Thesis

DIVINE WORD COLLEGE OF LAOAGSchool of Business and Accountancy

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CHAPTER I

THE PROBLEM

RATIONALE

Although it is commonly said that the only things certain in life are

death and taxes, it is unmistakable that taxes are in fact far from inevitable.

Individuals do not like paying taxes and they take a variety of actions to

reduce their tax liabilities.

(http://aysps.gsu.edu/isp/files/2_Tax_Compliance_and_Administration.pdf)

In general, taxation is the act of levying the tax, i.e., the process or

means by which the sovereign, through its law-making body, raises income

to defray the necessary expenses of the government. It is merely a way of

apportioning the cost if the government among those who in some

measures are privileged to enjoy its benefits and, therefore, must bear its

burdens.

It is said that income tax is the most degrading and totalitarian of all

possible taxes. Its implementation wrongly suggests that the government

owns the lives and labor of the citizens it is supposed to represent.

(www.ronpaul.com/on-the-issues/taxes/)

http://www.ronpaul.com/on-the-issues/taxes/


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There are great poverty problems in the Philippines. The country has

had severe economic problems for many years and one of the burdens of

the people is tax compliance. A lot of them don’t have steady jobs and

wasn’t able to make their time productive. Although there had been

reported progress in tax collections in certain regions in the country, there

are still problems with regards to collection. Some taxpayers are shown to

be finding ways to avoid paying amount levied or trying to evade

compliance.

One province of the Philippines is Ilocos Norte having twenty three

(23) municipalities. And one of them is the Municipality of Bacarra having

forty three barangays with 226 operating sari-sari stores which are subject

to tax. Based on the information gathered, not everybody is required to pay

tax unless otherwise meets the income minimum requirement. According

to the Local Government Unit of Bacarra, Ilocos Norte, tax collection

efficiency has been rated as good although problems on tax compliance

still exist.

Tax compliance is likely to become even more important with

development such as self- assessment and electronic commerce. It has

never been easy to persuade all tax payers to comply with the


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requirements of a tax system. Tax compliance is likely to become a more

significant aspect of tax policy as most of the old problems remain and new

considerations are raised by developments such as self-assessment, the

emergence of the global economy and electronic commerce.

(http://www.cipfa.org.uk/thejournal/download/jour_vol2_no2_c.pdf)

The researchers aim to study the reason of compliance and non-

compliance of tax payers particularly in Bacarra,Ilocos Norte. Furthermore,

the researchers would like to know how taxpayers behave on paying their

taxes despite the raging financial crisis in the country. Hence, the research

was conceived to understand how the attitude of the taxpayers of sari-sari

stores affects the present condition.

Theoretical Framework

Tax compliance has evolved into a major research topic in economic

psychology. The issue has been approached from various viewpoints

shedding light on different aspects of taxpayers’ behavior. Attitudes were

measured, prevailing social norms and lay theories explored, which people

have in mind when fulfill their annual tax declarations (Kirchler, 2007).

http://www.cipfa.org.uk/thejournal/download/jour_vol2_no2_c.pdf


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According to Feld and Frey 2002, a punishment for not behaving as

a “good” taxpayer is felt to be controlling in particular if the charges raised

do not fully apply. Taxpayers who are mistakenly accused to cheat on their

taxes may perceive the intervention by the tax office to be controlling.

Therefore their tax morale decreases or even erases. Similarly, increasing

monitoring and penalties for noncompliance, individuals notice that

extrinsic motivation has increased, which on the other hand crowds out

intrinsic motivation to comply with taxes. Thus, the net effect of a stricter

tax policy is unclear. If the intrinsic motivation is not recognized, taxpayers

get the feeling that they can as well be opportunistic. This puts the

relevance of policy instruments in supporting or damaging the intrinsic

motivation to the fore. Intrinsic motivation depends on the application of

policy instruments. Tax morale is not expected to be crowded out if the

honest taxpayers perceive the stricter policy to be directed against

dishonest taxpayers. Regulations which prevent free riding by others and

establish fairness and equity help preserve tax morale. In contrast,

receiving certain types of rewards for being a good taxpayer may be

perceived as supporting and tends to bolster and raise tax morale.

This motivational effect thus works in the same direction as the

relative price effect, and strengthens the attractiveness of giving rewards to


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“good” taxpayers. In the case of the normally applied punishment for failing

to pay the taxes due the relative price effect and the motivational crowding-

out effect work in opposite directions. This may explain why the empirical

evidence on the effect of punishment on tax evasion is inconclusive, and

the respective econometrically estimated parameters often are not

statistically significant, or are even of the wrong sign. If the crowding-out

effect is stronger than the relative price effect of punishment, tax evasion is

raised rather than lowered.

Moreover, a main point connected to the empirical and experimental

findings, is that these deterrence models predict far too little compliance

and far too much tax evasion (for an overview see Torgler 2002). In many

countries the level of deterrence is too low to explain the high degree of tax

compliance. Moreover, there is a big gap between the amount of risk

aversion that is required to guarantee such compliance and the effectively

reported degree of risk aversion.

Furthermore, Elffers (2000) shows that it is a long way before a

person become a tax evader. He defines three steps in the staircase to tax

evasion: (i) taxpayers have to have the will not to comply, (ii) not everyone

with the inclination to evade taxes is able to translate the intention into


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action, and (iii) individuals inclined to evade taxes check for the opportunity

to do so. In the third staircase standard economic theory comes into play

and individuals evaluate the expected value of evasion. Similarly, other

researchers argue that many individuals do not even think of tax evasion.

According to economic based theories or also known as deterrence

theory, which emphasize incentives, and psychology-based theories which

emphasize attitude (Trivedi&Shehata, 2005) that explain the reasons why

taxpayers comply and do not comply. Economic theories suggest that

taxpayers “play the audit lottery,” i.e. they make calculations of the

economic consequences of different compliant alternative, such as

whether or not to evade tax; the probability of detection and consequences

thereof, and choose the alternative which maximizes their expected after

taxreturn/ profit (possibly after adjustment for the desired level of risk). The

theories suggest that taxpayers are amoral utility

maximizershence,economic theories emphasize increased audits and

penalties as a solution to compliance problems. Economic based studies

suggest that taxpayers’ behaviour is influenced by economic motives such

as profit maximization and probability of detection (Trivedi&Shehata,

2005), and underreporting (Erard& Ho, 2002; Cobham, 2005).


