Overview of the Income Tax System and Compliance Levels in New

138 FIGURE 1 The IRD Compliance Model Source: New Zealand Inland Revenue 2007. It appears that the IRD‘s compliance strategy, as represented by the IRD Compliance εodel and the IRD‘s audit approach, has been particularly fruitful in identifying tax discrepancies. For instance, the most recent data reported in the Annual Report of New Zealand Inland Revenue 2008 indicates a net total discrepancies of NZ1,449 million as compared to only NZ996 million in the previous year. However, the Annual Report suggests that maintaining high levels of voluntary tax compliance is a problem . This is evidenced by the number of taxpayers who were required to file tax returns but did not submit their return forms in the past three years. Eighteen percent of individual taxpayers did not submit their tax return forms both in 2004-05 and 2005-06 years New Zealand Inland Revenue, 2006, rising to 22 percent in the 2006-07 year New Zealand Inland Revenue, 2007. LOW HIGH Have decided not to comply Use full force of law Don‘t want to comply Deter by detection Try to, but do not Assist to always succeed comply Willing to do Make it the right thing Make it easy HIGH LOW Factors that influence taxpayer decisions and behaviour Attitude to compliance Compliance strategy Economic Sociological Taxpayer Business Industry Psychological 139 The above statistics were supported by a research undertaken by the IRD in the 2006-07 year New Zealand Inland Revenue, 2007. This research, carried out on half a million return filing and paying tax events between 2001-2005 years, showed the following preliminary results: 1 83 percent of the returns complied with the majority completing all relevant filing and tax paying obligations; 2 nine percent of returns had a moderate level of compliance issues; 3 and eight percent demonstrated poor levels of compliance. These findings indicate that at least 17 percent of individual taxpayers in New Zealand have not complied in some form with the tax system. 16 It is important to note that this research focuses on taxpayers who have some choice about compliance and excludes taxpayers who are employees and have tax deducted at source through the Pay As You Earn PAYE system New Zealand Inland Revenue, 2007. In addition, Caragata 1998 reports that the estimated tax gap in New Zealand has increased substantially from NZ82 million in 1969 to NZ3.2 billion in 1994. More recent data from the IRD reports an amount of NZ996 million of tax discrepancies in 2006-07, of which NZ375 million was due to the tax avoidance and evasion practices New Zealand Inland Revenue, 2007. The figure shows an increase of 15 percent from the previous year. These statistics could possibly be attributable in part to the tax fairness issue as suggested by Etzioni 1986. 17 16 The percentage could be higher since the research results clearly stated that most of taxpayers 83 percent complied with the majority i.e. not fully complying of their filing and paying obligations. 17 However, it must be noted that fairness of the tax system may not have an impact on hard- core evaders‘ decisions, etc. 140 The above discussion indicates that the use of the IRD Compliance Model contributes to increasing tax collection through focussed tax audits but not to the same level of promoting voluntary compliance. Thus, the issue of voluntary tax noncompliance among taxpayers in New Zealand is a very relevant concern.

3. Literature Review and Hypotheses Development

This section provides an overview on the relevant literature on tax fairness perceptions, tax compliance and the variables under investigation, and is followed by hypotheses development.

3.1 Tax fairness perceptions

Previous studies indicate that fairness perceptions can take various forms. First, vertical fairness, which asserts that taxpayers with different economic situations should be taxed at different rates Erich et al., 2006. This would result in higher income earners paying tax at higher rates than low-income earners. Another component is, horizontal fairness, defined as ‗the equal treatment of equally circumstanced individuals‘ εichael, 1978. In other words, horizontal fairness recommends that taxpayers of similar economic positions should pay the same amount of tax. In addition to vertical and horizontal fairness, Bobek‘s 1997 study on the US tax system is also concerned with procedural fairness and policy fairness. Procedural fairness relates to the process employed to reach distribution outcomes while policy fairness deals with the content of the tax law. Another significant fairness dimension is exchange fairness Gilligan Richardson, 2005; Gerbing, 1988, which represents the exchange of contribution and benefit between taxpayers and government. This 141 dimension of fairness holds that taxpayers will have fair perceptions of the tax system if the benefits received from the government is equitable compared to their tax contributions. Other dimensions of fairness include a preference for either progressive or proportional taxation Turman, 1995, personal fairness, tax rate fairness, special provisions and general fairness Gilligan Richardson, 2005; Richardson, 2005; Christensen Weichrich, 1996; Christensen et al., 1994; Gerbing, 1988. The above review on studies of tax fairness suggests approximately ten dimensions of fairness. However, in this study, five dimensions are identified to be important in assessing the fairness of the income tax system. The dimensions are: overall fairness, exchange fairness, horizontal fairness, vertical fairness and administrative fairness. Overall fairness simply measures individuals‘ judgments whether the income tax system is generally fair or not. While exchange fairness is concerned with a reciprocal exchange between taxpayers and the government, horizontal fairness considers equal tax treatment among taxpayers in similar economic positions. Vertical fairness is assessed based on the ability to pay and preference for tax rate structure, either flat rate or progressive. Administrative fairness, on the other hand, relates to the content of the tax law policy fairness, procedures employed by the tax authority procedural fairness and the fairness of punishments imposed retributive fairness. Thus, based on the prior literature, it is therefore hypothesised that: H 1 : Fairness perceptions on the New Zealand income tax system is multi- dimensional.