Tuesday, October 11, 2011

Law and Culture

In the Public Economics workshop today, a professor presented a paper on patterns of tax evasion in Russia. It is relatively easy to evade taxes there; the company pays all taxes so they would report very low wages to the government but pay their workers under the table. They can only do this if the worker agrees to an employment contract with very low reported income; presumably the company splits the tax savings with workers by offering a higher salary. The professor has a data set that connected car ownership to reported income. It is much harder to drive an unregistered car than evade income taxes, so the value of someone's car is a better measure of their income than their reported income.

He found that people working for foreign-owned companies had five to six times as much reported income than people working for Russian companies, but that their cars were only worth about 20% more. This is evidence of large and pervasive tax evasion in domestic companies. There are several possible reasons for this. Foreign companies could be subject to legal action in their home country if they evade taxes. Foreign companies could be watched more closely by the Russian authorities, or they could have standard rules and contracts that they prefer to work by, or they could just have a preference for honesty.

Another interesting fact is that when workers move from foreign to domestic companies, they keep reporting a high level of income. They do not start evading taxes. There are two possible reasons for this. The paper's authors speculated that people develop a preference for honesty after working for foreign firms. However, this explanation was questioned by the other professors. A simple preference story is unlikely, because when people move from a tax-evading domestic company to a more honest foreign company, they stop evading taxes. There is no 'preference for tax evasion' that sticks with people. A better explanation is that the tax authorities would probably audit people who move jobs and report much lower income, so they have to stay honest once their true income is revealed by working for a foreign firm. 

The data also showed that when people move from a foreign to a domestic company, the reported incomes of other workers at their new company go up, but car values do not. Again, the authors assumed cultural transmission of honesty preference, but it is also possible that a big difference in reported incomes for people doing the same job would make the tax authorities suspicious, so once a company reports more income for one person, they have to report more income for everyone else. 

The the economic historian spoke up. He pointed out that there are large costs to lying, cheating, and dishonesty. If your job contract says you get paid $300 a year but you are verbally promised a lot of money under the table at the end of the year, what can you do if your employer does not pay you? Once people have experience operating in an honest environment, they discover that it is more efficient. One person cannot change a system alone, but they can negotiate for an honestly reported high salary if they can plausibly claim that tax evasion is very difficult for them because of their previously reported salary.

This story does not have a clear ending, conclusion, or moral. It is mainly just a look at a part of my life. But it does illustrate the difficulty of figuring out how the world works. There are complicated feedback loops between individual incentives and social conditions, and it is very easy to tell stories about them. Many different stories can fit the same facts. 

No comments: