1

Tax Return as a Political Statement

Alexander Libman, Andre Schulz and Thomas Graeber

Frankfurt School of Finance & Management

April 2011

2

Motivation

Communication between politicians in democracies

Multiple channels (open media, public statements)

High credibility (audience costs as in Fearon 1994)

In autocracies these channels do not work

Absence of public discussion and control over media

Communication within bureaucratic hierarchies is flawed by the “Yes Men” (Prendergast 1993)

Absence of audience costs → difficult to ensure credibility (of both loyalty and disloyalty statements)

This paper

Examination of one particular channel of communication

Channel of communication of particular influence, since it affects tax evasion decisions and hence the tax compliance

Tax returns can be used as a political statement

3

Stylized argument

Link between tax compliance and political preferences

Standard argument: dissatisfaction with political decisions reduces tax compliance (Cowell 1992; Falkinger 1995)

Standard assumption: tax evasion is risky as opposed to tax compliance (though expected utility may be higher)

Tax return as a political statement

If the government is predatory and tax evasion is widespread, tax compliance may be risky as opposed to tax evasion

Being (somewhat) dishonest and transparent: limited monitoring ability of the government → easier to catch more transparent taxpayer

Being honest and transparent: often impossible due to catch-22 logic

Furthermore, there may be ambiguities in the law, which will be misused by the predatory state, if it is aware of the possible prize to catch

Governments often deliberately create catch-22 conditions: the blackmail state (Darden 2008)

Then higher tax compliance could credibly indicate either

Strength: handicap hypothesis (Zahavi 1975) or

Submission and loyalty: loyalty hypothesis

4

Data and empirical case

Dataset

Tax returns of the Russian regional governors published in 2010 for their income of 2009

Group of high-ranked officials: political signaling is more likely

Data available (what is very rare with the individual-specific taxation information)

On the other hand, multiple claims of inaccuracy of returns: thus, there may be space for strategic decisions

Institutional details

Limitations on the public discourse for the high-ranked officials in Russia in the late 2000s

Governors appointed, but not always unambiguously loyal to the center

Appointment strategies differ significantly and do not necessarily ensure control (see Libman 2010 for a related question)

5

Data and empirical case

Identification

A general problem of signals in non-democracies

An external observer could over-interpret them (think of the Kremlinology)

It is necessary to find another variable indicating political preferences (what is almost impossible for tax compliance studies)

We can do it: results of the federal elections in Russian regions

Numerous and convincing reports of manipulation in the late 2000s (Myagkov and Ordeshook 2008; Nureev 2010; Mebane and Kalinin 2010)

Governors engaged in ‘ensuring’ necessary election outcomes for the federal government (either Medeved / Putin or Edinaya Rossiya)

But there is significant variation of regional support of the leadership at the federal elections(48 to 99% in Duma elections 2007; 59% to 92% in presidential elections in 2008)

Our approach

Correlation between voting patterns and tax returns

Controlling for individual- and regional-specific chacteristics

Attempting to control for true income (as much as possible)

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Empirical strategy

Step I: Tax returns as political statement

Correlation between voting and tax returns

Significant and negative correlation: consistent with the stylized logic described above

Controls

True income: average income of bureaucrats in the region, business affiliation dummy

Person-specific characteristics: age, duration of stay in power, profession

Region-specific characteristics: distance from Moscow, territory, population, income per capita, dummy republic, fiscal transfers, oil and gas, total administrative expenditures, education, institutional charactetristics

Control of police and security services (Petrov 2009)

Step II: Disentangling between handicap and loyalty hypotheses

Total income of the governor’s household (husband + wife)

Effect is still present: loyalty hypothesis

Effect disappears: handicap hypothesis

… controlling for business connections of the wives / husbands

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Sample Almost all Russian governors (given data availability)

Key independent variable: share of votes for Medeved in 2008 (robustness: votes for Edinaya Rossiay in 2007 – results remain the same)

Exclusion of all governors appointed after 2008 (elections of Medeved)

No selection bias

Exclusion of three governors with extremely high income (Tver, Kaliningrad and Krasnoyarsk) – results mostly remain robust, but not for all sets of controls (possible small sample problems and multicollinearity)

OLS and TSLS (with democracy index in 1993-1999 as instrument) – results remain robust

Variable New governor Same governor Difference

Presidential elections

2008 (votes for

Medvedev)

