Trust and Tax Compliance among Malaysian Working Youth

ABSTRACT This paper presents the results of a survey on tax compliance amongst working youth in Malaysia. One of the two trust variables and tax knowledge were found to be significant determinants of filing tax returns. Trust in the tax authority strongly predicts the level of tax compliance while trust in the existing tax system is currently low among the working youth and fails to predict compliance. In addition, youth in the registered taxpayers group exhibit greater level of compliance intention than non-registered youth. Therefore, greater awareness programs on the importance of registering as taxpayers and tax filing upon the countrys economic development can be taken by the related authorities to encourage more trust on the existing tax system and voluntary compliance amongst working youth.

I.

INTRODUCTION

Tax non-compliance can be considered as an evergreen issue in a nation. High tax compliance level among taxpayers helps in reducing the monitoring and auditing duties of the tax collector. In addition, it can help the tax revenue target set earlier to be easily achieved because many developmental states including many Asian countries rely more on targeted taxation than high levels of tax collection (Sindzigre, 2007). In particular, targeted taxation is chosen because of the high level of subsidies currently been used in Malaysia in prices of common goods such as petrol, cooking oil and sugar. As a legal entity to collect tax, the Inland Revenue Board of Malaysia (IRBM) has undertaken many initiatives to promote compliance and deter tax evasion in order to ensure the ruling governments targeted tax revenue is achieved.

Tax revenues serve the most important role in supporting a government spending. The government needs a good and stable financial resource to manage a whole nation. As a development state, Malaysia tends to set an annual targeted taxation to finance the anticipated expenses including public health care, education and national defense. For example, the IRBM in 2010 was able to collect RM79.54 billion in direct tax collections, exceeding the target of RM76.16 billion (IRBM, 2011). In the same year, as many as 1,572 non-compliance cases were charged in court with estimated tax revenue of RM90.09 million. With the introduction of Self Assessment System (SAS) in 2001 which has reduced a lot of clerical consulting tasks, the IRBM has been able to increase the audit duties to combat the non-compliance problem.

Promoting tax compliance can be carried through economic measures such as adequate monitoring through auditing as well as efficient penalty for tax offenders. In order to achieve this aim, the tax authority of a particular nation should be granted sufficient power to carry out its duty. In addition, high tax compliance can also be expected when the public has high tax morale. This socio-psychological aspect of the public can encourage more voluntary compliance rather than enforced compliance achieved through pure economic measures. Among the public segments that potentially has high level of noncompliance and having relatively low tax morale is youth who are arguably having low sense of responsibility towards the society as a whole (Wearing & Headey, 1997). By contrast, older people are less likely to justify cheating on taxes than younger people (OECD, 2012). Therefore, the present study was undertaken to assess whether or not trust and tax literacy act as determinants of tax compliance among the working youth in Malaysia.

II.

TAX SYSTEM IN MALAYSIA

Background Tax system in Malaysia follows rather a standard tax regime practiced in most of its counterpart nations. Currently, taxes are levied to individuals and corporations in the forms of tax on occupational, business and investment incomes. Income tax in Malaysia is territorial and imposed only on income that has Malaysian source except for banking, shipping, air transport and insurance industries where the global income rule is applied. In general, the personal income tax system in Malaysia is progressive in nature as the tax rate increases as an individuals income increases.

The taxpayers are categorized by residency status. The status determines the difference tax rates, deductions, reliefs and rebates. Most non-residents taxpayers are taxed via withholding tax mechanism and subjected to double taxation agreement (DTA) between their countries and Malaysia, if the DTA exists. The country has implemented current year assessment since 2000 followed by SAS in 2001 for companies, and 2004 for individual taxpayers.

Inland Revenue Board The Inland Revenue Board of Malaysia (IRBM) has been given the authority to administer and regulate the laws, as passed by the Parliament to ensure that they are carried into effect and to make the tax system work. The main purpose of its existence is to secure and collect revenue incomes for the government. In achieving this purpose, the IRBM has the responsibilities to encourage and assist voluntary compliance, deter tax evasion, maintain public confidence in the integrity of the tax system, administer the tax laws fairly and create a climate of public trust their fairness, impartiality and firmness (IRBM Act, 1995). Besides advising the government on matters related to taxation, the IRBM is also appointed as a collection agent for government and on behalf of any statutory body to recover the unpaid loans to that body under any written laws in Malaysia.