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Psychology theories of tax compliance assume that psychological

factors – including moral and ethical concerns are also important to

taxpayers and so taxpayers may comply even where the risk of audit is

low. Psychology theories de-emphasize audits and penalties and instead

focus on changing individual attitudes towards tax system. Trivedi and

Shehata (2005) concluded that some taxpayers’ behavior may follow

economic theories while others may follow the psychological theories and

a mixture of the two is also possible.

These study analyses people’s attitude towards tax compliance.

While obligatory advance tax payments do not interfere with the taxpayer's

evasion decision under expected utility theory, they do affect the decision

to evade under prospect theory. The present paper applies prospect theory

to a simple model of tax evasion, exploring the role that advance tax

payments may play in enforcing tax laws. The paper demonstrates, as

empirically found in the US, which advance tax payments may substitute

for costly detection efforts in enhancing compliance. However, contrary to

a recent claim in the tax evasion literature, deliberate high advance tax

payments are unlikely to eliminate the incentives for noncompliance.

(


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http://www.aibuma.org/journal/Paper9_TaxPayers_Attitudes_Lumumba.pdf

)

Tax compliance can be seen as a continuum (James & Alley, 2002),

ranging from commitment to society’s and government’s objectives on the

one hand, to law enforcement on the other. On the compliance side,

McBarnet (2001)differentiates between (a) committed compliance,

referring to taxpayers’ willingness to pay taxes without complaining, (b)

capitulative compliance, describing taxpayers who give in and pay taxes,

and (c) creative compliance, which covers activities addressed to reducing

taxes within the brackets of the law.

Similarly, Kirchler (2007; Kirchler, Hoelzl, & Wahl, 2008) developed

the concept of a framework – the “slippery slope framework” – which

differentiates between taxpayers who voluntarily comply with the law,

versus taxpayers who comply as a result of enforcement activities.

Voluntary and enforced compliance as well as tax avoidance and evasion

are described as resulting from the interaction between taxpayers’ trust in

authorities and authorities’ power to monitor taxpayers.

When trust in the authorities is high, taxpayers will pay their taxes

voluntarily. In contrast, when trust in the authorities is low, taxpayers are

http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2874665/#R24




http://www.aibuma.org/journal/Paper9_TaxPayers_Attitudes_Lumumba.pdf


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assumed to be motivated to withhold their contributions. When trust is low,

but authorities’ power to effectively audit and sanction wrong behavior is

strong, taxpayers’ compliance is enforced; however, it is assumed that

taxpayers are motivated to reduce their taxes within the legal range of the

law and engage in tax avoidance, but are deterred from illegal reductions.

If trust in the authorities and also in the power of the authorities is low,

taxpayers are expected to break the law and evade taxes.

(http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2874665/)

Conceptual Framework

The research paradigm shown in Figure 1 depicts the conceptual

framework of the study which determined how the sari-sari store owners

attitude and their extent of adherence to policies affect their tax compliance

behavior.

The study is preliminary focused on the premise that the tax

compliance behavior of the taxpayers who are deriving income from their

respective businesses currently operating in the municipality of Bacarra

are influenced by their profile and certain attitudinal factors.

The profile and problems encountered by the sari-sari store owners

comprised the independent variables of the study while their tax

http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2874665/


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compliance behavior constituted the dependent variable of this research

undertaking. Tax compliance behavior served as the dependent variable.

Independent Variable Dependent Variable

Profile of Sari-Sari Store Owners

Personal Profile

Sex

AgeTax Compliance

Behavior of Sari-sari Store Owners

Highest Educational Attainment

Attitude

Family Size Extent of adherence

to policies Civil Status

Business Profile

Capitalization Number of years of

operation Average annual

gross earnings Average annual tax

payments


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Problems encountered along

tax payments

Figure 1. Research Paradigm on Tax Compliance Behavior of Sari-Sari Store Owners in the Municipality of Bacarra

Two components of the profile of the sari-sari store owners will be

considered in the study – personal and business profile variables. The tax

payers’ personal circumstances included their sex, age, highest

educational attainment, size of the family and civil status, while their

business profile will be described in terms of the capitalization, number of

years they are in the business, and the average annual gross earnings and

annual tax payments. The problems encountered by the owners as

taxpayers particularly along tax payments will also be determined. These

three sets of factors were all premised to be significantly related with the

owners’ tax compliance behavior which will be described along their

attitude and extent of adhere to policies.

Scope and Delimitation of the Study

This research will be a survey involving Sari-sari store owners in the

municipality of Bacarra, Ilocos Norte. This study will include attitudes and


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attitudinal factors because of positive and negative attitudes and factors

affecting attitudes such as justice in a tax system, peer attitude,

understanding of tax laws, paying tax fines and penalties, use of

informants, rewarding taxpayers, degree of being detected for nonpayment

of tax, degree of risk aversion, positive government image.

The personal profile variables comprise of the tax payer’s sex, age,

highest educational attainment, number of the family members and civil

status, while the business profile composed of their capitalization, number

of years in operation, average annual gross earnings and average annual

tax payments. The municipality of Bacarra has a total of 226 sari-sari store

owners of which 59 were drawn as samples in the study. These sari-sari

store owners were taken from the five barangays with the highest number

of sari-sari stores. These are Barangays 1, 21, 34, 37A and 40 in Bacarra,

Ilocos Norte.

Furthermore, this paper outlines the relevance of rules to understand

tax morale. It tries to find explanations why taxpayers obey, rather than

simply evade taxes. The development of a typology of taxpayers shows

that the same tax rules can have different compliance effects.


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Statement of the Problem

In the municipality of Bacarra, Ilocos Norte, taxpayers exhibit varying

levels of tax compliance. The challenge of lack of knowledge of Tax

Compliance Behavior towards a tax system is serious on the grounds. The

extent of the impact of attitudes and attitude change on tax compliance

behavior was not well understood and studies in this area have not been

carried. Therefore addressing this knowledge gap was the primary purpose

of this study.

It was for this reason that this study will attempt to find out how

taxpayers’ attitudes influence tax compliance behavior in the municipality

of Bacarra especially the sari-sari store owners.

