Researchers have explored the relationship between the national culture and tax evasion behavior. Tax evasion is a common issue; for example, Greece’s underground economy is projected to account for 40% of GDP. According to the Italian tax authorities, 15% of all economic activity goes unreported. Estimates of missed tax revenues in 2001 in the United States were as high as $353 billion. Many studies have looked at the effects of different penalties, audit rates, and other variables on tax evasion; however, fewer empirical studies have looked at tax compliance levels from an international perspective. This study delves deeper into national culture’s role in explaining countries’ tax evasion behavior. This is the first study to use Hofstede’s (1980) cultural framework as an explanator
of international tax compliance diversity, that is, it uses Hofstede’s four cultural dimensions as measures of culture and analyzes their relationship to tax evasion for 50 countries in various geographic areas.
Dimensions of National Cultural
Hofstede (1980) presents a multidimensional view of national culture and identifies a limited set of societal values that he refers to as cultural “dimensions.” These dimensions were derived empirically from a large research project (116,000 surveys) that examined the work-related values of matched samples of employees from a multinational corporation (IBM) in 50 countries and three regions. Hofstede discovers that four work-related cultural dimensions along which countries differ explain half of the variance in mean scores, and he suggests that specific relationships exist between these cultural dimensions and individuals’ preferences and actions. Strong versus weak uncertainty avoidance, individualism versus collectivism, masculinity versus femininity, and large versus small power distance is the dimensions. These cultural dimension scores are normally between 0 and 100, but values less than 0 or greater than 100 are technically possible.
According to Hofstede, societies that score high on the Uncertainty avoidance (UA) dimension prefer to reduce uncertainty or ambiguity by relying on written or unwritten behavioral rules, formalization of organizational structure, and standardization of procedures. Societies low on the UA dimension, on the other hand, are more adaptable and tolerant of behavior and opinions that differ from their own. A high score on the Individualism (IND) index indicates that people are more concerned with themselves than with the group(s) to which they may belong. In contrast, a low score on the IND index characterizes the person seen as a whole only when considered in terms of an in-group affiliation. The group, not the individual, is regarded as the fundamental unit of society. A high score on the Masculinity (MASC) dimension is associated with competition and material success. On the other hand, a lower score is considered “feminine,” and is characterized by mentoring and achieving a higher quality of life. Acceptance of inequality and its institutionalization in hierarchies that place people in their “rightful” places characterize high-power distance (PD) societies. Low-PD societies, on the other hand, are distinguished by a norm
value that inequalities between people be minimized, and to the extent that hierarchies exist within a society and its organizations, they exist only for administrative convenience.
Hypothesis 1. The higher the UA in a country, the higher the level of tax evasion in that country.
Hypothesis 2. The higher the IND in a country, the lower the level of tax evasion in a country.
Hypothesis 3. There will be a significant relationship between MASC and the level of tax evasion in a
Hypothesis 4. The higher the PD in a country, the higher the level of tax evasion in a country
A country’s shadow economy divided by its GDP serves as our proxy for tax evasion (TXEVAS). Schneider estimates the shadow economy (all market-based legal production of goods and services that is intentionally hidden from public authorities) for 145 developing, transition, and developed countries. As a result, the higher the value of
TXEVAS, the greater the extent of tax evasion in a given country.
The independent variables are measured using Hofstede’s UA, IND, MASC, and PD (1980). The multivariate analysis also included a control variable, LNGNP. LNGNP was calculated as the natural logarithm of a country’s GDP, as obtained from the World Bank (2002).
The model is highly significant (F = 43.056, p.0001), and the independent variables account for a sizable proportion of the variation in the dependent variable (adjusted R2 of .585). The results for the primary variables of interest are the same whether the control variable (GNP per capita) is included in the model or not. In the model, there is a variable (GNP per capita). Hypothesis 1 predicted that higher UA is associated with higher levels of tax evasion across countries. Even after controlling for differences in economic development, the regression coefficient for UA is positive and significant (p.0001). As a result, we conclude that a higher UA is associated with a higher level of tax evasion.
