Tax Evasion and National Culture

Tax Evasion 

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 analyses 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
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 relation 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

Dependent variable

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.

Independent variables

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).

Hypothesis testing

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

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)

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

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