Shining the Light on a Culture of Tax Evasion
Research by professors Adair Morse and Margarita Tsoutsoura has influenced the debate in Greece as the stricken country tries to climb out from under a mountain of debt.
Adair Morse Margarita Tsoutsoura
Tax evasion, particularly among the professional classes, has been an open secret in Greece for years. Such a foregone conclusion, in fact, that banks loaning to individuals find it necessary to estimate their clients' "true" incomes when determining how much money to lend them.
Last year, in the midst of the country's financial crisis, the problem took center stage as a result of research by Adair Morse, associate professor of finance, and Margarita Tsoutsoura, assistant professor of finance. The researchers published a groundbreaking paper that quantified the widespread tax evasion for the first time and forced Greek policy makers and the public to confront some unpleasant truths.
When the researchers presented their findings at a conference in Athens last summer, members of the Greek finance ministry, leading academics, and the media all took note. Officials from the International Monetary Fund and the European Commission did, too.
"The paper had significant impact," said Nikos Konstandaras, managing editor of Kathimerini, one of Greece's leading newspapers. "We gave it prominence because it was very interesting to our readers and made an important contribution to the debate."
Not for the first time, Booth research was helping to define the conversation on fundamental economic questions.
A native of Greece, Tsoutsoura knew tax evasion was a fact of life in her home country. But just how pervasive was it? She and Morse, along with Nikolaos Artavanis, assistant professor at the University of Massachusetts at Amherst, were determined find out.
The researchers realized Greek banks had a strong financial incentive to calibrate their clients' true incomes against what they reported to the government in order to determine how much loan money to offer. So Morse, Tsoutsoura, and Artavanis obtained access to loan data from one of the country's large banks and compared it with government data. They documented what they found in their paper, "Tax Evasion Across Industries: Soft Credit Evidence From Greece."
They found that self-employed, highly educated professionals such as lawyers, doctors, and accountants evaded more income tax than lower income occupations. In sum, tax evasion by the self employed was worth at least a stunning total of $38 billion (€28 billion) in 2009.
Assuming that money would have been taxed at 40 percent, the lost revenue was equivalent to almost a third of that year's budget deficit shortfall of $48 billion (€35.4 billion).
In their data comparison, the authors found that if one believed the monthly income that self-employed households reported to the tax authority, these households would have had to spend 59 percent of their monthly income just servicing debt. In the case of the highly educated professionals - lawyers, doctors, financial service professionals, and accountants - the ratio rose above 100 percent.
The authors understood that these numbers were outlandish. Not only would such accounting leave loan-takers with, at most, a fifth of their income to live on, it also would mean a borrowing rate far above the 30 percent level seen as standard practice by banks in Greece and elsewhere across Europe and the United States.
In reality, average self-employed workers earned almost twice as much money as they declared in their tax returns. The biggest offenders were professionals, with doctors earning two and a half times what they reported.
"It is one thing to say that an economy has pervasive tax evasion, it is another thing when you can demonstrate it with scientific evidence and put it out as a platform for people to use," Morse said.
Revelations of widespread tax evasion came as no surprise to many jaded Greeks, who say off-the-books payments were as part of the culture as fishing and olive oil. Evasion was taken for granted and almost considered beneficial, and it was common for people to negotiate a lower fee or lower price in exchange for not taking a receipt.
"If you go to the doctor you are going to have to pay under the table or you're not going to get health-care service," said Elena Panaritis, a former Greek member of Parliament and founder of Thought For Action, an interactive internet-based platform for knowledge sharing.
Yet quantifying the sheer extent of the tax evasion, as Morse and Tsoutsoura did, struck a nerve with an already-disgruntled Greek public and forced policy makers into action.
The researchers' findings came at a time when foreign-imposed austerity measures had left the country reeling from a decline in living standards. The multibillion-euro bailout by the so-called troika - the European Union, European Central Bank, and International Monetary Fund - had triggered mass protests from Greeks angry at the impact that the terms inflicted on their livelihoods.
While tax evasion certainly undermined Greece's efforts to pay off its debt, it is not the only reason the country fell into a financial morass in the first place. Greeks also took advantage of the cheap borrowing rates available in Eurozone countries.
