Last month, the OECD Committee on Fiscal Affairs released a report on tax morale that describes how taxpayer attitudes affect tax compliance. While the report concludes (perhaps unsurprisingly) that negative attitudes toward governments and tax systems allow taxpayers to rationalize noncompliance, fraud analysis identifies rationalization as only one of three risk factors for noncompliance or evasion.
Donald Cressey, a criminologist known for his work on sociology and white-collar crime, introduced the so-called fraud triangle in 1973 after studying 200 inmates convicted of embezzlement. It assumes that pressure, opportunity, and rationalization all must be present for fraud to occur. The American Institute of CPAs includes all three elements in its definition of fraud risk factors.
An article by James A. Tackett, Joe Antenucci, and Fran Wolf used Cressey’s fraud triangle to explain tax evasion in Tax Notes (Feb. 6, 2006, p. 654). The authors suggested that, although the fraud triangle is used to predict an array of occupational frauds, it is uniquely applicable to tax evasion because it closely resembles embezzlement of government funds (the subject of Cressey’s initial study). They concluded that all three elements are present in tax evasion.
Tax payment requirements create financial pressure, which is present in higher levels in the arenas where the most tax evasion occurs — for example, cases involving small business, self-employment, and individuals with high marginal tax rates.
A tax system based on voluntary compliance creates opportunity. Tax evasion occurs when the payoff of cheating is greater than the expected cost of being caught, and so declining audit rates decrease deterrence and increase opportunity. Conversely, increases in withholding and information reporting mitigate opportunity and have been proven to increase compliance.
Rationalization provides the perpetrator with a moral justification for evasion, which speaks to taxpayer morale. The most common source of rationalization for tax evasion is perceived unfairness in the tax system, such as beliefs about uneven tax burdens, government fiscal irresponsibility, and inconsistent tax enforcement. All of these were invoked in the OECD’s report on tax morale.
Scholars have proposed adding various elements to the fraud triangle, rendering it no longer a triangle at all. The most prominent suggestion adds a fourth element of capability to create the fraud diamond. Capability means the knowledge and skill necessary to carry out the fraud and avoid detection. As tax and accounting systems become more complex, this element may become as essential for undetected tax evasion as pressure, opportunity, and rationalization.
An understanding of tax morale can bring about tax policies that increase compliance. Acknowledging other fraud risk factors like pressure and opportunity may improve those odds.