IRBM has engaged in many activities in promoting high level of tax compliance in Malaysia such as continuous tax education programmes designed to provide exposure and awareness on taxation laws to IRBMs clients and future taxpayers. Besides educating, it provides a forum to inform and update clients on their rights and responsibilities as taxpayers in order to increase the rate of voluntary tax compliance (IRBM, 2010). Implementing an effective tax audit programme serves as a key factor in ensuring that the level of tax compliance continues to improve and that taxpayers comply with the provisions of applicable tax laws and regulations, particularly within the environment of a SAS for individual taxpayers which was introduced in 2004.

Working Youth Taxpayers The Ministry of Youth and Sports of Malaysia (MYSM) adopts the youth definition as those who are in the age range between 15 to 40 years old consistent with the Youth Association and Development Act 2007. Youth in Malaysia currently represents 46 percent of Malaysian population (MSYM, 2010). As at 2010, this segment consisted of 12,808,667 individuals of the 27,565,821 total population,while 7,875,100 from this figure were identified as labour force(Department of Statistics, Malaysia, 2010). Given the high number of working individuals in this segment, potential implications of compliance as well as noncompliance in tax matters are high.

In general, youth are found to have low financial literacy; hence poor financial planning which result in carrying large amount of debt early in their lives (Lusardi Mitchell & Curto, 2010). Their daily activities tend not to align with their long-term financial aims. These have happened due to delaying activities to achieve targeted financial objectives and not having many responsibilities such as having families. In many instances, youth are one of the segments that exhibit low level of compliance such as safe driving and adhering to speed limits (Elliott, Armitage, & Baughan, 2003; Scott-Parker, Watson, King & Melissa, 2012). Relating to commonly perceived behaviours of youth, tax non-compliance can as well be a major concern for tax authorities.

With respect to tax matters, youth between 18 to 45 years old were found to be less compliant than older individuals (Houston & Tran, 2001). Tax evasion cases among this segment revolve around under reported incomes as well as over-claiming tax deductions (Braithwaite, Smart & Reinhart, 2010). Younger taxpayers are more risk-seeking, less sensitive to penalties and reflect the social and psychological differences related to the period in which they are raised (Richardson, 2006). Other suggested explanations include younger taxpayers may be lacking capacity to fulfill taxpaying requirements (Braithwaite, Smart & Reinhart, 2006), they may be more defiant of conventional authority (Kirchler, 1999) and they may regard taxation as unfair, warranting political resistance (Watts, 1999).

Tax Compliance Tax compliance can be defined as reporting all income and paying all taxes in accordance with the applicable laws, regulations and court decisions (Alm, 1991, p. 577). Among the popular efforts to increase compliance include audits and penalties (Sandmo, 2005). However, more recent studies in the area have included socio-psychological factors that can further explain the behaviour.

High tax non-compliance such as high rate of tax evasion can cause a government to spend less on public societal benefits. In addition, high tax compliance reduces a tax authoritys costs of promoting and regulating tax income collection. According to IRBM, the average tax compliance rate in Malaysia is 74% (The Star, 2012). The figure seems to improve every year, and as reported for year assessment 2007, the compliance rate was 83.7% (Loo & McKerchar, 2012).

Tax compliance decisions have been poorly predicted by the traditional model that includes monitoring probability and expected penalty (Ruiu & Lisi, 2011). Hence, later works on tax compliance

have introduced the concepts of tax morale and the slippery slope framework which are believed to be able explaining the bahaviour better. These socio-psychological variables such as fairness and social norms can explain tax compliance behaviour because the residents of the country feel an obligation to do so; hence, not a result of fearing the costs of non-compliance.

Tax morale can be defined as as the intrinsic motivation to pay taxes arising from the moral obligation to pay taxes or the belief in contributing to society by paying taxes (Cummings et al., 2009; Frey and Torgler, 2007). On the other hand, the slippery slope framework suggests that compliance can either be voluntary or enforced and these are influenced by the trust in the tax authority and the power of tax authority, respectively.

