By Francesco Guala.

Introduction – brief history of taxation

Taxation is the process by which governments collect revenue from individuals and businesses to fund government expenditures. The primary purpose of taxation is to generate the necessary financial resources for the functioning of the state and its ability to provide essential services and public goods _^[1].

In a letter dated 1789, Benjamin Franklin wrote: “Nothing can be said to be certain, except death and taxes” _^[2]. This means that more than 200 years ago, taxes were already well-established in society. Taxation has existed since ancient Egypt’s prosperous area about 4000 years ago. Taxes were levied on some goods, such as cooking oil, to fund the government’s operations and finance wars _^[3]. Ancient Greece established a direct tax on its citizens holding the right to vote to ensure a stable source of income. In ancient Rome, emperor Augustus (who was in power from 27 BC until AD 14) introduced a wealth tax, and later, emperors established tariffs to fund wars and emergencies _^[3]. Over the course of history, governments implemented various forms of taxation, such as the 1696 window tax in England (a wealth tax aimed at circumventing direct income taxation) _^[4], or the 1868 milling tax in Italy _^[5], as part of their efforts to restructure public finances.

The evolution of societies from simple to complex structures has been marked by a significant shift in their needs and demands. A reliable funding source is essential to meet these demands, and taxation serves as an instrument in this regard, allowing governments to collect resources from the population based on their income, wealth, or consumption habits. In complex societies, taxation is crucial for several reasons. Firstly, it facilitates the provision of public goods and services that contribute to the overall well-being and progress of the community. Secondly, taxation helps address economic disparities by redistributing wealth and funding social welfare programs. Lastly, taxation is essential for regulating economic activities, driving certain behaviors, and mitigating externalities _^[1].

In addition to the need for funds or financing wars, religion also influences tax systems. An example of this influence is the practice of Zakat, “a religious obligation for all Muslims to donate a certain portion of their wealth each year to charitable causes” _^[6]. It is based on income and wealth; the minimum amount is 2.5% of the wealth of the well-to-do members of the society. Regarded as a mandatory tax, the Zakat is based on the Sharia, a set of religious rules followed by Muslims _^[6]. This obligation serves a dual purpose: first, it acts as a means of purifying the yearly earnings of the contributors; second, the collected funds are redistributed to the less fortunate, functioning akin to a welfare state system.

We note that from the moment there was a complex institutionalised society, there was taxation. The more advanced societies are, the more sophisticated their tax systems are. With changing needs and increased public spending, systems nowadays are very complex, with many different types of taxes serving different purposes.

Tax Morale

A simple question, therefore, arises: Why do we pay taxes?

There is a complex answer to this easy question. If we were rational individuals, we could either evade taxes and risk getting caught or pay taxes in due time and keep complaining. At first sight, individuals pay taxes because they fear getting caught _^[7]. However, as highlighted by the research, audits are infrequent _^[7] (and so is the possibility of getting caught), and the fines are generally lower than the initial amount of tax due _^[7]. This means there is a behavioral aspect to consider when considering tax compliance. It is tax morale.

Tax morale is “the intrinsic motivation to pay taxes, the willingness of taxpayers to voluntarily comply with their obligations” _^[8]. It is acknowledged that people comply with their tax obligations not only because of pecuniary factors but also because of intrinsic factors, including guilt, shame, honesty, and the cultural framework _^[8]. In short, people pay taxes even if, by doing so, they do not maximise their utility function. More academically educated people have higher tax morale than less educated _^[10], women more than men, older more than younger, and religious people more than non-religious. Moreover, tax compliance is higher in countries where tax rates are higher in relation to GDP, creating a virtuous circle between public administrations’ performance and tax compliance (Figure 1) _^[10]. 

These situations arise in the so-called developed countries that benefit from “advanced technological infrastructure and have diverse industrial and service sectors” and where citizens enjoy qualitative access to healthcare and higher education _^[11].

Figure 1. Tax morale and tax-to-GDP ratios

Therefore, socio-economic factors explain tax morale and different levels of compliance. Another element is the perception people have of the tax system: the population’s trust in the institutions that collect taxes. We know that the taxes we pay are (or should be) used to finance public spending, but how do I feel about it? Is what I am getting back enough compared to what I pay? Who is getting the most out of it?  

Countries aiming to improve the lives of citizens, enhance tax morale, foster trust and compliance, and increase their revenues must focus on two things: 1. Improving audits and controls to punish those who are not compliant. 2. Transparency. It is essential to communicate easily, directly, and effectively to the population about how resources are spent and for what objectives _^[12]. These measures are not easy to implement, but the benefits resulting from them are many. In particular, improving audits allows administrations to lower tax collection costs and thus better allocate resources. Moreover, with enhanced transparency, citizens have a broader knowledge of public administration processes. This contributes to a better quality of democracy, leading to greater compliance overall with taxation. _^[10]

In conclusion, tax morale is a complex interplay of psychological, social, and economic factors influencing individuals’ tax compliance. Administrations must explore methods to build trust, transparency, and a sense of fairness in tax systems, contributing to more sustainable fiscal systems and general well-being.

Edited by Justine Peries.

References

[1] “Taxation | Definition, Purpose, Importance, & Types.” Britannica, https://www.britannica.com/money/topic/taxation#Overview Accessed 9 December 2023.

[2] Sparks. “The Writings of Benjamin Franklin, Vol. X (1789-1790)”. Macmillan.

[3] Willis. “A brief history of taxation.” Accountancy Age, 26 January 2021, https://www.accountancyage.com/2021/01/26/a-brief-history-of-taxation/. Accessed 9 December 2023.

[4] Oates, and Schwab. “The Window Tax: A Case Study in Excess Burden.” American Economic Association, 2015, https://www.aeaweb.org/articles?id=10.1257/jep.29.1.163#:~:text=Imposed%20in%20England%20in%201696,houses%20with%20very%20few%20windows.

[5] “Dipartimento Finanze – 1868 – 1884 Tassa sul macinato.” Dipartimento delle Finanze, https://www.finanze.gov.it/it/il-dipartimento/fisco-e-storia/i-tributi-nella-storia-ditalia/1868-1884-tassa-sul-macinato/. Accessed 9 December 2023.

[6] “Zakat: The Basic Rules for One of the Five Pillars of Islam.” Investopedia, 26 July 2022, https://www.investopedia.com/terms/z/zakat.asp#:~:text=Zakat%20is%20an%20Islamic%20finance,be%20a%20form%20of%20worship.

[7] Alm, et al. “Why do people pay taxes?” Journal of Public Economics, vol. 48, no. 1, 1992, pp. 21-38.

[8] OECD. “Understanding tax morale: What drives people and businesses to pay tax?” 2021. YouTube. https://www.youtube.com/watch?v=kYZMo6Rn9Sk 

[9]. Doerrenberg, and Peichl. “Tax Morale and the Role of Social Norms and Reciprocity: Evidence from a Randomized Survey Experiment.” IZA Institute of Labor Economics, 2018, https://docs.iza.org/dp11714.pdf. 

[10] OECD. “Tax Morale: What Drives People and Businesses to Pay Tax?” 2019, https://www.oecd.org/tax/tax-morale-f3d8ea10-en.htm. 

[11] “What is a developed country.” BDC, https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary/developed-country. Accessed 9 December 2023

[12] OECD. “Tax Morale II: Building Trust between Tax Administrations and Large Businesses.” 2022, https://www.oecd.org/publications/tax-morale-ii-7587f25c-en.htm.

[Cover Image] Photo by Nataliya Vaitkevich  of “Taxes” under Pexels licence