After Greece adopted the euro, public sector wages rose 50 percent between 1999 and 2007 - far faster than in most other Eurozone countries. The government also ran up big debts paying for the 2004 Athens Olympics. After years of overspending, the budget deficit ballooned out of control. Tax evasion didn't help.
After it emerged in 2010 that the government had concealed the scale of the deficit, the ensuing financial crisis forced Greece to accept a $140 billion loan from the troika. A year later, it accepted another $165 billion to defuse speculation that Greece would have to quit the euro.
The Booth research made it clear that not all Greeks were sharing the pain equally.
The day after the authors presented their paper, the Greek media pounced on its findings. The newspaper, Kathimerini, featured the research on its front and inside pages, and for the next week it was a top story on television and the web.
The newspaper credited the researchers with bringing to light an issue that "by its nature and previous government laxity is forever clouded in mystery and hearsay," Konstandaras said.
The International Monetary Fund cited the research in a January review of its lending to Greece that ultimately led to the approval of the next tranche of the IMF loan.
The IMF said the Booth research showed that the losses to the state from tax evasion were "enormous." It suggested that in 2012 unreported income was worth 6 percent of GDP or $15.3 billion, and potential income tax losses of about 1 percent to 1.75 percent of GDP.
A spokesman for the European Commission, which monitors the ongoing situation in Greece, said staff involved in the Greek program had looked at the Booth research, which he said provided some "interesting insights and uses an original methodology."
EYES ON PARLIAMENT
It wasn't only middle class professionals that were evading taxes. In 2010, Christine Lagarde, then French finance minister (and now managing director of the IMF), sent to Greek officials a list of 2,000 wealthy Greeks who held Swiss bank accounts.
The journalist who broke the story of the Lagarde list two years later, Kostas Vaxevanis, was arrested on a charge of breach of privacy brought last fall by a Greek government desperate to keep a lid on the revelations. He ultimately was acquitted, but the prosecution sparked another round of headlines around the world.
While the Lagarde list erupted into its own political issue, it was the Booth paper that unveiled the tax issues underlying it, Konstandaras noted. "In the end I think the direction shown by the methods and conclusions of the paper will be of greater significance than the Lagarde list scandal," he said.
The Booth research hit a nerve not because it cited the wealthiest Greeks, but because it shined a spotlight on the large numbers of tax-evading self-employed workers - an estimated one third of the Greek workforce.
The research also turned attention to the professional class. Previous governments were understood to be afraid to pursue the tax-evading classes, including lawyers and medical doctors, because there would be a flight of capital. "This was the justification for turning a blind eye in a country that was starved of cash," said Dimitri Sotiropoulos, a senior research fellow at the Hellenic Foundation for European and Foreign Policy in Athens and associate professor of political science and public administration at the University of Athens.
A blind eye, too, because the professional class comprises sectors represented by members of Parliament.
In 2010, Parliament debated a bill that specifically targeted doctors, dentists, lawyers, architects, and engineers - the professions later revealed as being at the heart of tax evasion. It would have mandated tax audits for income reported below a certain threshold.
But the bill failed to pass and the researchers noted how the occupations represented in Parliament match up with those that evaded taxes, and not just lawyers. Half of the non-lawyer parliamentarians were in the top three tax-evading industries, and nearly two thirds in the top four evading industries.
Members of Parliament have protested that they did not act unethically, but that they had little incentive to pass tax reform that would harm their own professions.
The overlap between the professions and Parliament that the research identified is a reason why so many well-paid people have been able to evade tax, Sotiropoulos observed. "It explains the leniency with which tax legislation has been written and implemented."
There is no doubt that the embarrassing revelations by Morse and Tsoutsoura's research have created impetus for reform. The question is, will it be enough? "You have to ask, 'Where is the political willpower to make change?'" Morse said.
THE PUSH FOR REFORM
And yet, there is some evidence that politicians are willing to take action. In January - three years after the failed bill - lawmakers overwhelmingly voted to increase taxes on middle- to high-income earners, self-employed professionals, and businesses.