III.

RESEARCH MODEL AND HYPOTHESIS DEVELOPMENT

Tax morale has been used as a proxy of tax compliance by some studies (e.g., Torgler & Schneider, 2007 and Torgler, 2003) but it underestimates actual compliance decisions (Ruiu & Lisi, 2011). For this reason, we used filing tax return intention as the proxy for tax compliance. This is also in accordance with the IRBM in releasing their annual tax compliance based on tax filing data and has been used in several local studies (e.g., Loo & Hoo, 2005; Mohamad, Ahmad & Deris, 2010; Palil & Mustapha, 2011). Furthermore, as taxpayers file their annual returns, they can expect to receive any excess tax payments and at the same time avoid potential penalty of not filing it on time.

Trust has been examined in a large literature from social and philosophical perspectives (Olsen, 2008). Although there are disagreements in its definition, trust is very much associated to individuals perceived vulnerability as a result of others actions. Rousseau et al. (1998, p. 395) put forward a good working definition of trust that is a psychological state comprising the intention to accept vulnerability based upon positive expectations of intentions and behavior of others.

In taxation literature, trust is deemed a significant attitudinal variable that shapes tax morale among the public (Torgler and Schneider, 2007b) and that trust can be composed by horizontal trust (among taxpayers) and vertical trust between taxpayers and the state (Frey and Torgler, 2007). In other words, tax rules which are perceived to be fair will have high horizontal trust among taxpayers while a just and efficient tax authority shapes high vertical trust.

Tax evasion can be caused by a number of factors, but trusting the tax system can be considered the main one (Hammar, Jagers & Nordblom, 2009). Although we are more concerned with tax filing compliance than tax evasion per se, we have included trust in the tax system in the research model (see Figure 1). Trust in the tax system can be viewed as either taxpayers perceptions on the fairness, tax burden and tax distribution. Fairness is related to the perceived balance of taxes paid and public goods received, and to the perceived justice of procedures and consequences of norm breaking (Hoffman, Hoelzl & Kirchler, 2008) whereas distribution justice relates to a fair exchange of resources, benefits, and costs, and is distinguished as horizontal, vertical, and exchange fairness (Kirchler, 2007). A resident who perceives the current tax system as unfair tends to exhibit low level of compliance including late filing or even not filing tax returns at all. Hence, we are interested to test the following hypothesis: H1 : Trust in the tax system is positively related to filing tax return intention.

Trust in tax authorities relates very much to taxpayers perception on procedural justice of the existing tax systems (Kirchler, Hoelzl & Wahl, 2008). In addition, high compliance can be expected from trusting the tax authorities (Torgler & Schneider, 2007a). Similarly, Feld and Frey (2007) highlight the importance of how taxpayers feel they are treated by tax authorities and refer to a psychological contract and a relationship of mutual respect that leads taxpayers to behave loyally and to pay taxes honestly. In several studies, trust in tax authorities is found to be positively correlated with tax payments (e.g., Hammar et al. 2009 and Torgler, 2003). In the similar vein, we formed our next hypothesis as: H2 : Trust in the tax authority is positively related to filing tax return intention.

Tax knowledge can be acquired through formal education which enables individuals to understand tax better (Bahari & Ling, 2009). Nevertheless, there is currently no tax syllabus being formally taught in public education systems in Malaysia. Therefore, for the public to learn about tax is through experience of filing tax returns themselves or through awareness programmes run by related agencies. Self assessment system itself demands taxpayers to learn tax laws which can be a burden to new users (Natrah, Muzainah & Idawati, 2003) but over time, the taxpayers will become more literate in tax especially those related to tax laws. By understanding the tax laws, people are more willing to respect the tax system including in complying with its requirements (Eriksen & Fallan, 1996). In addition, we expect that increased in tax knowledge in individuals will help them form positive trust in the tax system and tax authorities. Based on these arguments, our tested hypotheses related to tax knowledge are: H3 : Tax knowledge is positively related to filing tax return intention. H4 : Tax knowledge is positively related to Trust in the tax system. H5 : Tax knowledge is positively related to Trust in the tax authority.

Based on the preceding discussion, we used the following research model to test the stipulated hypothesis.

