In several countries across Europe, tax collection is patchy and likely contributes to economic problems. In a comparative study of countries engaged in transitions from communist rule to democracy and market economies, Simon Hug and Franziska Spörri assess the interplay between trust and institutions and how this affects tax morale. The study finds that allowing for referendums can strengthen the link between trust and tax morale, but that this effect will only increase morale where there are already high levels of trust within the country.

The vicious circle of tax evasion and reduced state capacities

Tax evasion can be a major problem for countries engaged in transition processes from communist rule to democracy and market economies. While, loosely speaking, taxes were not required to be levied by communist states; the newly democratised states had to find resources to offer basic public services. In the absence of sufficient resources a state’s capacities are severely diminished, and it faces considerable difficulties to offer basic public goods. These diminished capabilities and the ensuing under-provision of public goods, however, also affect the tax morale of citizens. Why should a citizen pay taxes, if the state fails to offer basic services? Hence, several authors consider this interaction between state capacities and tax evasion as a vicious circle.

Trust may be a crucial element in breaking this vicious circle. Moreover, trust may play an important role in explaining tax morale and tax evasion. This raises the question of whether political institutions may foster such trust and whether institutions allowing citizens to directly affect policies (such as through referendums) influences tax morale. This question is all the more relevant, since many of the newly democratised and formerly communist countries have introduced in part wide-ranging institutions for referendums in their constitutions.

Referendums and tax evasion

In our study we expected institutions allowing for referendums to have two effects on tax evasion. First of all, referendums should lower the external cost (i.e. the enforcement cost) of decisions as a potentially larger share of the citizens are participating in the decision-making process. This should foster tax morale in a direct way. Second, referendums should lead to outcomes more closely reflecting the voters’ preferences. As a consequence, compliance with policies more in accordance with the voters’ wishes should be easier, which would again be indicative of heightened tax morale.

We assumed that different types of referendums have distinct effects. More specifically, referendums triggered by actors that are not veto players in the normal decision-making process, are those that most strongly move policy outcomes toward the preferences of voters. The effect is weaker for referendums that are mandatory, while the effect is largely nil in cases where a veto player in the normal legislative process (that is, individuals or collective units such as a president, or a political party who are required to support a policy for it to be accepted) triggers a referendum. Based on these theoretical considerations we expected the strongest direct effects of referendums for those triggered by non-veto players, followed by required referendums.

Trust is influenced by the presence of referendum institutions

Based on both theoretical and empirical studies on how institutions affect tax morale, we assessed empirically whether institutions allowing for referendums explain cross-country differences. In our multilevel analysis we find both for a set of transition countries and a larger set of countries that the different sets of referendum institutions affect the way in which trust is linked to tax morale. These effects are strongest and most significant for the transition countries. In these countries it is especially the effects of trust in parliament and of the rating of the political system and national officials that are influenced by the presence of referendum institutions. Among these institutions it is exclusively those that allow non-veto players to trigger a referendum that lead to a strengthening of the effect of trust on tax morale.

Referendum institutions have no direct effect on tax morale

An additional interesting insight of our study is that the various referendum institutions have no direct effect on the level of tax morale across countries. While some differences appear across countries, they cannot be explained in a statistically significant way by the presence or absence of particular referendum institutions. Hence, introducing referendum institutions in a country does not directly solve the problem of non-existent tax morale. Such an introduction, especially of a popular veto or a popular initiative, increases, however, the effect of trust on tax morale. Hence, in countries with sufficiently high levels of trust introducing such referendums might well lead to an increase in tax morale. At the same time, however, such referendum institutions might also decrease tax morale in countries with low levels of trust. Consequently, the vicious circle between tax morale and state capacities and thus trust is only partly broken by referendum institutions. Nevertheless, referendum institutions which are out of the hands of veto players offer an interesting policy tool according to our results. Hence, they might also be considered by some countries affected by the debt-crisis and suffering from low tax morale.

For a longer fully-documented version of the article see Hug, Simon and Franziska Spörri (2011). Referendums, trust, and tax evasion. European Journal of Political Economy, 27, 120-131.

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Note:  This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.

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About the authors

Simon Hug – University of Geneva
Simon Hug is professor at the Department of Political Science and International Relations at the University of Geneva, Switzerland. His research interests include the formation of new political parties, the effect of institutions, and more particularly referendums and federalism, on decision-making and conflict resolution, formal theory and quantitative methods. His most recent book is Value Change in Switzerland (co-edited with Hanspeter Kriesi, Lanham Lexington, 2010).

Franziska Spörri – University of Zurich
Franziska Spörri is an Assistant at the Department of Political Science at the University of Zurich. Her research interests are political economy, the effectiveness of development assistance, and micro-finance.

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