Tackling the undeclared economy in the European Union: an evaluation of the tax morale approach

• DOI: http://doi.org/10.1111/irj.12142
• Published date: 01 July 2016
• Author: Ioana A Horodnic,Colin C Williams
• Date: 01 July 2016

Tackling the undeclared economy in the

European Union: an evaluation of the tax

morale approach

Colin C Williams and Ioana A Horodnic

ABSTRACT

To evaluate a new approach towards tackling the undeclared economy, which views

participants as social actors rather than rational economic actors, this article reports

evidence from 27,563 face-to-face interviews conducted across the European Union

during 2013. Multilevel logistic regression analysis revealsa strong association between

participation in undeclared work and the level of tax morale. Finding that higher tax

morale (and thusa lower propensityto engage in undeclared work) is stronglycorrelated

with greaterlevels of state intervention but also with individual-level characteristics such

as gender, age, education and employment status, the article concludes not only by

confirming a political economy approach and refuting modernization and neo-liberal

explanations andremedies, but also by revealing for the firsttime the importance of so-

lutions not so farconsidered, including improvingeducational attainment, oldercitizens

mentoring foryounger people and improving women’sparticipation in the labour force.

1 INTRODUCTION

Tackling undeclared work lies at the very core of the study of industrial relations. Un-

less monetary transactions not declared to the state for tax, social security and/or la-

bour law purposes are addressed, the outcome will be a lack of state control over the

quality of working conditions, weakened trade union and collective bargaining and a

growing pressure on formal businesses to operate undeclared themselves due to the

unfair competition (Andrews et al., 2011). To advance understanding of how to tackle

undeclared work, this article transcends the conventional rational economic actor ap-

proach that views participation in undeclared work as arising when the pay-off is

greater than the expected cost of being caught and punished (Allingham and Sandmo,

1972). Given that many voluntarily comply even when the benefits of undeclared

work outweigh the costs (Alm et al., 2012; Kirchler, 2007; Murphy, 2008), a ‘social

actor’approach is advanced, which views participation in undeclared work as arising

when tax morale, defined as the intrinsic motivation to pay taxes (Cummings et al.,

2009; Torgler, 2007a, 2007b), is low. The consequent goal of this emergent approach

is to elicit greater voluntary commitment to compliant behaviour by raising the level

of tax morale (Alm et al., 2012; Alm and Torgler, 2011; Torgler, 2012).

❒Colin C. Williams,Sheffield UniversityManagement School, Universityof Sheffield, Sheffield, UK. Ioana

A. Horodnic, Department of Management, Marketing and Business Administration, AlexandruIoan Cuza

University of Iasi, Iasi, Romania. Correspondence should be addressed to Professor Colin C Williams,

Sheffield University Management School, University of Sheffield, Conduit Road, Sheffield S10 1FL, UK;

email: C.C.Williams@sheffield.ac.uk

Industrial Relations Journal 47:4, 322–340

ISSN 0019-8692

© 2016 The Authors. Industrial Relations Journal Published by John Wiley & Sons Ltd

This is an open access article under the terms of the Creative Commons Attribution-NonCommercial-NoDerivs License,

which permits use and distribution in any medium, provided the original work is properly cited, the use is non-commercial

and no modifications or adaptations are made.

This article contributes to the advancement of this emergent tax morale ap-

proach in three ways. First, and empirically, we report a Eurobarometer survey

from 28 member states of the European Union (EU-28) which reveals the strong

positive association between participation in undeclared work and the level of tax

morale at both the individual, population group and country levels, along with

the individual-level and country-level determinants of low tax morale. Second,

we theoretically advance this tax morale approach by viewing tax morale through

the lens of institutional theory as a measure of the gap that exists between the

codified laws and regulations of formal institutions (which we here term ‘state

morale’) and the unwritten socially shared rules of informal institutions (which

we here term ‘civic morale’) and as low when there is asymmetry between state

morale and civic morale. Finally, we make two policy advances. On the one

hand, we confirm the political economy explanation that higher tax morale

(and thus the propensity to engage in undeclared work) results from greater state

intervention in the form of higher taxes and social expenditure. On the other

hand, we, for the first time, display the importance of additional solutions so

far unconsidered, including improving educational attainment, older citizens

mentoring younger people and improving women’s participation in the labour

force as means of improving tax morale (and thus reducing the propensity to en-

gage in undeclared work).

To advance understanding, therefore, the second section reviews the previous

literature on tax morale so as to formulate hypotheses regarding the association

between tax morale and participation in undeclared work, the variations in tax

morale across populations and its determinants and what needs to be done to re-

duce the acceptability of undeclared work. To test these hypotheses, the third sec-

tion then reports the data used, namely, a 2013 Eurobarometer survey involving

27,563 face-to-face interviews in the EU-28 and the analytical methods employed:

a staged multilevel logistic regression model utilising the hierarchical nature of

the data (individuals within countries). The fourth section then reports the find-

ings, whilst the fifth and final section discusses the theoretical and policy

implications.

To define the undeclared economy, Castells and Portes (1989, 15) describe such

activity as ‘a specific form of income generating production…unregulated by the

institutions of society in a legal and social environment in which similar activities

are regulated’. Although this defines the undeclared economy through the lens of

both the formal (‘legal’)andinformal(‘social’) institutions in a society, this def-

inition fails to recognise first, that the undeclared economy, even if unregulated

by formal institutions, is regulated by the rules of informal institutions and sec-

ond, that such activity can be ‘legitimate’from the viewpoint of informal institu-

tionsevenifitis‘illegal’from the viewpoint of formal institutions (Williams and

Franic, 2016). Here, therefore, and reflecting the consensus in the literature, the

undeclared economy is defined as a socially legitimate activity, which is legal in

all respects other than it is not declared to the authorities for tax, social security

or labour law purposes (see Williams, 2014a). If it is not legal and legitimate in all

other respects, it is not part of the undeclared economy. Whilst the declared econ-

omy is legal (from the viewpoint of formal institutions) and legitimate (from the

viewpoint of informal institutions), the undeclared economy is illegal but legiti-

mate, unlike the criminal economy (e.g. forced labour), which is both illegal

and illegitimate.

323Tackling the undeclared economy in the European Union

© 2016 The Authors. Industrial Relations Journal Published by John Wiley & Sons Ltd