<insert Figure 1 about here>

IV.

RESEARCH METHODS AND FINDINGS

Measurements Driven by an objective to understand key factors that encourage high tax compliance among Malaysian working youth, a survey based on the research model in Figure 1 utilising measures in Table 1 was conducted on youth registered in the database of the Ministry of Youth and Sports Malaysia. In Table 1, trust in the tax system was measured by six items, trust in the tax authority was measured by seven items

and compliance in filing tax returns was measured by five items. In addition, measures on tax knowledge were based on tax self-administration, basic and advanced levels1.

<insert Table 1 about here>

A free online platform was used to administer the survey to youth registered in the ministrys database. Over a period of three weeks, a total of 2,030 responses have been received. The researchers decided not to prolong the survey after being advised that the number of respondents is deemed satisfactory and common in any previous surveys conducted by the ministry themselves. From the total responses, only 500 were randomly selected and used in the analysis so as to mitigate the potential problem of reduced effect size (Hair et al., 2006). The software used to complete the study was SmartPLS (Ringle, Wende & Will, 2005).

Descriptive The descriptive figures of this sample are given in Table 2 and scores on tax knowledge are given in Table 3. Note that we had used score of 1 for correct answer on tax knowledge items while 0 is used for wrong answers, missing answers and dont know.

<insert Table 2 about here> <insert Table 3 about here>

More than half of the selected sample respondents are in their prime youth age while only 36 respondents are between 30 and 40 years old. Among this sample, majority are non-registered taxpayers and Malays. As for the score on tax knowledge, they can be considered as having poor tax knowledge with the mean scores for tax administration, basic and advanced knowledge are 2.73, 4.31 and 4.25
1

Measures of tax knowledge can be obtained from the corresponding author.

respectively. Surprisingly, the numbers of respondents who scored zero in the tax knowledge questions seem to indicate that many of them are not very familiar with taxable income and deductions.

Validity of Instruments Validity of measures was checked by examining the composite reliability (CR), average variance extracted (AVE) and Cronbachs Alpha. From the original measures, only one item (TRS4) was

discarded due to low loadings, while the remaining items exhibits strong validity as reported in Table 4. Note that tax knowledge was measured by using the total score of all tax knowledge questions.

<insert Table 4 about here>

Between construct validity was assessed by checking whether or not each construct measures what it is supposed to measure. In this approach, the latent constructs correlations were compared against the square roots of AVE. For this study, Table 5 shows that all inter-construct correlations were less that the constructs square root of AVE which demonstrates good discriminant validity.

<insert Table 5 about here>

Structural Model The structural results of the research model are presented in Figure 2. The PLS algorithm used in the study was standardized item scores, centroid weighting scheme with 300 maximum iterations. The results indicate that filing tax return intention can be reasonably predicted by the model with 21.3% variance explained by the exogenous variables. Only two significant relationships were found from the five stipulated relationships; these are TRA FRI (weight = 0.426) and TK FRI (weight = 0.126). In addition, trust in the current tax system failed to explain the likelihood of tax filing while tax knowledge could not explain both the trust variables. The summary of findings is given in Table 6.

<insert Figure 2 about here> <insert Table 6 about here>

Multigroup Analysis We further analysed the PLS results between groups of registered and non-registered taxpayers. The variance explained for non-registered taxpayers is 23.4% for FRI, while it is only 20.2% for registered taxpayers. The low difference can be attributed to the mixed relationships between variables within the different groups. Here, results of the t-spooled analysis provided in Table 7 showed two significant differences in between-variable relationships between the two groups; these are TK FRI, TK TRA relationships. In particular, registered taxpayers demonstrated high positive relationship between their tax knowledge and filing tax return, whereas non-registered taxpayers intention to file tax returns could not be explained by their tax knowledge. Furthermore, the relationship between tax knowledge and trust in authority for registered taxpayers seemed to be negative (but not significant), while the similar relationship for non registered taxpayers is significantly positive. One possible explanation to these differences is that the registered taxpayers having filed tax returns before have learnt something more than non-registered taxpayers about taxation matters and hence the tax authoritys efficiency may fall short of their expectation.

<insert Table 7 about here>

V.

