Economic inequality is usually associated with the unequal distribution of personal income or wealth. However, inequality in access to public goods, such as education or healthcare, may have more detrimental impacts on society. With the increasing use of the internet and social media in an ever more globalized world, people are exposed to economic inequalities more and more frequently. It is now also easier for taxpayers to compare their government’s performance with that of other countries. Ultimately, tax compliance may depend on the perceived benefits of the public goods financed via the tax system. The Covid-19 pandemic constitutes a good example. Since its outbreak, people have been closely following developments in other countries, including healthcare and vaccination efficiencies. An important resulting question is how such news, allowing for efficiency comparisons, affect tax-payer behavior?
This question is rather difficult to investigate with observational data due to many unobservable factors, including differing tax systems, culture, and types of public services. To overcome this difficulty, we conduct a laboratory experiment studying how making inequality more salient affects people’s tax compliance.
For this purpose, we ran a public goods game, a well-known experimental tool for investigating tax compliance and cooperative behavior. In this game, a number of participants (for example 3) each receive an amount of money (for example 10€). They then decide how much of this money to keep and how much of it to allocate to a public good project. The experimenter (in the role of the public authority) multiplies the total amount collected in the public pool with a multiplication factor and distributes it among the players equally. In the end, players earn what they keep to themselves and also the return they receive from the public good. Using this simple game, we investigate how inequality in personal returns, measured as the so-called marginal per capita return, as well as information about such inequality affect contributions to the public project.
The results show that participants, who knew only about their personal benefits, contributed more if they had higher returns from the public good. This is not surprising as existing studies also show this relationship. However, when we informed the groups about the existence of groups with higher and lower returns, the contribution gap increased drastically. In particular, when participants with low-benefits learned about the existence of the high-benefits group, they almost stopped contributing altogether.
Does this mean that transparency regarding inequality hampers tax compliance? Not on its own: we ran the same experiment again, this time introducing smaller inequality in returns from the public good between high and low benefit groups. This time, the polarization we observed in the first experiment disappeared.
Thus, we learn that, even if all other conditions are the same, merely knowing that people are being treated unequally can yield strong tax evasion. Therefore, one solution to increase tax compliance is to fight extreme inequalities, even if it is impossible to prevent them completely.
Pablo Brañas-Garza (University of Loyola)
Elena Molis (University of Granada)
Levent Neyse (WZB and DIW Berlin)
The study is published in the Journal of Behavioral and Experimental Economics
This Insight was published by BSE Insights and BCCP.
