THE INFLUENCE OF PENALTIES ON TAXPAYERS’ COMPLIANCE: A COMPARISON OF THE THEORETICAL MODELS

Abstract

The increased reliance on penalties has been based on the relationships specified in the deterrence theory. Since then many researchers have modified the traditional model(s). Recently, researchers have begun to add the non-economic factors, i.e., those that cannot be quantified such as perceived equity and fairness, and tax education. This paper investigates why taxpayers evade taxes and in what way the tax authorities can influence their behavior. This include a discussion of the theoretical models of taxpayers’ compliance, which are influenced by factors such as perceived equity and fairness, public expenditure, public income and the substitution effect on audit rate and penalty rate, and the effect of corruption and labor supply. Besides the above factors, we also believe that the delivery mechanism that ought to deliver the work effectively, efficiently, with accurate and reliable information seems to address the need for full automation in management and administration. A good briefing for both the tax advisors and taxpayers on tax procedures and its law making may also contribute to a climate of professional cooperation and voluntary compliance. The findings show that both the theoretical model of the tax compliance and the empirical evidence on penalty rate and detection rate do have a significant effect on the tax evasion (i.e., increased taxpayers’ compliance) but their effectiveness may be greatly reduced in an economy which is perceived to have an unfair tax administration and tax system. We also notice that a decrease in marginal tax rate is likely to increase the compliance level due to substitution effect. However, the income effect is still subject to question. Although the labor supply factor may seem inappropriate in the study of efficiency, in essence, switching from legal to illegal work and taxpayers’ effort in concealing part of their income proved to be appropriate to apply in the case of evasion and compliance.

JEL classification: M420

Key words: Evasion, Detection, Penalty