Abstract
This article synthesizes insights from deterrence theory and social psychology literature on retributive justice to develop and test a theoretical model which predicts how and why observers’ tax compliance intentions are influenced by knowledge of the punitive outcomes faced by individuals found guilty of tax fraud. We test our model experimentally on a sample of Canadian taxpayers and manipulate perceived responsibility for a fraud and whether a fraud perpetrator is punished. We show that observers’ tax compliance increases when a fraud perpetrator is punished only when the perpetrator is perceived as blameworthy. The psychological process through which this positive influence operates is relatively complex, as it includes perceptions of punishment deservingness and affect. We also find that tax compliance decreases when a tax fraud perpetrator is unpunished, regardless of perceived blameworthiness. Our results are robust when we control for economic determinants known to influence fraud. The article concludes by discussing our findings’ implications for fraud research and policy.
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Notes
One of these is the KPMG-Isle of Man tax scheme in Canada, which we adapt in our experimental setting.
Anand et al. (2015) similarly observe that much research examines fraud occurring within an organization, focusing on fraud perpetration and prevention.
In Feather’s (1998) model, seriousness of offense is endogenous to responsibility and harshness of penalty is endogenous to punishment deservingness. In our study, we control for these variables.
We examine affect as a positive (pleasure) or negative (displeasure) response related to an event. This is consistent with similar research examining the role of affect in judgment and decision making (e.g., Mercer, 2005).
The Investigative Consortium of Investigate Journalists documents that some, but not all, tax authorities punished parties identified in the Panama Papers (Wilson-Chapman et al., 2019).
We do not expect the presence or absence of a retributive outcome to moderate the association between responsibility and deservingness. Feather (1996, p. 273) notes that deservingness affects judgments about a penalty, which implies that a penalty (punishment) occurs after deservingness perceptions are formed. As shown in our supplemental analysis, there is no significant interaction effect of punishment occurrence and responsibility on deservingness.
Tax compliance intentions are a proxy for tax behavior. As Bobek et al. (2013, p. 458) state, “Concerns that behavioral intentions might not map directly to taxpayers’ actual behavior in a situation are partially mitigated by the fact that a joint investigation of actual and hypothetical tax evaders (Webley et al., 2001) indicated that both groups had similar attitudes and motivations”. As well, there is strong empirical support (Sheeran, 2002) for several psychological models, including the theory of planned behavior (Carpenter & Reimers, 2005), that affirm that an individual’s intention is the strongest predictor of their behavior. In the tax compliance literature, it is common to measure tax compliance intentions rather than actual tax behavior due to social desirability bias (e.g., Blanthorne & Kaplan, 2008; Bobek et al., 2013; Farrar et al., 2019; Verboon & Van Dijke, 2007).
These aforementioned streams of literature do not enable us to predict direct effects of responsibility, punishment occurrence, or punishment deservingness on tax compliance intentions, nor do they allow us to predict a direct effect of responsibility on affective reactions. Nevertheless, we investigate non-hypothesized effects in a subsequent supplemental analysis.
Sample sizes per cell varied from 97 to 102. Our Qualtrics software indicated that the quotas had been reached when the total participants were at 399 rather than 400.
Our sample appears reasonably representative of the Canadian population with respect to age and income. According to Statistics Canada (2021a, 2021b), the median age for all Canadians in 2020 was 40.9. The median age of our sample is 32.0, but includes individuals ages 20–70. In 2019, the median income in Canada by age group was $41,700 (ages 25–34), $51,500 (ages 35–44), $54,200 (ages 45–54), $42,800 (ages 55–64), and $30,400 (age 65 and over) (Statistics Canada 2021a, 2021b). When we compared our data segmented similarly by age group, the median score for income category was 3 ($50,000–$74,999) for all age categories except age 65 and over, which had a median score of 2 ($25,000–$49,999).