"What we are seeing now is that discipline by party leaders has been strong enough to counterbalance this natural tendency of resisting changes that will affect their own professions," Sotiropoulos said.
Herakles Polemarchakis, the government's chief economic adviser until 2011, said he was "mildly optimistic" that the government would succeed in its efforts to crack down on tax evasion. "Changing the laws makes a big difference," he said. "It is an excuse to say that it is there in the DNA of people to cheat, so there's nothing we can do and should forget it. I don't think that's the case."
It is unfortunate that members of Parliament waited until the sixth year of recession to clamp down on tax evasion by professionals, Konstandaras said. That means reforms will yield much lower revenues than if they had been implemented earlier.
"This is not to say that the measures should not be taken, only that the damage to the economy, and to people's faith in the system, is already great," he added.
In their paper, Morse, Tsoutsoura, and Artavanis suggested that the authorities use trade associations that issue permits as a forum for tax collection.
Artavanis said that linking the permits to factors such as the applicant's occupation, business location, and the number of years operating a practice would make it easier to identify evasion.
For example, if a professional's permit specified an income of around $80,000 a year, then he would need to explain to the authorities why he was declaring only $40,000. "This is the right direction to go because the burden of proof moves from the government to the professional," he said.
Ultimately cultural change is needed, and it won't happen quickly, Sotiropoulos said. "Changes of mentalities and reflexes do take some time."
The researchers are optimistic. "I think we are moving in the right direction so I want to be hopeful and believe that things can get better," Tsoutsoura said.
Artavanis believes Greeks increasingly see taxes as a "common responsibility" with consequences for their standards of living. "It is becoming harder and harder to justify this sort of behavior and people increasingly now ask doctors and lawyers for receipts so they know they will have to pay their taxes," he said.
Konstandaras is more pessimistic, saying that Greece now faces a "crisis in trust."
"People do not believe that the state - and notably the tax and justice systems - are fair," he said. "They see that those who can get away with evading taxes do so, while the rest are forced to pay ever higher taxes with incomes that are continually reduced."
Perhaps the long-term positive impact of this research and other revelations regarding tax evasion is that Greek citizens now understand the consequences it has on their lives at a time when the country is struggling to emerge from a historically unprecedented debt explosion.
"If people were to begin to see fairness in the tax system, they would be more prepared to accept the reforms that have changed their lives," Konstandaras added. "So, for us, taxes are a major issue and this shows in our coverage of the research."
A visit to a Greek tourist shop a few years ago brought the problem of tax-evasion reform home to Christopher Pissarides, a Nobel laureate, economist, and professor at the London School of Economics.
"The owner told me that we all needed to abide by the law and pay taxes," recalled Pissarides, a former member of the Central Bank of Cyprus' interest rate committee.
"But when it came to the time for me to pay he said, 'Would you mind me not giving you a receipt because when these people in Parliament start doing what they should, then I will start giving receipts.'"
In the News
The Booth research was picked up by major news media outlets across the world after the authors disclosed their findings at a conference in Athens during the summer of 2012.
"Nikolaos Artavanis, Adair Morse and Margarita Tsoutsoura cleverly exploit a discrepancy."
The Washington Post, July 9, 2012
"The economists were also able to identify the top tax-evading occupations - doctors and engineers ranked highest - and found they were heavily represented in Parliament."
The Wall Street Journal, July 9, 2012
"A new study provides startling insights into the culture of tax evasion."
The New York Times, September 1, 2012
"An intriguing study."
Financial Times, September 4, 2012
"The trio use a novel technique to calculate levels of tax evasion in Greece."
The Economist, September 4, 2012
"An in-depth study blames the current malaise not on dodgy taxi drivers or moonlighting refuse collectors, but on the professional classes."
The Guardian of London, September 9, 2012
"The shocking scale of tax dodging in Greece is laid bare in a report showing that professionals are among the worst offenders."
Daily Mail of London, September 11, 2012
"Tax evasion - not avoidance - costs Greece 28 billion euros annually, according to a study by the University of Chicago Booth School of Business."
CNBC.com, November 1, 2012