Of Lions and Taxes: Why Brazil Needs More Trust, Not More Agents

Luis Fabiano | flickr / Globovision

In Brazil, there is an agency known as “the Lion,” whose agents fly around the country in black helicopters, conducting operations such as the “Black Panther” and “Delta.” They aren’t looking for drugs. Or gangs. They’re tax agents.

The Lion, dubbed for its official emblem and its ferocious hunt of tax dodgers, uses nearly any tactic conceivable in its pursuit. With a force of about 12,000 agents, the agency monitors tax receipts of millionaires, hunts for smugglers, sizes up mansions from the air, and scrutinizes tax returns.

Gary Becker would be proud. Brazil’s approach follows from the classic “economics of crime” model, which Becker developed in 1968 and applied to tax compliance by Allingham and Sandmo in 1972. While it has many permutations, in its most simplified state, the model describes a rational individual who gambles on tax evasion by weighing the expected return of his evasion against the probability of detection and his expected punishment if caught. If the expected return of evasion is higher than his expected penalty, he chooses to evade; if not, he does not.

Indeed, as the model would predict, tax evasion is relatively low in Brazil (with all those helicopters flying around—would you expect anything else?). When it comes to tax collection, Brazil outperforms most of its Latin American peers and other BRIC nations. While Mexico and Paraguay lose about 50% of their potential tax revenues, Brazil only loses about 16%. And while the Brazilian economy only grew 2.7% last year, the Lion increased tax collection by 10.1%. Italo Lombardi, an analyst with Standard Chartered in New York, put it this way: “When it comes to collecting taxes, Brazilians are really good. They are probably some of the best in the world.”

Many credit the agency’s creative, and sometimes harsh, methods with vaulting Brazil into a success story of tax compliance in Latin America. But that’s not the whole story. While Brazil is doing very well among its developing country peers, it still has a much lower compliance rate than most developed countries—for example those in Europe—where enforcement is not as strict. The truth is: the economics of crime model doesn’t tell the whole story.

For decades, researchers have observed the model’s failure to explain tax compliance worldwide. As it would turn out, economics is a poor way to describe tax evasion behavior. Researchers believe tax compliance is based (more fully) on a few variables:

Fairness. People are more likely to comply with taxation if they feel the tax rate is fair and it is being universally applied. Seeing millionaires get away with tax evasion makes ordinary people more likely to evade themselves.
Moral obligation / social standards. There seem to be some tendencies to comply with taxes if “everyone else is doing it” and people fear ostracization or just “being different.”
Government efficiency and trust. Citizens are more likely to comply with taxes if they feel the government is spending their money efficiently and if they have a general trust of government institutions.

Brazil does a fairly good job with (1). No one is safe from the Lion’s scrutiny—not even soccer stars like Luis Fabiano, a famous soccer star whose sports car was seized by police or even current President Dilma Rousseff who came under scrutiny in 2009 because of what she said was an innocent mistake on her tax return.

On the other hand, Brazil is not doing so well with (3). According to a CNI-Ibope poll released in April, a full sixty-five percent of Brazilians disapprove of the government’s tax policies. Gilberto Luiz do Amaral, head of studies at the Tax Planning Institute put it this way: “Tax collection in this country is very high, but why is the application of that money not as efficient as collection?” Other grumbling Brazilians point to inadequate infrastructure, education and other decrepit public services. Clearly there’s a disconnect. At least in the eyes of the people.

But President Rousseff has said that she sees the need for improvement in this area. In a television address recently, Rousseff noted “the government needs to use public resources efficiently and with honesty so that people feel they are getting a good return for their taxes.”

While its model is taking it far, to achieve a level of tax compliance found in developed countries, Brazil needs more than helicopters and 12,000 agents. It’s already on the right track—by applying enforcement of its laws equally, and acknowledging the need for reform, it can hope to achieve the “quasi-voluntary” compliance of other nations. But, as always, it takes more than guns and agents and Lions. It takes real, true economic, political, and cultural change. Given Brazil’s clear level of devotion, I’m optimistic they’ll get there.