Tax compliance is the lifeblood of well-performing societies. Developed countries like the US and Europe spend massive amounts annually to make it effective. But, developing country like, Bangladesh is far behind in this regard.
Some progressive firms are still trying to improve it by providing tax compliance services. Indeed, a country can function healthily if there are factual reports of taxable income. Timely payments of tax dues are also crucial for developing economies.
However, finding mechanisms to improve tax compliances is quite challenging for two reasons. First of all, there are fewer data available on tax compliance. Secondly, it is difficult to find effective tools for given institutional constraints.
In this article, we’ll be discussing the issues about measuring tax compliance and its determinants. Also, we’ll talk about the possible mechanism to improve tax compliance.
Measuring Tax Compliance – Issues and Its Determinants
As mentioned, it is challenging to measure tax compliance and its determinants. Especially in developing countries like Bangladesh, the size of the informal sector is extensive. A few taxpayer surveys might be able to determine an illustrative sample of the population. But they depend on self-reports.
Besides, professional firms and individuals are not willing to report their recording and tax payment status. Surveys can be complex depending on those self-reports while evaluating the fundamental effects of interventions designed to improve tax compliance.
It mainly becomes problematic when the taxpayers intend to show the program as successful. Administrative data, on the other hand, is restricted. It only includes the firms and individuals that are in the tax net.
Hence, administrative data samples are highly protected. All these make it difficult to understand tax formalization, which is a crucial compliance margin. However, combining new data sources can create a merged firm dataset.
The new data sources include spatial data, attitudes toward tax compliance, social networks, tax filing, etc. These datasets can help measure tax compliance rates, the relationship between firm characteristics and compliance, and many more.
Another challenge in understanding compliance patterns and raising tax revenue is finding valuable tools for improving compliance. Usually, tax evasion models have focused on audit-based execution combined with penalties. These are often costly in reality.
How to Improve Tax Compliance?
Increasing tax rates would increase tax revenues, respectively. But how can a person’s willingness to pay taxes be improved? First of all, we need to change the narrative towards the tax system.
Below we’ve suggested a few mechanisms to improve compliance.
The role of information is vital in improving tax compliance. It is essential to consider the digitization of records and how the taxpayer’s provided data is verified.
These are central factors in determining the ability of a developed country’s collecting revenue. A lot of developing countries have ample technical capacity to implement such systems.
The Power of Social Recognition
Another strategy to encourage voluntary tax compliance is to influence the power of social recognition. This can be achieved by publicizing information about a firm’s taxpaying behaviours.
Also, we can reward taxpayers depending on their neighbour’s tax compliance. Moreover, the current social pressure applied by a firm’s peer group can be taken as an advantage. This will help each firm owner to behave more sensibly.
Notably, recognition-based reward programs operate outside of the traditional governance. The direct interaction between tax officials and firms can be partial. Besides, recognition works based on easily verifiable information.
So, it is pretty easy and affordable to implement this program. There are more market-based strategies to encourage firms to register, formalize and pay taxes. Those are not proven to be reasonable.
Tax Money Redistribution
When citizens know where their tax money is going, they feel inspired about paying taxes more carefully than before. If they know their money was used for significant social activities, they’ll have a positive attitude toward paying taxes.
When people don’t know where their money was distributed, their thought goes wild. Some might think their hard-earned money has been ruined on hopeless projects. Having this feeling can create a negative attitude further towards tax compliance.
In the end, it turned out to be a legitimate excuse for tax evasion. Here the government should provide a precise scenario about tax redistribution. They must show that the tax paid by an individual is spent in build a few kilometres of a rural road.
Thus, the taxpayer can visualize where their paid taxes are going. If the individual stories of taxpayers are included in the communication, the emotional entity could be increased.
Currently, taxpayers are getting a chance to communicate with the income tax department. It is called an emotionless, faceless entity. When the communication comes from the finance minister, the taxpayer will be more emotionally rewarded.
So, these are possible ways to encourage voluntary tax compliance. The above-discussed ways have been proven as more practical and cost-effective ways to improve tax compliance. This way, the government can achieve improved tax revenue. The more we observe tax compliance as a behavioural issue, the better we can solve it!