'They are a Tax Fearing People' : Deterrent Effect – Penalties, Audit and Corruption in a Developing Country

Critical to a country's tax revenue base is taxpayer compliance, with Allingham and Sandmo's model of tax compliance predicting that if detection is likely and penalties are severe, people will be more compliant. However, the mixed evidence about the deterrence effect has been attributed to such factors as low penalties and corruption. Given the importance of a value added tax (VAT) for developing nations, this study explores to what extent is there a deterrent effect to improve compliance with VAT Law in such a country. In particular, this article reports the findings from focus groups and a survey of 240 small and medium businesses (SME) in Bangladesh.The results indicate that there is greater deterrent effect for SME taxpayers who have a compliant history compared to non-compliant taxpayers. These results are consistent over a number of measures of deterrence, including the likelihood of audits and penalties. Part of the reason for the reduced deterrence for non-compliant SME taxpayers appears to be due to Tax Officers being ‘managed' through bribes. The findings demonstrate that in a developing country for a deterrent effect through audits and penalties to lead to greater compliance, it is essential that corruption is addressed