In our experimental design, we decided not to manipulate the magnitude of the dollars evaded. This design choice was made as we are more interested in whether or not a punishment occurs. Furthermore, not manipulating the magnitude of dollars allows for a cleaner experimental design that reduces a possible confound between magnitude of dollars and punishment.
Except for the four tax compliance statements and attention-check and manipulation check questions, all other questionnaire items prior to the demographic measures were presented in random order across several screens. Across the entire instrument, for any measures with multiple items, the groups of items were presented in random order.
Responsibility is manipulated as an ex-ante construct, as opposed to ex-post. Particularly, offenders are perceived as being responsible for the tax fraud ex-ante, whether or not the offender accepts this responsibility ex-post. In the statistical analysis, the higher responsibility condition is coded as ‘ + 1’, whereas the lower responsibility condition is coded as ‘0’.
A news story (Cashore, 2015) reports that one of KPMGs clients who invested in the Isle of Man tax scheme said that he was unaware of Canadian tax laws when he emigrated from South Africa in the mid-1990s. The taxpayer said, “I went to the best people in the country. I’m being drawn into this, and I don’t think I should have been in the first place.” It is unclear whether an observer would perceive that a client in this type of situation is responsible for the tax fraud, or not.
In subsection 239(1) of the Income Tax Act, R.S.C. 1985 c. 1 (5th Supp.), and subsection 380(1) of the Criminal Code of Canada, R.S.C. 1985 c. C-46.
In the statistical analysis, the condition where punishment occurred is coded as ‘ + 1’, whereas the condition where punishment did not occur is coded as ‘0’.
This manipulation intentionally does not make clear whether the tax authority chose not to prosecute the tax evaders, or chose to prosecute the tax evaders but was unsuccessful in the prosecution attempt, as doing so could limit the generalizability of our findings. Thus, the manipulation allows for both possibilities. In the Isle of Man tax dodge, the Canadian tax authority chose not to prosecute the tax evaders. We discuss this issue further in the final section of the manuscript.
The tax compliance statements were solicited from a third-person perspective, which is common in tax compliance research, as it minimizes participant discomfort and reduces the risk that social desirability bias would contaminate the results (Armacost et al., 1991). Similarly, respondents were told to imagine that they were Chris when responding to all other questions.
Given that the Isle of Man tax dodge was publicized in 2017, and participants completed this survey in 2020, it is reasonable that few participants were aware of it. As well, given the robustness of our subsequent results, it is likely that the results would be even stronger if the research were conducted while a media story about a tax dodge was publicized.
As reported in Panel B of Table 3, the index of moderated mediation when all ten covariates are present is 0.049 and is significant, as a bootstrap confidence interval is entirely above zero (0.002–0.1283). The index of moderated mediation when no covariates are present is 0.101, and is also significant, as a bootstrap confidence interval is entirely above zero (0.013–0.239).
If participants answered the attention check question incorrectly, they are prompted that the response is incorrect, and are provided with a hint. Thus, participants have another opportunity to answer the attention check question and continue with the experiment (c.f. Berger et al., 2020). Among participants, 2.3% (or 9) of them fail this attention check question once. As analyses yield identical statistical inferences if these responses are excluded, we include all responses in our analyses.
In an ANCOVA with the ten significant covariates, the main effect of punishment occurrence on tax compliance intentions remains significant (F = 4.06, p = .045). The adjusted R-squared of the ANOVA (ANCOVA) is 0.025 (0.319).
Our model corresponds to Hayes’ Model 91 except that we also have a direct path from the moderator to the dependent variable. We use cmatrix syntax to test our model (Hayes, 2018a, p. 653).
This model corresponds to Hayes (2018a) Model 92.
Government of Canada, Finance Committee meeting May 5, 2016. Online: https://openparliament.ca/committees/finance/42-1/18/.
