How to treat Tax Evaders: A Neuroeconomic Point of View

Table of contents

1. Introduction: Sovereign tax behavior?

2. Development of tax collecting methods and their effects
2.1. Taxpaying as a social dilemma
2.2. Empirical evidence for the relationship between sanctions and trust
2.3. The relevance of trust for taxpaying

3. Taxpaying: A neural determined matter?
3.1. What our brain thinks about taxes
3.2. Neuronal determination of financial risks

4. Summary

5. List of literature

1. Introduction: Sovereign tax behavior?

Dealing with tax behavior bases most times on a probabilistic point of view: Scientists collect and interpret survey data and assume patterns for the behavior of the many (Fehr & Camerer, 2007, p. 219). Especially in cases of fundamental rules and possible sanctions these patterns may change and allow further interpretations. Consequently it is possible to analyze the different effects of tax systems and their instruments. Incidentally this point of view deals with the possible obligations and expectations between the citizenships that have to pay taxes and the country that collects taxes. But the most important question is about the best method for collecting these taxes and especially from those who want to avoid paying them. Considering the large field of consequences of tax evasion for citizens and country and the many possibilities to evade taxes, the total loss through this kind of tax behavior is hard to measure. But it can be assumed that the total set of evaded taxes is very high and that this is a major problem in every tax system. Therefore many scientists try to focus on the instruments for perceiving lost taxes. Some of these instruments are sanctions by law or amnesties for those who self-indicate their evasive behavior. Again it is possible to measure the effects of sanctions and amnesties on the total income of taxes. But what about the internal motivation of each of those tax evaders to react on this external tax collecting input? What kind of inner progress urges the tax evader to pay his tax: Is it the sovereign thought about the consequences, the late conviction that paying taxes is honest or is it more than thinking and feeling — perhaps it is an unavoidable reaction on that external tax collecting factor, determined by the tax payer's genes?

This question is not as strange as it seems to be, because in the last few years many medical and psychological scientists have focused on the neuronal determination of economic behavior. That research field — called neuroeconomics — pointed out that for example the results for a decision can be predicted seconds before the recipient himself is able to mention his thoughts about a fictive or real situation (Soon et al., 2008, p. 543). Furthermore these scientists search for an internal mechanism in human beings that is able to decide between 'wrong' and 'right' or 'fair' and 'unfair'. If such a determined and internal behavior exists, it would be possible to look out for a tax system that seems to be adequate for most human beings in a biological way and to measure the internal reactions concerning sanctions or amnesties. Hence the intention of this seminar paper is to combine the psychological results about the reactions to sanctions and amnesties with neuroeconomic research and their possible predictions for taxpaying behavior. It is not only a view on individual behavior; it is quite a view inside the taxpaying individual itself.

2. Development of tax collecting methods and their effects

As mentioned above there are two possible solutions for collecting taxes: The older point of view focuses on sanctions against those who evade taxes; the second one deals with soft and gentle influence on the tax evading individual. Hence there are two different underlying theories between these concepts. Sanctioning seems to be an adequate method to deterrence inappropriate behavior — such like tax evading. It depends on the opinion that "[...] people are rational actors [...]" and try to "[...] maximize their expected utility" (Murphy, 2008, p. 114). According to neoclassical economics acting in a rational way means to calculate somehow the relation between input and output. For example it would not be rational to buy one portion of ice-cream for five Euros if there is a cheaper solution in the same area with equal quality. Otherwise someone would pay too much and lose money.

Sanctioning tax systems try to manipulate the rational calculation of each individual: Losing money or freedom are the major risks in evading taxes if the tax system declares sanctions against tax avoiding law breakers. Both of these risks should be harder for each individual than the loss through paying taxes. It is the basic assumption of sanctioning tax systems "[...] that by handing out harsh punishment and penalties to rule-breakers this will deter them from re-offending in the future" (Murphy, 2008, p. 115). But the most interesting point about the punishing methods is the fact that there seem to be "[...] inverse relationships between the threat of legal punishment and the volume of crime" (Murphy, 2008, p. 114).

Therefore scientists focus on the other possible solution for dealing with tax evaders: Instead of influencing the individual calculation of use they focus on "[...] procedural justice [...]" (Murphy, 2008, p. 116) with the aim to interact with the emotions and ethical behavior of the taxpaying individual. The basic assumption is that punishing people by sanctioning them for inadequate tax behavior stigmatizes them and makes them feeling more uncomfortable with the concept of collecting taxes compared to the actual situation itself. This is what Murphy (2008) calls the "[...] mediating effect of emotions [...]" (p. 118). With his 2008 published study "Enforcing tax compliance: To Punish or Persuade" he proofed that there is a significant strong effect between being punished for tax avoidance in the past and resentments against tax authorities and taxpaying. Furthermore he explains that these resentments base on the previous experiences with tax authorities and that the positive effect strength on avoiding taxes increases once they are established. That underlines the existence of emotions in a taxpaying context and their influence on the behavior of the taxpayer. Therefore the next part focuses on the emotion "trust" and its relevance in monetary contexts. As taxpaying does not only depend on the opinion in the tax collecting system, it also depends on the trustworthiness of these institutions and the trust that paying taxes is a collective business with equal standards for each one of the taxpayers.

2.1. Taxpaying as a social dilemma

It is possible that each person that is asked for paying his taxes once considered one simple question: "Should I fill in my tax form honestly or conceal certain incomes?" (Mulder et al., 2006, p. 147). This question is one of the main points for social dilemmas, because it enrolls the conflict between personal and collective interests. The need for paying taxes is in western countries out of question: Taxes are important for security forces like military and police, for large institutions like the education system right up to the quality of the streets in front of someone's house. But not all of us profit the same way from these benefits. And sometimes one has to pay more or less than others — which depends on the individual income and the underlying taxation. Thus the calculation for the asked input in form of money and the personal output can be inadequate. Furthermore this can be mentioned as another point of view on the well known 'free rider' problem in economics and social sciences. Someone else participates for less or nothing on the collective established goods — the goods which are paid by the honest taxpayers. This is another spot for sanctioning methods to affect tax behavior: On the one hand combining taxation with sanctions in case of non-cooperative behavior should increase the trust that others will pay their taxes. But on the other hand it can set up the opinion "[..1 that others will cooperate simply because they wish to avoid the sanction placed on defection" (Mulder et al., 2006, p. 148). These are two different points of view, the first one is mostly neutral associated and the second one negative because it assumes that people have no internal and honest motivation, they only react to an external and negative context. According to Mulder et al. (2006) this opinion should decrease the level of trust between individuals (p. 149).

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