Firm–government relationships: A social exchange view of corporate tax compliance

Abstract

Research SummaryThe economic exchange view of corporate tax compliance holds that when governments fail to provide adequate public services, firms comply less with taxes as quid pro quo. However, firms differ widely in the degree to which they respond to government inefficiencies in the form of tax noncompliance. We argue that such heterogeneity is largely because firm–government economic exchanges do not happen in a vacuum, but rather within the context of social exchange. Factors such as bribery, tax compliance burden, and consistency of tax enforcement affect firms' perceptions of fairness and trust in the social contract and moderate the quid pro quo in the economic exchange. We find broad support for our hypotheses in a sample from transition economies in Eastern Europe and Central Asia. Managerial SummaryFirms' propensity to pay their fair share of taxes is a function of the level of service provided by the government. Such an eye‐for‐an‐eye mentality would manifest more strongly when firms face higher levels of corruption or when they must shoulder a heavier tax burden; however, this mentality would be less apparent when tax enforcement is consistent and efficient. The degree of firms' effort to balance the economic relationship with the government is therefore influenced by how well they believe the social contract is upheld by their government within a broader social exchange relationship. While the prevalence of bribery and heavy compliance burden damages firms' perception of fairness and trust toward the government, consistent tax enforcement improves it.