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Acknowledgements
The authors thank participants at the Canadian Academic Accounting Association annual meeting (2020), the Accounting, Behavior & Organizations research conference (2020), the Tax Administration Research Centre (Exeter, UK) annual conference (2020) and the East Coast Behavioural Accounting Workshop (Spring 2021) for helpful comments. We also thank Leslie Berger, Lan Guo, Rick Hatfield, Khim Kelly, Adam Presslee, Steven Salterio, Michael Wynes and workshop participants at the University of Waterloo and Wilfrid Laurier University for helpful comments. We gratefully acknowledge funding provided by the CPA Ontario Centre for Capital Markets and Behavioural Decision Making, Lazaridis School of Business and Economics, Wilfrid Laurier University.
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Appendices
Appendix
Experimental Instrument
Part 1: Basic Tax Scenario, Common to All Experimental Materials
Chris is a local entrepreneur who owns a food truck. He receives a lot of cash from customers, which is difficult to keep track of. He is in the process of preparing this year’s tax return.
Recently, Chris read the following story in the news about some taxpayers.
Specific Scenario Information
No punishment, lower responsibility
CRA Uncovers Tax Scheme
Several years ago, a large accounting firm approached a number of wealthy clients. The accounting firm told them they could pay less taxes by investing funds in a company on the Isle of Man. The clients followed this advice, and made the investment.
Recently, the taxpayers were all audited by the Canada Revenue Agency (CRA). As it turned out, the tax shelter was a bogus arrangement that was intended to deceive the Canadian government. The taxpayers had to repay all the taxes they evaded, which is a standard practice and not a punishment.
However, the taxpayers were never punished. They were neither fined nor sentenced to jail.
Punishment, lower responsibility
CRA Uncovers Tax Scheme
Several years ago, a large accounting firm approached a number of wealthy clients. The accounting firm told them they could pay less taxes by investing funds in a company on the Isle of Man. The clients followed this advice, and made the investment.
Recently, the taxpayers were all audited by the Canada Revenue Agency (CRA). As it turned out, the tax shelter was a bogus arrangement that was intended to deceive the Canadian government. The taxpayers had to repay all the taxes they evaded, which is a standard practice and not a punishment.
Moreover, the taxpayers were then punished by being fined and sentenced to jail for several years.
Punishment, higher responsibility
CRA Uncovers Tax Scheme
Several years ago, a number of wealthy individuals read a brochure about paying less taxes by investing funds in a company on the Isle of Man. The individuals acted on their own, didn’t ask anyone for advice, and made the investment.
Recently, the taxpayers were all audited by the Canada Revenue Agency (CRA). As it turned out, the tax shelter was a bogus arrangement that was intended to deceive the Canadian government. The taxpayers had to repay all the taxes they evaded, which is a standard practice and not a punishment.
Moreover, the taxpayers were then punished by being fined and sentenced to jail for several years.
No punishment, higher responsibility
CRA Uncovers Tax Scheme
Several years ago, a number of wealthy individuals read a brochure about paying less taxes by investing funds in a company on the Isle of Man. The individuals acted on their own, didn’t ask anyone for advice, and made the investment.
Recently, the taxpayers were all audited by the Canada Revenue Agency (CRA). As it turned out, the tax shelter was a bogus arrangement that was intended to deceive the Canadian government. The taxpayers had to repay all the taxes they evaded, which is a standard practice and not a punishment.
However, the taxpayers were never punished. They were neither fined nor sentenced to jail.
Part 2: Questions
Thinking about the scenario you just read, please read the following statements and indicate your level of agreement by clicking on the appropriate response, where 1 = strongly disagree, and 7 = strongly agree.
Tax compliance intentions
-
1.
Chris will not declare all the cash to the CRA.
-
2.
Chris would be tempted to not report all of the cash receipts on the tax return.
-
3.
Chris is unlikely to report all of the cash earnings to the CRA.
-
4.
Under the circumstances, Chris might not report all of the cash earnings on the tax return.
Attention-check questions [note: #1 is also a manipulation check]
-
1.
After the CRA’s audit, what happened to the taxpayers?