DISCUSSION AND CONCLUSION

Using the 500 randomly selected sample from the 2030 working youth respondents, we found two significant relationships out of five stipulated hypotheses. Trust in tax authority strongly predicts filing tax return intention followed by tax knowledge while the remaining three relationships were not found to be significant. The relatively high trust in tax authority as compared to trust in the existing system can be

explained by the potential increased in satisfaction on the efficiency of the current tax authority and its improved as well as transformed services. In particular, the self assessment system which was introduced in 2004 could play a major role in this relatively high trust and this is supported by the increasing rate of tax filing returns via the online system. Therefore, even without promoting positive trust in the existing tax system, IRBM can always find rooms for improvements in their services to promote greater level of compliance among the taxpayers, especially those of the working youth.

Overall, this study found that the current level of tax literacy among working youth in Malaysia is still low. Hence, education campaigns need to be targeted at younger age groups to ensure they know about their obligations to the state. Furthermore, increased tax literacy can explain the likelihood of the youth to comply with filing tax returns. Nevertheless, in determining the relationship of tax knowledge on trust, we found that increased in tax knowledge does not necessarily lead to increased trusts in the tax system and tax authority. As taxpayers accumulate more knowledge regarding tax either via formal readings or through experience of filing tax, they seem to exhibit stronger intention to complete tax filing exercise in the future. This finding seems to suggest that tax knowledge has an influence on the tax morale of individuals as they become more responsible and understand better about the importance of contributing to public spending through tax when they are more tax literate.

Trust in the existing tax system is low among the sample and it does not relate to their intention to file tax return. This trust element normally relates to political aspect of the nation especially regarding public confidence in the competency and integrity of the existing government. As such, it tends to be biased towards public sentiments of sensitive issues including political rumours. Based on World Values Survey data, trust in government in Asia countries was second lowest among the participating countries (OECD, 2012). In addition, the public support of the existing government has followed a diminishing trend since the last two elections and the future ruling government is very much in cloud. Therefore, a suggestion to

overcome this issue is through increasing the transparency of tax policy making and modernize tax administration procedures.

After the sample was split into two groups based on taxpayer status, we also found two significant relationships within each of the group. Trust in tax authority remains strong determinant of tax compliance in both groups. Nevertheless, tax knowledge effect on compliance is only significant for registered taxpayers. In addition, tax knowledge was found to be positively related to trust in tax authority for nonregistered taxpayers. The relationship between tax knowledge and filing return intention is stronger among registered taxpayers suggesting that their tax knowledge increased after having registered or filed tax return before, hence more willing to continue filing tax returns. Interestingly, the multigroup analysis also showed that registered taxpayers with high tax knowledge seemed to trust the tax authority less, while nonregistered taxpayers with relatively high tax knowledge demonstrate positive attitude towards the IRBM. This finding indicates that as taxpayers become more tax literate through filing tax returns exercises, they are likely to question the competence of the tax authority and demand more actions that can meet their expectation. This in turn leads to them achieving cognitive trust as Olsen (2008) argued that cognitive trust is primarily related to perceived competence and reliability of the provider, where perceived competence is easily demonstrated by past performance. Therefore, we believe that IRBM should continue improving their offered services to taxpayers while at the same time find ways to encourage non-registered taxpayers to register as early as they can because their image among them is currently being perceived to be positive.

This study has some limitations that future research can improve. First, the relatively low variance in compliance variable being explained by the research model indicates that there are potentially many other variables which can be included to increase the prediction of compliance behaviour. Second, this study is cross sectional, a longitudinal study would be advisable to compare the current stage of e-filing implementation with those improved functions of the system in future.

ACKNOWLEDGEMENT
The authors would like to express our thanks to the Ministry of Youth and Sports of Malaysia for financial support and cooperation in the survey administration.