The study will try to answer the following questions:

1. What is the profile of sari-sari store owners in the municipality of

Bacarra, Ilocos Norte in terms of

1.1 Personal Profile along

1.1.1 Sex;

1.1.2 Age;

1.1.3 highest educational attainment;

1.1.4 number of family member;


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1.1.5 civil status; and

1.2 business profile in terms of

1.2.1 capitalization;

1.2.2 number of years of operations;

1.2.3 average annual gross earning; and

1.2.4 average annual tax payment?

2. What are the problems encountered by the sari-sari store owners

in Bacaarra in relation to tax payment?

3. What is the status of the tax compliance behavior of sari-sari

store owners in the municipality of Bacarra, Ilocos Norte along

3.1 attitudes; and

3.2 extent of adherence to policies?

4. Is there a significant relationship between the profile of sari-sari

store owners in the municipality of Bacarra, Ilocos Norte and their

tax compliance along

4.1 attitude; and


5. Is there a significant relationship between the problems

encountered by the sari-sari store owners in the municipality of

Bacarra, Ilocos Norte along


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5.1 attitude; and


Importance of the study

The Researchers. The researchers, who have the special interest in the

study, are envisioned to further their knowledge, and their awareness of

the country’s tax administration and policies implemented regarding tax

payments and collections. The findings and an understanding of the study

will enable the researchers also to contribute information to the

benefactors.

Sari-Sari store owners. The study will enable the owners to know their

responsibilities and their rights as taxpayer.

BIR. As the supervisory body, the results of the study will foremost benefit

the agency as it will be a guide for them in the formulation and

implementation of better tax administration policies, if there is any.


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Other business owners. It will make them understand more of their

responsibility as taxpayers for their own business.

Local Government Unit.Through the findings, they could be better guided

in devising ways to better implement tax policies and to come up with

sound decisions relative to tax imposition and collection. Establishing

better relationship with taxpayers can also be realized by taking into

consideration the implications of the results of the study.

Academe. The study will provide in the further research with regards to tax

compliance and other similar issues as it will benefit them in the present

and future condition.

Other researchers. As this will enable them to relate future studies about

tax compliance behaviour, the study will give them as well important

information they will be needing in their research.

Definition of Terms

To better understand and afford a clearer view of the study, the

following terms are herein defined operationally.


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Attitudes. The term implies the personal views or perspectives of the

owners of the sari-sari store owners in the city of Laoag, as regards to tax

payments.

Average annual gross earnings. This refers to the total amount of

gross receipts obtained by the sari- sari store owners from the operations or

transactions of the business for a span of one year.

Average annual tax payments. This is determined in view of existing

tax policies that applies to the business. It is derived from the total tax

payments made by the sari- sari store owners in one year.

Capitalization. This refers to the amount of money involved when the

sari- sari store owners started their business.

Profile. The term implies the personal and the business profile of the

sari- sari store owners who served as respondents of the study. Their

personal profile is described in terms of their sex, highest educational

attainment, the number of family members and civil status. Business profile

covers the number of years within which their businesses have been in the

operation, their capitalization, average annual gross income and the average

annual taxes paid by them.


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Size of the family. This refers to the number of members in the family.

Sari-sari store owners. These are the taxpayers who operates sari-

sari stores registered with the BIR and were given permit to operate in the

different barangays in Laoag City.

Tax compliance behavior. This refers to the extent of adherence of

the sari- sari store owners to the tax policies, the problems encountered by

them as they go through their business and the reasons why they comply or

fail to comply with the policies.

CHAPTER II

REVIEW OF LITERATURE AND STUDIES

This chapter presents a summary of various literature and studies

that have direct and indirect bearings on this study.

Related Literature

Taxation – It’s Nature and purpose

Taxation is a system of compulsory contributions levied by

government on persons, corporations, and properties, primarily as a


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source of revenue for government’s expenses and other public purposes. It

is for this reason, in order for the government to provide the public with the

necessary goods and services, revenue must be raised through taxation.

This revenue is generated through direct and indirect forms of

taxation. Direct taxes are paid on income. This effectively means that the

more income you earn the greater your contribution is expected to be to

the state. Indirect taxes are levied on expenditure. This tax is imposed on

the basis of the individual consumption – the individual pays only on what

he consumes. However, it must be noted that taxation is used not only to

raise revenue but also to regulate consumption and may even be used to

curtail various forms of business activities. For instance, alcoholic

beverages and tobacco may be taxed heavily on the grounds that their use

is hazardous to the health of individuals. Such revenue, often called a “sin

tax”, is infact a penalty paid by the users of the substance.

The regulatory aspects of taxation are more apparent in indirect

taxes, such as customs duties and taxes, than in direct taxes such as

income tax. For instance, government can control private consumption,

especially of imported goods, by increasing customs tariffs. An increase in


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taxation on personal income on the other hand, may result in a decrease in

private savings without affecting the level of consumption.

The effectiveness of any government depends on the willingness of

the people governed to surrender or exchange a measure of control over

their persons and property, in return for protection and other services.

Taxation is one form of this exchange. In designing tax systems,

governments customarily consider three basic indicators of taxpayer

wealth or ability to pay: what people own, what they spend, and what they

earn. The kinds of taxes raised by government for revenue are numerous.

The most common are: personal income taxes, corporate income taxes,

property taxes, sales taxes, death and gift taxes, and import-export duties.

In order for a tax system to operate effectively, certain principles

must be put in place. Fairness: the tax must be fair, that is, citizens should

be taxed in proportion to their abilities to pay. Clarity and Certainty: the

application of a tax should be clear and certain. If the application is

uncertain and arbitrary the public can have no confidence in the system.

Convenience:Compliance with tax laws may increase if it is easy and

convenient. Efficiency: a good tax system should be structured so that it

can be administered efficiently and economically. Taxes that are difficult or


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costly to administer divert resources to nonproductive uses and diminish

confidence in both the levy and the government.

In the past, taxation was regarded solely as a means to finance the

necessary obligations of a government. The money was used to pay

elected officials, maintain state security, build roads, bridges and public

buildings; and pay for such services as schools, hospitals and fire fighters.

In recent times, the purposes of taxation have expanded considerably, as

have the roles of governments in society.

