believe that the tax system is unfair are more likely to commit tax noncompliance behavior.
Survey data from 1960-1980 by Etzioni (1986) documented that the fairness perception was more likely to affect tax compliance rather than tax rates. Turman (1995) and Roth et al. (1989) confirmed that fairness perceptions influence tax compliance behaviour. Similarly, Porcano and Price (1992), Harris (1989), and Song and Yarbrough (1978) found tax compliance to be significantly associated with perceptions of an improved tax system.
In his study, Richardson (2006) found that all of Gerbing's five dimensions of tax fairness exist in Hong Kong. However, his findings showed that self interest and special provisions for the wealthy were two dimensions that had the lowest significance. One possible reason was due to the cultural differences on the individualism, collectivism and power distance dimensions between Hong Kong and the US.
The recent cross-cultural study by Gilligan & Richardson (2005) observed the tax fairness dimensions between two culturally different jurisdictions, Australia and Hong Kong and reported that tax fairness perceptions about general fairness had a significant impact on tax compliance behaviour in both countries. It was also found that no universal patterns exist cross culturally between tax fairness dimensions and tax compliance behavior.
With respect to the tax system itself, there is particular support to suggest that perceptions of unfair tax burdens can affect taxpayers' views about paying tax and can go on to affect their compliance decisions. According to Betty Jackson and Valerie Milliron (1986), tax fairness seems to encompass at least two different dimensions. The first concerns the benefits that a taxpayer receives for the amount of tax paid. The second dimension involves the perceived equity of the taxpayer's burden in reference to that of other individuals which is related to taxpayers' perceptions of the vertical equity of the tax system. Hence, if compared to the amount paid by more wealthy taxpayers, one is paying more than his fair share of tax (that is, perceived vertical inequality), the latter is more likely to view paying tax as a burden than a taxpayer not confronted with such an issue.
Similarly, in an experimental study, Spicer and Becker (1980) found that the participants involved, increased the amount of taxes evaded when they perceived themselves to be the victims of vertical inequity. Kinsey and Grasmick (1993) confirmed such statement when they found that changes in attitudes towards tax cheating were due in part to perceptions of increased vertical inequality in the US tax system over time.
A recent study by Loo et al. (2007) also emphasized that attitudes towards the tax system positively influenced compliance behavior since a positive attitude towards the tax system is in fact the result of positive fairness perceptions. Thus, it was anticipated in this study, that taxpayers with positive perceptions on the fairness of the tax system are more likely to have positive attitudes towards the tax system and consequently be encouraged to comply.
Research into procedural justice has also shown that taxpayers demonstrate a more compliant behavior when there is the evidence they have been treated impartially and considerately by a tax authority (Wenzel, 2003). An empirical example is that of a study conducted in Swiss by Feld and Frey (2002), where it is suggested that the tax compliance increased when tax authorities treated taxpayers as trustworthy. What the findings presented in this section suggest is that, taxpayers' attitudes towards the tax system, and how they feel they have been treated by a tax authority, do play an important role in influencing their decision to comply or not.