69.576

No.obs.: 16

69.925

No.obs.: 66

-0.349

t-stat: -0.153

p-val: 0.879

Parliamentary elections

2007 (votes for

Edinaya Rossiya)

64.429

No.obs.: 26

64.667

No.obs.: 56

-0.238

t-stat: -0.095

p-val: 0.925

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Results: step I

(1)OLS

(2)OLS

(3)OLS

(4)OLS

(5)OLS

(6)OLS

(7)OLS

(8)OLS

(9)OLS

Share of votes for Medvedev in 2008 -74.924** -76.635** -82.194** -68.761* -85.402** -75.063** -84.218** -88.107* -80.009*

(34.421) (35.318) (35.684) (34.594) (33.402) (34.596) (40.468) (45.387) (41.423)

Year of birth -58.897 -63.555 -63.201 -64.917* -30.907 -40.528 -91.020* -14.076 -18.394

(39.775) (42.442) (38.480) (35.186) (34.693) (32.571) (51.232) (44.488) (44.201)

Year of appointment/ election 115.048 145.796* 113.905 83.855 71.712 47.549 79.894 40.979 63.978

(77.354) (80.466) (76.222) (72.246) (71.230) (67.339) (78.486) (69.328) (85.382)

Military -1,560.201

(1,002.219)

Economist -232.805

(1,381.228)

Bureaucrat -1,036.382

(964.745)

Business connections 585.884 466.772 601.594 542.867 396.306 608.842 566.011

(773.603) (754.479) (768.787) (760.713) (812.798) (792.267) (766.771)

Average salary of a bureaucrat 0.048** 0.037* 0.046** 0.060 0.054

(0.021) (0.020) (0.021) (0.051) (0.054)

Administrative expenditures 0.137

(0.094)

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Results: step II

(19)

OLS

(20)

OLS

(21)

OLS

(22)

OLS

(23)

OLS

(24)

OLS

(25)

OLS

(26)

OLS

Share of votes

for Medvedev

in 2008 9,282.983 -677.471 8,506.788 -677.892 -17,718.654 -827.367 -70,963.971 -597.414

(43,705.343) -976.671 (41,712.266) -981.912 (34,042.427) (1,064.475) (57,413.850) (1,224.561)

Year of birth -247,682.817 2,829.216 -232,739.205 2,835.415 -133,866.224 3,099.037 49,037.618 3,009.748

(198,902.258) (2,362.944) (182,960.977) (2,356.839) (87,460.679) (2,561.745) (58,707.172) (2,215.173)

Year of

appointment/

election 355,487.804 -1,657.427 313,835.075 -1,685.737 173,731.031 -2,086.593 32,880.665 479.265

(286,124.028) (2,737.337) (249,817.139) (2,854.643) (122,535.100) (3,115.344) (79,074.897) (2,174.200)

Business

connections -682,882.305 -27,728.343 -983,380.323 -28,037.089 -545,227.007 -26,736.614 -594,624.526 -23,928.927

(693,830.191) (18,283.503) (895,947.205) (18,419.675) (598,000.561) (17,825.815) (648,785.776) (17,750.959)

Business

connections of

the wife 44.208 0.084 48.469 0.090 0.360 -0.137 -122.324* -0.622

(42.563) (0.928) (43.824) (0.969) (20.572) (0.896) (66.832) (1.362)

Average salary

of a

bureaucrat 1577540.876 1,509.614 1012436.185 345.593 -211,966.742 -9,533.235

(1422475.239) (21,956.536) (1029795.381) (22,194.173) (748,130.597) (24,963.297)

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Conclusion

Key findings

Tax returns seem to have been used as political statements…

… and particularly as statements of strength

Relation to the literature

Tax compliance and political preferences

Very limited empirical literature due to lack of data (Prieto et al. 2006, Lago-Penas and Lago-Penas 2010, Torgler and Schneider 2006)

We add to the empirical evidence by showing that political attitude affects tax compliance and investigate an unusual channel of this linkage

No Taxation without Representation

Tax pressure can be endogenous to political attitudes due to tax compliance

Caveats

Ommitted variable bias (in spite of TSLS and some controls)

Small group irrelevant for taxation (but: in Russia share of large taxpayers is exorbitant; analogues in business tax compliance for companies owned by these governors)

Generalization (blackmail state found at least in Ukraine and in Peru though)