Today taxes have three functions. First and foremost, to provide the

money that makes it possible for government to function. Second, taxes

have an economic significance: they are used to promote goals such as

full employment, satisfactory rates of economic growth, and stability of the

money supply. The economic goals of taxation are achieved by raising or

lowering tax rates. The fewer taxes people pay, the more they have for

their personal use. Conversely, the more taxes they pay, the less money

they have available for themselves. Third, taxes are used as a

redistribution of wealth. The purpose of income redistribution is to lessen

the inequalities of wealth in society. This is done through what is called a

system of transfer payments. The effect of the system is to transfer money


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from those who have a good deal of it to those who have very little. Two of

the most common examples are social security payments and welfare

payments made to people who, for one reason or another, do not work.

(http://ird.gov.dm/index.php?

option=com_content&view=article&id=60:taxation-its-nature-and-purpose-

&catid=25:present&Itemid=27)

Tax behavior: economic and psychological determinants of

enforced versus voluntary compliance

The “slippery slope” framework (Kirchler, 2007; Kirchler, Hoelzl&

Wahl, 2008) starts from the idea that the tax climate in a society can vary

on a continuum between an antagonistic climate and a synergistic climate.

In an antagonistic climate, taxpayers and tax authorities work against each

other (“cops and robbers” attitude; high social distance between authorities

and taxpayers); in a synergistic climate, they work together (“service and

client” attitude, close social distance). The framework distinguishes

between enforced compliance and voluntary compliance, and proceeds

with the idea to think about tax compliance along two major dimensions:

the (coercive) power of tax authorities to enforce compliance and trust in

tax authorities. These dimensions and their interactions jointly influence

http://ird.gov.dm/index.php?option=com_content&view=article&id=60:taxation-its-nature-and-purpose-&catid=25:present&Itemid=27




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the type and level of tax compliance. Two different ways of how authorities

could gain cooperation from the public are distinguished: the first way

claims that the threat of audits and punishment can enforce compliance

(economic approach). The second way claims that perceived competence

in managing problems can activate citizens to aid the authorities and to

feel obliged to adhere to decisions, policies, and rules (psychological

approach). Trust in authorities depends on the following variables: (a)

subjective tax knowledge;(b) attitudes towards tax authorities and the

government; (c) personal, social, and national norms; (d) perceived

fairness: - distributive fairness (horizontal, vertical, exchange fairness);-

procedural fairness (fairness of procedures, i.e, neutrality, transparency

etc, and interactional justice with two aspects of interpersonal treatment: i)

interpersonal justice, reflecting the degree to which people are treated with

politeness, dignity, and respect by authorities. ii) informational justice,

focusing on the explanations provided to people that convey information

about why procedures were used in a certain way or why outcomes were

distributed in a certain fashion);- retributive / restorative fairness

(restorative justice focuses on crime as an act against another individual or

community, and the victim should receive some type of restitution from the

offender).Perceived fairness is connected to the trust dimension because a

http://en.wikipedia.org/wiki/Restitution


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just treatment of taxpayers (i.e., distributive, procedural fairness, retributive

fairness) helps to build and maintain trust. Retributive justice is connected

to the power dimension as well, because it depends also on detecting and

fining wrongdoers. In turn, an inconsiderate exertion of power that is

perceived as intrusive can reduce trust.

The responsive regulation approach (Braithwaite, 2007) fits well with

the current framework. It proposes regulatory rules and suggests that the

authorities should act responding to the beliefs and attitudes of the

taxpayers. These are captured in the concept of “motivational postures”,

defined as “an interconnected set of beliefs and attitudes that are

consciously held and openly shared with others”. Motivational postures are

commitment, capitulation, resistance, disengagement, and game playing.

(http://www.scitopics.com/

Tax_behavior_economic_and_psychological_determinants_of_enforced_v

ersus_voluntary_compliance.html)

Why do people comply?

In the article “Enforcing Tax compliance: To Punish or Persuade?”

(2008) Margaret Murphy, who has a background in psychology, describes

http://www.scitopics.com/Tax_behavior_economic_and_psychological_determinants_of_enforced_versus_voluntary_compliance.html




25

the debate within tax regulation: A long-standing debate in the regulatory

literature has been between those who think that individuals will comply

with rules and regulations only when confronted with harsh sanctions and

penalties, and those who believe that gentle persuasion and cooperation

works in securing compliance.

According to Murphy, the first view, which builds regulation on

deterrence, has been the dominant policy-model for tax administrations up

till today. This, however, is in spite of the fact that academic research has

shown that the deterrence model does not adequately explain tax

compliance behavior (see for instance: Alm& Gomez, 2008; J. Braithwaite,

2002; V. Braithwaite, 2003c; Murphy, 2004, 2008; Torgler, 2008). What

many of these researchers point out is wrong with the deterrence model is

that it is based on the assumption that people are: rational actors who

behave in a manner that will maximize their expected utility. In other

words, individuals assess opportunities and risks and disobey the law

when the anticipated fine and probability of being caught are small in

relation to the profits to be made through non-compliance. (Murphy, 2008,

114)

Murphy’s argument is that if people did behave in this way with

regard to tax compliance then the logical response from tax authorities


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would be to deter the individuals from non-compliance by raising the

stakes of their non-compliance. This means making stronger enforcement,

more checks, controls and punishment. This much-cited article “Income

Tax Evasion: A Theoretical Analysis” portrays taxpayers as rational utility

maximizing individuals. However, according to Murphy, when it comes to

tax compliance people are not rational actors. If they were, they would

quickly have figured out that they could underreport income or over-claim

deductions “because it is extremely unlikely that such cheating will be

caught and penalized” (Alm& Gomez, 2008, 74). This would result in fewer

taxpayers actually paying their taxes. Hence, Murphy draws our attention

to the ‘surprising fact’ that most people in the Western countries actually

comply and pay their taxes. Continuing this line of argument, James Alm

and Juan Luis Gomez write that the ‘compliance puzzle’ is to figure out

why people pay their taxes as so many of them actually do. And that “the

compliance decision must be affected in ways not captured by the basic

economics-of-crime approach. What other factors may explain why people

pay taxes?”

Looking at the studies which in different way seek to solve the

‘compliance puzzle’ by analyzing determinants for tax compliance, there

are broadly two groups of research; one which uses field experiments


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(primarily letter-experiments) and one which uses surveys as empirical

evidence. Both are quantitative and their purpose is to relate and compare

different variables on tax compliance, whereby it is investigated whether a

cause and effect relationship exists between different variables

(McKerchar, 2008, 10; 2010). What also characterizes these studies is

their belief in tax compliance being socially constructed. Basically, tax

compliance is described as being influenced by social factors such as

deterrence, moral, values or perceptions of procedural justice.

