Market competition, fairness and tax compliance: The formal sector perspective

This study aims to investigate the effects of the formal sector’s perception of market competition and tax fairness on tax compliance. The data has been borrowed from the World Bank’s Survey for the years of 2006-2018 on 49,788 managers of the formal private firms in 140 countries and is analyzed by using the ordered logistic regression. Our results show that the formal sector’s perception of market competition and tax fairness affect tax compliance. This study also finds that the interaction between the formal sector’s perception of market competition and tax fairness significantly affects compliance. Firms will exhibit greater tax compliance if they consider the competition with the informal sector less intense and tax systems fair. Overall, the results imply that governments need to create conducive market competition and to create and implement fair tax systems. Our findings demonstrate that market competition between the formal sector and informal sector empirically affects tax compliance. A high level of perceived market competition between the formal sector and informal sector tends to motivate the formal sector to avoid taxes to remain competitive. The results are in line with Keen (2012); Benjamin et al. (2014); and McCann & Bahl (2016). Tax avoidance carried out by formal companies when perceived high level of competition with informal sector through two arguments, first is the effort made by taxpayers to reduce costs so that they can still compete in the market. This is in line with Shleifer (2004). Second, tax avoidance is only a result of the company's strategy to remain competitive in the market by lowering prices, which implies lower corporate profits and lower taxes which are often seen as tax avoidance. Further, perceived tax fairness also significantly affects tax compliance. When taxpayers perceive tax systems fair, neutral, and reliable, they are more likely to exhibit greater tax compliance behavior. Similarly, when taxes paid by the formal sector are commensurate with fairness received by formal taxpayers both distributive, procedural, and retributive, the formal sector tends to comply with tax regulations. Fair, clear, and consistent tax systems will then enhance tax compliance. The findings are supported by Akinboade (2015) and not in line with Zhiyong & Qingyang (2007) and Saad (2012). This study also shows that the interaction between the formal sector’s perception of market competition and tax fairness empirically affects tax compliance. The interaction between the formal sector’s low perceived market competition and high perceived tax fairness results in the highest tax compliance. The results imply that these two factors are not substitutive in the sense that high perceived market competition and high perceived tax fairness still do not lead to greater tax compliance. In a similar vein, low perceived tax fairness and low perceived market competition do not enhance tax compliance. Thus, governments need to reduce the formal sector’s perception of market competition and simultaneously to increase the formal sector’s perception of tax fairness to enhance tax compliance significantly. Only focusing on a single variable will not enhance tax compliance significantly.