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Yes, Greece has a serious tax evasion problem

AP Photo/Petros Karadjias
Democracy could be the key to getting on a better fiscal footing.
Published This article is more than 2 years old.

When trying to make sense of Greece’s long-running inability to balance its books, an easy villain to point out is its citizens’ proclivity for not paying taxes.

Greece’s informal economy, where little in the way of taxes is paid, is about 25%-30% of GDP, according to the best guess of economists who study it. Greece has taken steps to boost tax collections at the insistence of the so-called Troika—the ECB, IMF and European Commission. And it’s easy to see why those creditors, who are keeping the country afloat on loans, would be bothered that Greeks don’t seem willing to fund the government themselves by stepping up and paying taxes.

But understanding why people pay their taxes is essential to understanding, economically speaking, why this week’s planned Greek referendum on accepting a bailout offer may actually be an important step towards transforming Greece into a going fiscal concern. (For what it’s worth, we’re not just talking about Greece. Other heavily indebted southern European countries such as Italy also have large shadow economies and tax compliance problems.)

Economists have made an exhaustive study of countries like Greece that suffer from an affliction known as “low tax morale.” Historically, economic theory has been hard pressed to explain why tax morale—essentially the motivation or moral obligation the populace feels to pay taxes—would exist at all.

Early attempts to use economic theory to model tax evasion suggested it was a simple matter of people balancing the potential benefits of pocketing extra money owed to the taxman against the potential risks of getting caught and being forced to pay a penalty. Under the assumptions of that model, tax evasion could be solved by simply boosting penalties and enforcement.

However, as is so often the case, economic theory did a rotten job of explaining what was happening in the real world. Evidence showed that people were far more likely to pay their taxes than they should have been, given the relatively low chance of getting caught cutting corners. Tax morale was the missing link between the theory and real world behavior.

Where does that willingness to pay taxes come from? A number of factors are linked to it. Religious societies tend to be better about paying their taxes, for example. And places that treat taxpayers relatively well, for instance if minor violations or mistakes aren’t pounced on like strong signs of cheating, also tend to have higher tax compliance. Another recurring theme in determining tax morale has been satisfaction with government.

But there’s one area that seems especially germane to Greece at the moment: democracy. Studies have found that if citizens can vote on taxation levels evasion is lower. This makes sense. No one likes being told what to do, especially by outsiders.

In this light, Greece’s plans to hold a referendum on whether to accept another painful bailout program aren’t only politically necessary, they’re essential to making any program effective.  For Greece to be a sustainable entity, it needs more than financial assistance. It needs to build more trust in political institutions that have only existed since 1974, when the military dictatorship that previously ruled Greece collapsed.

In short, if Greece is ever going to be a going fiscal concern, it’s got to start building popular buy-in. To be sure, a referendum wouldn’t result in Greek tax payers suddenly turning into eager Northern-European style contributors to the public coffers. But as a trust-building exercise, reinforcing the people’s consent on the path the country is set to take, a referendum wouldn’t be a bad way to start.

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