(http://www.mindlab.dk/assets/738/

Taxing_Assemblages__PhD_dissertation__Karen_Boll__FINAL.pdf)

Factors and drivers that influence taxpayers’ compliance behaviour

While businesses constitute such an important segment for revenue

bodies, there is a need for more conceptual and empirical work that

focuses on the drivers and mechanisms behind tax compliance behaviour

of businesses. One emerging and promising perspective in this respect is

the relation between corporate governance and businesses‘ compliance

with laws and regulations (e.g. Van Oosterhout, 2009).

http://www.mindlab.dk/assets/738/Taxing_Assemblages__PhD_dissertation__Karen_Boll__FINAL.pdf



28

Knowledge of the drivers of tax compliance behaviour can help to

delineate strategies and interventions that impact these drivers and thus

behaviour. But also more general knowledge about human behaviour and

principles of persuasion can be extremely helpful to increase the

effectiveness of communication and treatments (e.g. Cialdini, 2009).

Research with a broader behavioural perspective has identified a

large number of factors and drivers that are associated with tax

compliance. Of particular policy significance is the finding that personal

ethical norms can drive tax compliance, with deterrence playing a role

when obligation and social pressure fails. Moral obligation and anticipated

feelings of shame and guilt have emerged as significant factors in

explaining compliance and are regarded as among the most consistent

predictors in the literature (Braithwaite 2009).

Based on the findings in the research the factors and drivers behind

taxpayer compliance behaviour can be categorised into five main

categories:

Deterrence, e.g. audits, perceived risk of detection and severity of

sanctions;

Norms, both personal and social norms;


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Opportunity, both to be compliant (e.g. low compliance costs,

easy rules) and to be noncompliant (e.g. opportunities for

evasion);

Fairness, related to outcomes and procedures, and trust, both in

the government or tax authority and in other taxpayers; and

Economicfactors, containing general economic factors, factors

related to the business or industry and amount of tax due.

Deterrence: Deterrence is based on the concept that the risk of detection

and punishment will improve compliance behaviour. Under this approach

citizens pay their taxes out of fear that the government will catch and

penalize them (Lavoie 2008). The aim of deterrence is therefore mainly to

prevent tax evasion but the concept also includes the idea that the

punishment of an evader will discourage future evasion.

The relationship between deterrence and tax compliance is complex.

Research on the effect of deterrence conducted by revenue bodies and

academic research show different results. Valerie Braithwaite (2009) has

described deterrence as a double edged sword. Deterrence can

strengthen the moral obligation to pay tax because it points out what is the

right thing to do. But deterrence can also create resistance from the


30

taxpayer by feelings of oppression. Thus, deterrence can have a positive

or negative effect on compliance. The question therefore is not whether or

not revenue bodies should use deterrence, but how it can be used most

effectively.

Furthermore, research shows that the effect of fines on tax

compliance is usually also very small or negligible (Braithwaite 2008). The

effect or importance of deterrence cannot be understood without

considering the context in which it is applied. Of particular policy

significance is the finding that personal norms (moral obligation) can be the

main driver for tax compliance but with deterrence playing a role when

moral obligation and social pressure fails (Wenzel, 2004). When personal

norms in favour of compliance are strong, deterrence will have weak effect

on compliance. Taxpayers then comply because they think it is the right

thing to do, not because they are afraid of punishment. But when personal

norms are weak, deterrence becomes more important (Wenzel 2004). If

the taxpayer is not affected by a moral obligation to pay tax then the threat

of punishment can have a positive impact on behaviour. The opposite is

true for social norms. When social norms in favour of compliance are

weak, deterrence will have weak effect on compliance, but when social

norms are strong, deterrence will have a greater impact on behaviour


31

(Wenzel 2004). This means that formal sanctions (deterrence) work better

if there is a social cost associated with it. Other people need to perceive

the punished behaviour as wrong.

Norms: Moral or normative considerations are found to be an important

determinant of tax compliance. Taylor (2001) points out that there is a

connection between risk of detection, formal sanctions and compliance,

but the research shows that the fear of experiencing feelings of guilt and

the risk of social stigmatisation has a considerably greater deterrent effect.

These drivers (conscience and social acceptance) behind taxpayer

behaviour have attracted more and more attention over the past few years.

Studies so far have generally focused on personal norms, often referred to

as tax ethics, tax mentality or tax morale (e.g. Braithwaite & Ahmed, 2005),

and somewhat less on social norms.

In the tax context, personal norms can be defined as the belief that

there is a moral imperative that one should comply (Wenzel, 2005).

Personal norms with regard to taxes reflect a taxpayer‘s values and tax

ethics (Kirchler, 2007). Personal norms are also related to different

personality characteristics, such as egoism and honesty. Social norms can

be defined as the behaviour, ideas and convictions among social groups.

Social norms evolve and are modified through social processes within and


32

between the groups. Hence, norms are not static but still have certain

continuity due to their social character. Norms of a particular social group

influence the behaviour of people that identify themselves with that group.

Research shows that opinions and behaviours of others, or the ideas one

has about others‘ opinion and behaviour, are of great importance for

taxpayer compliance behaviour (e.g. Wenzel, 2004).

What holds true for law in general holds true for tax compliance

specifically. Traditional methods of enforcement through audit and

penalties explain only a small fraction of voluntary tax compliance.

Theorists and researchers attribute the vast majority of compliance to what

they loosely describe as internal motivations or “tax morale.” The field is

still young, the subject complex, and some of the empirical data is

inconclusive. Nevertheless,the literature clearly indicates that tax morale

plays a major role in tax compliance.

Although the exact components of tax morale are not yet fully

delineated, nor the precise mechanisms by which they work, the literature

already has identified certain elements. Research shows that tax

compliance is affected by (social and personal) norms such as those

regarding procedural justice, trust, belief in the legitimacy of the

government, reciprocity, altruism, and identification with the group.


33

Cognitive processes, such as prospect theory, also influence an

individual’s reaction to tax issues. Studies also indicate that certain

demographic factors such as age, gender and education correlate with tax

morale.