-
(A)
They had to repay the taxes they had evaded, and were fined and sentenced to jail.
-
(B)
They had to repay the taxes they had evaded, but were neither fined nor sentenced to jail.
-
2.
In the scenario, what did the taxpayers decide to do?
-
(A)
Invest in a risky business venture in the Caribbean.
-
(B)
Invest in a company on the Isle of Man.
-
(C)
Provide financing to a mining company.
Responsibility manipulation effectiveness questions
-
1.
The taxpayers have only themselves to blame for investing in the tax shelter scam. (1 = strongly agree; 7 = strongly disagree)
-
2.
The taxpayers felt solely responsible for what happened with the tax shelter. (1 = strongly agree; 7 = strongly disagree)
Thinking about the scenario you just read, please read the following statements and indicate your level of agreement by clicking on the appropriate response, where 1 = strongly disagree, and 7 = strongly agree. Please answer these questions as if you were Chris.
Affective reactions
-
1.
After the CRA’s audit, what happened to the taxpayers makes me angry. [reverse-scored]
-
2.
After the CRA’s audit, what happened to the taxpayers makes me satisfied.
-
3.
After the CRA’s audit, what happened to the taxpayers makes me disappointed. [reverse-scored]
-
4.
After the CRA’s audit, what happened to the taxpayers makes me pleased.
Deservingness [generic]
-
1.
The taxpayers who invested in the tax scheme deserved to be punished.
-
2.
There should be negative consequences for the taxpayers who participated in the tax scheme.
-
3.
The taxpayers who invested in the tax scheme need to be held accountable for their wrongdoing.
Severity of offense
-
1.
I think tax evasion is a serious offense.
-
2.
I think tax evasion is a severe crime.
Harshness of penalty
(1=much too lenient; 7=much too harsh)
-
(1)
What do you think of the end result to the taxpayers after the CRA’s investigation?
-
(2)
What do you think of the outcome the taxpayers received from the CRA?
-
(3)
What do you think of the final consequence to the taxpayers?
Justifying tax evasion
Can cheating on tax if you have the chance always be justified, never be justified, or something in between (1 = never justifiable; 10 = always justifiable).
Audit likelihood
Chris expects to be audited by the CRA.
Detection likelihood
If Chris does not report all the cash from customers on his tax return, he expects the CRA to find out.
Other Questions
Please provide the following demographic information about yourself.
-
(1)
What is your gender? Male Female Other
-
(2)
In which year were you born?
-
(3)
How many years of work experience do you have? (round to nearest year)
-
(4)
Please indicate your highest level of education completed:
Less than High School
High School
Associate’s Degree
Bachelor’s Degree
Master’s Degree
Professional Degree or Doctoral Degree
Other
-
(5)
Please indicate your approximate annual income (before-tax):
Less than $25,000
Between $25,000 and $49,999
Between $50,000 and $74,999
Between $75,000 and $99,999
$100,000 or more
Prefer not to answer
-
(6)
How would you categorize your political beliefs?
Very conservative
Moderately conservative
Slightly conservative
Middle of political spectrum
Slightly liberal
Moderately liberal
Very liberal
Please answer the following final questions.
-
(7)
Before taking this survey, were you familiar with any news stories about tax schemes or tax havens? Yes No.
-
(8)
Before taking this survey, were you aware of any Canadians linked to a secret tax dodge in the Isle of Man? Yes No
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(9)
Have you ever been audited by the CRA? Yes No
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(10)
Who usually prepares your tax return?
I do
My spouse/partner
Paid preparer
Other
-
(11)
Do you have any other comments or anything else you would like to share?
________________________________________
Thank you for your contribution to our research!
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Farrar, J., King, T. To Punish or Not to Punish? The Impact of Tax Fraud Punishment on Observers’ Tax Compliance. J Bus Ethics 183, 289–311 (2023). https://doi.org/10.1007/s10551-022-05061-w
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DOI: https://doi.org/10.1007/s10551-022-05061-w