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Figure 1: Research model used in the study

Figure 2: Results of structural model

Table 1: Item Measures Items TRS1 TRS2 TRS3 TRS4 TRS5 TRS6 Definition/Statements Youth perceived trust in the current tax system in Malaysia. Income tax rate in Malaysia is ______ (1-unfair:5-fair). Generally, the income tax system in Malaysia is fair. Overall, the burden of tax in Malaysia tax systems has been fairly distributed. Current tax rates are far too high. (R) Tax revenue is wisely spent by the government on project and infrastructure that are beneficial to taxpayer. The taxes I have to pay are not too high considering the social benefits provided by the government. Youth perceived trust in IRB as tax collector. IRBM cares about the position of taxpayers. IRBM trusts the assessment made by taxpayers themselves. IRBM considers the views of average citizens over changes to their systems. I am satisfied with assessment and collection of tax process made by IRBM. IRBM gives good cooperation when taxpayers need information about tax. Overall, IRBM is very efficient in carrying their duties and affairs with taxpayers. In my opinion, IRBM is able to check the correctness of all the information reported in tax form submitted by taxpayers. Youth inclination towards tax return requirements. I lodge my tax return as soon as possible, even if I do not expect a tax refund. I am a loyal and law-abiding citizen, so it is not right for me to under-report the income or claim an undeserved deduction. I am willing to report my entire income voluntarily even though I will not be examined (audited) by IRBM. I will not claim any expenses and relieves more than my eligibility because I am afraid to be caught by IRBM. I will report the correct tax computation because I am liable for tax refund.

TRA1 TRA2 TRA3 TRA4 TRA5 TRA6 TRA7

FRI1 FRI2 FRI3 FRI4 FRI5

Table 2: Descriptive of sample Age 20-24 25-29 30-40 Missing Total 290 137 36 37 500 Taxpayer Registered Not Registered Missing 107 389 4 500 Ethnic Malay Chinese Indian Others 304 85 50 61 500 Employment Self-employed Private Government Missing 106 226 107 61 500

Table 3: Tax knowledge score Knowledge Items Tax admin Score 0 1 2 3 4 0 13 47 8 10 0 14 5 10 11 14 (%) 33 (6.6) 30 (6.0) 111 (22.2) 191 (38.2) 135 (27.0) 43 (8.6) 133 (26.6) 276 (55.2) 48 (9.6) 79 (15.8) 188 (37.6) 228 (45.6) 5 (1.0) Min. 0 Max. 4 Mean 2.73

Basic knowledge

4.31

Advanced knowledge

12

4.25

Table 4: Validity of measures Loading 0.715 0.834 0.782 0.729 0.798 0.722 0.799 0.832 0.837 0.841 0.851 0.789 0.737 0.793 0.834 0.559 0.772 1.000 a TRS4 was discarded due to low loading. TRS1 TRS2 TRS3 TRS5 TRS6a TRA1 TRA2 TRA3 TRA4 TRA5 TRA6 TRA7 FRI1 FRI2 FRI3 FRI4 FRI5 TK Mean 2.75 2.71 2.90 2.71 2.98 3.16 3.33 3.18 3.16 3.31 3.24 3.32 3.44 3.52 3.51 3.14 3.57 11.30 S.D. 1.074 1.059 1.057 1.115 1.040 1.048 0.931 0.956 0.935 0.921 0.937 0.946 0.982 1.006 1.008 1.016 0.926 5.223 CR 0.881 AVE 0.597 Alpha 0.837

0.931

0.658

0.913

0.860

0.555

0.797

N/A

N/A

N/A

Table 5: Discriminant validity TRS TRS TRA FRI

b

TRA

FRI

0.773b 0.554 0.251 0.811 0.444 0.745

Diagonal elements are square roots of AVE.

Table 6: Summary of findings Path TRS FRI TRA FRI TK FRI TK TRS TK TRA Hypothesis H1 H2 H3 H4 H5 Path Coefficient 0.014 0.426 0.126 0.012 0.078 t-value 0.237 6.326 3.125 0.225 1.752 Results Not supported Supported Supported Not supported Not supported

Table 7: Between group comparison Registered Path TRS FRI TRA FRI TK FRI TK TRS TK TRA Coeff. 0.026 0.402 0.234 -0.114 -0.137 t-value 0.188 2.813 2.989 1.150 1.733 on-registered Coeff. 0.012 0.469 0.039 0.081 0.157 t-value 0.195 7.199 0.841 1.309 2.850 t-spooled 0.100 -0.465 1.953 -1.524 -2.614 p-value 0.920 0.642 0.051 0.128 0.009