The components of tax morale, like internal motivators in other areas

of the law, are not static. They interact with each other and the

environment and are influenced by each individual’s own cognitive

framework. Consequently, an external agent, such as the BIR (Bureau of

Internal Revenue), can influence tax morale norms and thereby tax

compliance. It can activate compliance norms in a variety of ways including

education, properly framing communications, fair procedures, and a

regulatory framework that incorporates current and future findings of tax

morale research into its operations and dealings with taxpayers.

Fairness and trust: Fairness and trust are perceived by many

researchers to be important drivers for compliance. Valerie Braithwaite

points out the importance of mutual trust and cooperation between the

taxpayers and their tax authority in order to achieve voluntary compliance

(Braithwaite, 2008). Kirchler and Hoelzl (2006) argue that fair treatment of

taxpayers and trustworthiness of tax authorities will enhance voluntary

compliance.


34

Murphy (2004) shows in a study of accused tax avoiders that there is

a correlation between fair and correct treatment of the taxpayer and trust in

the revenue body. Trust is in turn correlated to the willingness to comply. If

regulators are seen to be acting fairly, people will trust the motives of that

authority, and will defer to their decisions voluntarily. Fairness and trust are

thus interlinked and the one cannot exist without the other.

The perception of fairness depends thus to a great extent on how

the citizens perceive the authority‘s actions. A taxpayer may perceive an

authority as just and fair even if it has made a decision that goes against

him, if the authority acted in a good manner. This leads in turn to fewer

complaints about the authority‘s decisions. What is important is not,

therefore, whether the outcome is positive or negative, but whether it is

fair. If an authority treats an individual courteously, it shows respect for the

individual and helps increase the perception of fairness.

Economic factors: Economic factors can be motivational factors and

situational factors and can in both capacities influence compliance

behaviour. In the context of tax compliance there is, however, a lack of

research linking economic factors to compliance behaviour. The only

economic factor that has received a lot of attention is the amount of taxes

to be paid or the tax rate.


35

A study commissioned by the Swedish Tax Agency (2009) shows

that self-reported compliance is much higher for businesses with

employees than businesses without employees. This is of particular

interest since the same study showed that businesses with employees

were less happy with both the tax system and the tax agency.

Of interest is also the fact that there is a correlation both between tax

evasion and corruption (Tedds, 2007) and between corruption and

economic growth. Increases in GDP per capita are found to lead to a long-

term reduction in corruption. But economic growth increases corruption in

the short-term (Brown &Schackman, 2007). These findings suggest the

possibilities that economic growth can reduce tax evasion in the long run

but increase tax evasion in the short run.

Economic factors play a role in tax compliance. A general conclusion

is that factors that are positive for economic growth also tend to promote

tax compliance.

Interactions: Research shows that specific combinations of the drivers

mentioned in previous sections can have effects on compliance behaviour

up and above the individual effect of one of the drivers. As a result, in

recent years the attention given in research to the effect of specific

combinations of motives is growing. Importantly, results indicate that


36

motives can undermine each other in their effect on compliance behaviour.

An example is that from a high level of perceived deterrence people can

infer that non-compliance is the (social) norm.

A willingness to comply can be undermined by an external incentive

(like a threat of punishment for non-compliance). External incentive can

also strengthen a person‘s own personal motivation if the individual

perceive the interventions to be supportive.

Deterrence in the absence of both social and personal norm will

have to be very strong in order to work (and thus running the risk of further

preventing norms to be fostered). It is therefore essential to use deterrence

and interventions as a way of creating or supporting social norms.

Another prerequisite for a supportive intervention is that it must be

perceived as fair and is characterised by procedural fairness. This shows

that deterrence, norms and fairness are interlinked and that they cannot be

treated and used as separate drivers behind behaviour. The different

factors influence each other and the best effect on compliance is achieved

when they are working aligned and in support of each other.

Deterrence works better than no incentives at all. But personal

norms and social norms are far more influential than deterrent factors.

Moreover, deterrence usually impacts a specific act or decision, while


37

personal norms guide behaviour on a more general level. Social norms

can both influence personal norms and can lead to high social costs for

non-compliance, making it a very strong incentive for honest behaviour.

Norms can be maintained and strengthened by a deterrent component

applied in the right way, thus creating an even stronger incentive for

compliant behaviour. Deterrence is therefore a powerful tool for supporting

or strengthening norms. Deterrence can, however, also destroy norms if

used in the wrong way. The actions of the revenue body (deterrent or

others) will be more effective if interventions or treatments are perceived

as procedurally fair and if there exists a high level of mutual trust between

the revenue body and taxpayers.

Reducing opportunities for tax evasion and increasing opportunities

for compliance works well together with deterrence and norms as long as

such regimes are perceived to be legitimate and associated with high

levels of procedural fairness. Limiting opportunities for non-compliance too

much brings the same risk as deterrence and can crowd-out internal

motivation to comply. Forced compliance, either through deterrence or no

opportunities for evasion can reduce the willingness to comply and thus

make the whole system less legitimate and create incentives for defiant

behaviour.


38

(www.oecd.org/dataoecd/58/38/46274793.pdf)

Demographic Factors

Various demographic factors correlate with tax compliance behavior,

such as age, gender, and religiosity. These are correlations not causations

and may reflect different worldviews, schemas, framing, or a combination

of these. Although the precise reasons for the correlations are not known,

knowledge that they exist is useful in devising compliance tactics. What

helps one population may be a detriment to another. Studies have found

these major demographic correlations: Demographic Factors

Various demographic factors correlate with tax compliance behavior, such

as age, gender, and religiosity. These are correlations not causations and

may reflect different worldviews, schemas, framing, or a combination of

these. Although the precise reasons for the correlations are not known,

knowledge that they exist is useful in devising compliance tactics. What

helps one population may be a detriment to another. Studies have found

these major demographic correlations:

Gender: Although some of the study results are mixed, in general the

evidence suggests that women are more compliant than men (perhaps

because they are more risk averse), respond better to positive appeals

http://www.oecd.org/dataoecd/58/38/46274793.pdf


39

(whereas men respond better to negative ones) and respond better to

normative appeals.

Age: Older individuals are generally more compliant than younger ones.

This could be due to a variety of factors such as older individuals have

more social capital (more willing to follow or internalize social norms), have

more at risk, and/or have more knowledge of tax.

Education: Findings regarding the correlation of education and

compliance have been mixed. As with other factors, however, mixed

findings may be the product of the measurement tools—both how

compliance is defined and education measured. Education may correlate

with compliance because the internalization of social norms occurs through

a process of socialization and education influences that process.

