Tax Compliance: The Economic Deterrence Model

CHAPTER TWO

LITERATURE REVIEW

2.1 The Meaning and Concept of Tax Compliance

Conceptually, tax compliance is a terminology that lacks universal acceptance in definition as it is shrouded in varied views and interpretations backed by un-precise tax laws making it complex and difficult term to accurately define.

Roth et. al. (1989) defined tax compliance as filing all required tax returns at the proper time and that the returns accurately report tax liability in accordance with the tax code, regulations and court decisions applicable at the time the return is filed. This definition is central to the definitions provided by other researchers (see, Long and Swingen, 1991; Alm, 1991; Hasseldine and Li, 1999; James, 1999; James and Alley, 2004;

2.2.1 The Economic Deterrence Model

The economic deterrence models are oriented towards theoretical standpoint in providing comprehensive examination of tax evasion and compliance (See, Jackson and Milliron, 1986). These models have been founded on the economic theory of crime, which was theorized by Becker (1968) and subsequently promoted by Allingham and Sandmo (1972) and Yitzhaki (1974) in their theoretical examination of the determinants of tax compliance. The economic theory of crime has it that rational, expected utility maximizing agents, in comparison with their consumption levels, have the tendency to under report their earnings for tax purposes unless the likelihood of detection is intrinsic (Becker, 1968). The theory assumes that basically tax payers are unwilling to discharge their tax liability and that, it is the risk of audit, detection and penalty that often “deter” them into compliance, hence the termed: "deterrence model". Deterrence is broadly classified into two approaches, namely: punitive and persuasive (Fischer et. al., 1992 and Hite 1989). Whereas the punitive approach focuses on improving the probability of detection, raising tax rates and instituting stricter and tougher penalties to punish non-compliance, the persuasive approach

It relies on interviews and questionnaire to assess the relationship between tax compliance and socioeconomic variables as sex, level of education, occupation, age, income levels and socioeconomic class membership. OECD (2001) describes the use of surveys to gather evidence on tax compliance and points out that their strengths include "their ability to capture a broad range of explanatory variables known only to taxpayers, notably their understanding of compliance requirements, relevant values and attitudes, expectations of risks and benefits of non-compliance". Andreoni, et. al., (1998) noted that survey data appears significant in two respects: (a) it unearths further attitudinal and social variables when it is compared with tax return and audit data, and (b) it is generally amenable to testing alternative theories of taxpayer motivation and behaviour especially when incorporated into structural econometric models. Surveys generally assume honest and candid responses from respondents (Friedman and Amoo, 1999). However, for certain sensitive questions this assumption may be difficult to accept. In addition, survey studies often encounter a number of challenges. First, results depend crucially on the representativeness of the sample, which is often difficult to assess. Second, respondents are reluctant to