Hypothesis 2 predicted that lower IND is associated with higher levels of tax evasion across countries. IND has a negative and significant regression coefficient (p =.005). This finding supports Hypothesis 2 by indicating that lower (higher) IND is associated with higher (lower) tax evasion. Although no specific direction was proposed, Hypothesis 3 predicted that MASC is related to levels of tax evasion across countries. A significant relationship was discovered, as expected. MASC is moderately significant and has a negative relationship with levels of tax evasion across countries. As a result, Hypothesis 3 is supported.
Hypothesis 4 predicted that higher PD is associated with higher levels of tax evasion across countries. The regression coefficient for PD is positive and significant (p =.014), as expected. Higher PD is associated with higher levels of tax evasion across countries, supporting Hypothesis 4. A significant relationship exists between the level of economic development (LNGNP) and tax evasion levels across countries, according to the control variable. LNGNP has a negative and highly significant regression coefficient (p.0001). Thus, across countries, higher (lower) levels of economic development are associated with lower (higher) levels of tax evasion.
Implications and conclusions
The proposed model’s results show that three of Hofstede’s cultural dimensions are related to levels of international tax evasion in the expected directions. The findings show that higher (lower) uncertainty avoidance and power distance are associated with higher (lower) tax evasion levels across countries, whereas higher (lower) individualism is associated with lower (higher) tax evasion levels across countries, as predicted. This finding is consistent with previous research on the relationship between Hofstede’s framework and global financial reporting,
particularly in terms of uncertainty avoidance and individualism. We also discover that higher (lower) masculinity is associated with lower (higher) masculinity.
The findings suggest that national culture can help explain differences in tax evasion levels across countries. Based on our findings, we can define a low tax compliance country (i.e., a high tax evasion country) as having a high UA, a low IND, a low MASC, and a high PD. These findings may help to direct future research by establishing a framework for future international tax compliance studies.
Policymakers should take cultural values into account when developing tax compliance legislation and investigating potential behavioral irregularities. Some tax penalties that work well in the United States may not work well in countries with different cultural profiles. Furthermore, through social stigmatization programs, several
states in the United States have been successful in reducing tax evasion. While social stigma may be an effective deterrent for tax evaders in the United States – a country with lower UA, higher IND, lower MASC, and lower PD – it may not be as effective in a country with a less tax-compliant cultural profile. Citizens in a less taxed country (higher UA, lower IND, and higher PD) may react differently to a social stigmatization penalty. In a country where tax evasion is common, being punished and then publicly identified as an offender may not be enough to start the stigmatization process.
Furthermore, the findings have implications for audit-selection models and tax return preparation outsourcing. Firms continue to outsource accounting and tax work, and McKinsey Global Institute research indicates that up to 31% of finance and accounting jobs could be exported by 2008. While India is the market leader in outsourcing work, a Gartner, Inc. report notes that several emerging countries, including the Philippines, Malaysia, Vietnam, and Eastern European nations (including Hungary and Poland), are beginning to challenge India’s leadership in offshore business process outsourcing. Some of the countries to which work is being outsourced have low tax compliance levels, partly due to their cultural profiles. If this behavior is carried over into their accounting and tax return preparation work, such tax returns will have higher noncompliant rates. As a result, the efficacy of audit-selection models may be improved if they include an additional variable (whether or not return preparation was outsourced, and if so, to which country). Profiling is inherent in audit-selection models; the selection variables are used because, in aggregate, they help develop a profile of each tax filer as having “good” or “poor” audit potential. The findings suggest that a country’s audit program should take nationality into account. That is, when examining corporate returns and nonresident returns, the home country should be used as an additional variable for audit selection. Given a large number of multinational corporations (MNCs) doing business in multiple countries and foreign nationals working in multiple countries, employing such a variable could reduce tax evasion by foreign MNCs and individuals. For example, if tax evasion is widespread and tolerated in Greece, it is possible that Greek companies and citizens working abroad are more non-compliant than other companies and individuals. Adding the home country as a selection variable may help identify evaders.