Education may also correlate with compliance because higher moral

reasoning positively correlates and higher moral reasoning can be taught.

Marital status: Findings regarding the effect of marital status are mixed.

Religion: A study of the correlation between tax compliance and religion in

more than 30 countries, found a positive correlation for all the main

religions but found different correlations with different religions. For

example, agreeing with an earlier study, Torgler found that those with a

strong Protestant work ethic were more likely to oppose taxation. The


40

correlation may exist because religion acts as a “supernatural police” or

because it is a proxy for such traits as work ethic and trust.

Income: The evidence regarding the correlation between income and

compliance is mixed.

(http://www.mindlab.dk/assets/738/

Taxing_Assemblages__PhD_dissertation__Karen_Boll__FINAL.pdf)

Impact of the Tax System on Small Business Development

This section discusses the compliance attitude of MSEs and the

consequences of non-compliance with the tax system for small business

development, the economy, and public sector governance. A complicated

tax system and arbitrary tax administration are among the main reasons

for small businesses to operate in the informal economy. Tax compliance

costs are regressive and put a disproportional burden on small businesses.

After a review of the core factors contributing to high compliance costs, this

section of the toolkit analyzes the impact of non-compliance. But non-

compliance is not a free option for MSEs. It entails substantial costs, which

result from expenditures (e.g. bribes) required to avoid penalties and

forced registration, and from the lack of services and business

development opportunities, such as access to credit, public sector




41

contracts, and publicity programs to promote the small business. While the

impact of non-compliance on the overall tax yield might be negligible, it

seriously affects the equity of the tax system and increases the tax burden

(and reduces the competitiveness) of compliant, registered businesses.

Finally, strengthening government accountability requires broadening of

the tax net.

(http://www.ifc.org/ifcext/fias.nsf/AttachmentsByTitle/

ManualsandToolkits_DesigningTaxSystem/$FILE/

Designing+a+Tax+System.pdf)

The importance of the compliance cost factor

A high tax burden is not necessarily due to high tax rates. Tax

compliance costs can add substantially to the overall costs of formalizing a

small business. While some costs arise in all areas of complying with laws

and regulations, these costs tend to be particularly high in the tax area.

This is the case even in countries with a modern tax system and a highly

efficient tax administration. A 2006 compliance cost survey in New Zealand

revealed that businesses allocated over 41% of total compliance costs to

tax-related issues. Many survey respondents felt that tax compliance is too

complicated and is stifling growth in small businesses, and that there is no

http://www.ifc.org/ifcext/fias.nsf/AttachmentsByTitle/ManualsandToolkits_DesigningTaxSystem/$FILE/Designing+a+Tax+System.pdf




42

relief offered to small businesses that would lead to increased investment

and growth. Compliance costs according to the definition developed by

Cedric Sanford include the costs incurred by taxpayers or by third parties

(such as businesses) in meeting the requirements of the tax system, over

and above the tax liability itself and over and above any harmful distortions

of consumption or production to which the tax may give rise”. For

individuals, compliance costs include the costs of acquiring sufficient

knowledge to meet legal requirements; of compiling the necessary receipts

and other data; making the relevant calculations and completing tax

returns; paying professional advisors for tax advice; and paying incidental

costs of postage, telephone, and travel to communicate with tax advisors

or the tax office. For a business, the compliance costs include the costs of

collecting, remitting, and accounting for tax on the products or profits of the

business, and on the wages and salaries of its employees. Compliance

costs for businesses also include the costs of acquiring the knowledge to

enable this work to be done, including knowledge of their legal obligations

and penalties.

MONETARY COST TIME COST PSYCHOLOGICAL

COST


43

Fees paid to tax

advisors,

lawyers, accountants

Time spent by

taxpayer on studying

tax laws and filing tax

returns

Stress and anxiety

arising fromcomplying

with a specific tax

orfrom a tax-related

activity

Salary of staff working

on

preparation of tax

returns and tax

accounting

Time spent to prepare

and support

a tax audit

Frustration as a result of

taxpayer harassment

Tax literature and

software

Time spent to prepare

appeals

Phone calls, postage

cos(http://www.ifc.org/ifcext/sme.nsf/AttachmentsByTitle/toolkit_tax/$FILE/

toolkit_tax_system1-3-08WEB.pdf)

The role of local governments

http://www.ifc.org/ifcext/sme.nsf/AttachmentsByTitle/toolkit_tax/$FILE/toolkit_tax_system1-3-08WEB.pdf

http://www.ifc.org/ifcext/sme.nsf/AttachmentsByTitle/toolkit_tax/$FILE/toolkit_tax_system1-3-08WEB.pdf


44

Little consideration has been given in academic discussions and in

country practice to the role of local governments in collecting taxes from

small and micro businesses. Similar to the case of business associations,

local governments frequently have better knowledge of small businesses

activities and better access to MSEs (Medium and Small Enterprises) than

the central government tax administration. In addition, several other

considerations could support an increased involvement of local

governments in small business tax collection:

The presumptive small business tax burden frequently is

assessed by the tax administration instead of self-assessment by

the taxpayer. However, most taxes in the general tax system are

self-assessed taxes, and a central tax administration that

administers self-assessed taxes my not organizationally be

prepared for agency assessment without major reorganization.

There is a need for low labor costs for the tax officials as there

is a small tax yield per business. High-paid professionals of

central revenue authorities may not be cost-efficient revenue

collectors for small business taxes.

The complementary functions of local government should

lower costs and increase effectiveness of identifying and


45

registering small businesses and assessing their tax liability.

These complementary activities include local business

registration, land use regulation, property taxation, management

of public markets, taxi ranks, bus stations, etc. All these activities

require a local government to actively deal with businesses in its

jurisdiction.

There are three basic alternatives for the role of local government in

small business taxation:

a) Central government tax administration and local governments cooperate

in the collection of MSE taxes. This could be in the form of information

exchange and access of central government tax administration to data

administered by local governments (e.g. data on local business registration

or fees and user charges collection). Such cooperative arrangements are

highly desirable.

b) Consideration could also be given to shifting the responsibility for the

collection of small business taxes to local governments. Local

governments would collect the taxes on behalf of the central government

and be compensated for collection costs incurred (probably topped up with

incentives for efficient collection and achieving collection targets). Such


46

arrangements need to be considered carefully, however, and the risk of

them not working very well in practice is considerable. Administrative

capacity at the local level in many developing countries is weak and

expertise in the area of tax administration and compliance management is

not available. This not only decreases the efficiency of revenue collection,

but also results in a lack of sufficient service and support programs. In

addition, the relationship between central and local authorities is tense in

many countries and there is a risk that revenues collected by local

governments on behalf of the central government are not properly

transferred to the Treasury. Finally, collection by local governments is not

necessarily more efficient. Data from Kenya show that the number of

businesses actually registered by local authorities is less than 30% of the

estimated number of existing businesses. Cooperative arrangements

therefore generally should be a preferred approach to full transfer of the

collection responsibility to the local level.

c) Finally, small business taxes could become true local taxes,

administered by local governments and the revenue yield going to the local

budget. To satisfy the criteria of a good local tax, local governments in this

case should have certain discretion to determine the tax base and set the

tax rate. Small business taxes can be an attractive revenue source for


47

local governments. Despite the deficiencies in collection, the Kenyan small

business tax, e.g., has been collecting more than 15% of local government

own source revenues. A major risk, however, is to guarantee a smooth

transfer of small businesses from the presumptive to the standard tax

regime. Local governments have little incentives to encourage small

business growth and transfer the taxpayer to the central tax administration

once the MSE grows beyond the small business system threshold. It is

also possible that problems of tax competition emerge; the dimension of

such risk depends on the mobility of the tax base (the business operation).

(

http://www.ifc.org/ifcext/fias.nsf/AttachmentsByTitle/ManualsandToolkits_D

esigningTaxSystem/$FILE/Designing+a+Tax+System.pdf)


48

Related study

A study which documented the taxpayers’ attitudes and tax

compliance behaviors was conducted by the Australian Taxation Office

(“ATO”). In the study, taxpayers were selected according to their historical

tax compliance behavior, in order to better understand community attitudes

to tax. Seven non-business taxpayer groups were firstly identified and

three separate groups of tax agents, tax office staff and youth were also

studied. Analyses identified relationships between tax-based values,

beliefs, attitudes, knowledge and actual tax compliance behavior.

The results indicate that in the main Australian non-business,

taxpayers were compliant; that there was a propensity to comply and that

there was no “tax rage”. Nevertheless, taxpayers did indicate that they

tolerated low levels of non-compliance and saw this behavior as a common

method of gaining justice. The factors that impacted taxpayers’ ability to

maintain compliance collectively contributed to increased risk behaviour.

Non-compliance or compliance was preceded by factors from personal and

environmental circumstances. These factors then impacted taxpayers’

capacity to meet their obligations. Avoidance of dealing with tax problems


49

rather than deliberate tax avoidance were, in the main, a major contributor

to actions defined by tax law as tax avoidance.

Our study is entitled Tax Compliance Behavior of Sari- Sari Store

Owners in the Municipality of Bacarra. The study of Australia was related

to this study because it determined the compliance behavior and taxpayers

attitude in the adherence to tax policy.


50

CHAPTER III

RESEARCH METHODOLOGY

This chapter discusses the research design, the sources of data

which includes the locale of the study, the population and the sampling

design. It also presents a discourse on the instrumentation and the data

gathering procedure, likewise the tools for data analysis.

Research Design

Research design is considered as a “blueprint” for research, dealing

with at least four problems: which questions to study, which data are

relevant, what data to collect, and how to analyze the results. These

questions employ the use of descriptive research design as adapted in this

study. Descriptive research design is a scientific method which involves

observing and describing the behavior of a subject without influencing it in

any way. The researchers use this design to find out the respondents

attitudes and behavior towards tax compliance.


51

The design adapted in this study is very suitable because it precisely

focuses on the taxpayers’ attitudes and tax compliance behavior which will

be considered in accordance to the set research objectives.

Sources of Data

Locale of the Study. The study will be conducted in the Municipality of

Bacarra, Ilocos Norte where the various businesses which were focused in

the research are presently situated and operating.

Population and Sampling. All of the data or information that are needed to

provide answers to the questions dealt with in the study will be gathered

from the sari- sari store owners, who are duly registered as taxpayers with

the BIR-RDO.

The sari-sari store owners will be grouped according to the

barangay. The barangays with the five highest number of sari-sari stores

will be considered.

Instrumentation and Data Collection

The data needed for the study will be gathered through the use of a

questionnaire.


52

The tool will consist of three parts. Part I of the questionnaire delved

on the profile of the respondents, which will be subdivided into their

personal and business circumstances. Part II will consistof items on

problems encountered by sari- sari store owners. Items on the tax

compliance behavior along attitudes of the sari- sari store owners and

extent of adherence to policies will comprise Part III of the questionnaire.

The researchers themselves will administer the questionnaire after

approval of the request for the conduct of the study and due permission

will be obtained from concerned authorities. Retrieval will be made right

after all details have been noted by the respondents and clarifications will

be made to ensure completeness of the information.

Tools for Data Analysis

The following statistical tools will be used in the analysis of data:

For sub-problem 1 which will be focused on the personal and

business profile of the sari-sari store owners, frequency count and

percentage together with the mean will be employed.

For sub- problem 2 which will be delved on the problems

encountered by the respondents, the weighted mean will be employed.


53

Interpretations of the results will be based on the following scale of mean

values and descriptive information:

Scale of mean values Descriptive Interpretation

4.51- 5.00 very much serious

3.51- 4.50 very serious

2.51- 3.50 moderately serious

1.51- 2.50 slightly serious

1.00- 1.50 not serious

For sub- problem 3 which will determine the tax compliance behavior

respondents along attitude and extent of adherence to tax policies, data

analysis will also be done by way of weighted mean.

Data interpretation will be based on the following scale:

Scale of mean values descriptive interpretation

On Attitude On Adherence

4.51- 5.00 very highly favorable very high extent

3.51- 4.50 very favorable high extent

2.51- 3.50 favorable average extent


54

1.51- 2.50 slightly favorable low extent

1.00- 1.50 unfavorable very low extent

For sub- problem 4 & 5, wherein significant relationships will be

determined, the Pearson r will be employed. Interpretation of findings will

set at .05 levels. The entire analysis will be facilitated through the use of

SPSS version 17 software.

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