The Impact of Tax Fairness on Sales Tax Evasion: Mediating Roles of Trust in Tax Authorities and Perceived Tax Deterrence among Pakistani SMEs

Abstract

Sales-tax evasion remains a persistent challenge in developing economies, especially among small and medium-sized enterprises (SMEs) where formal monitoring is limited, and informal norms are strong. In Pakistan, where SMEs form the backbone of the economy, evasion not only erodes public revenue but also fosters unfair market practices. While enforcement and institutional trust are often studied, the social dynamics, particularly peer influence, have received limited scholarly attention in this context. This study investigates how peer influence affects sales-tax evasion behavior among SMEs and whether this relationship is mediated by trust in tax authorities and perceived deterrence. By extending the slippery slope framework, the research aims to reveal the psychological and social mechanisms through which compliance decisions are shaped. The objective is to inform contextually appropriate policy responses that address both attitudinal and behavioral drivers of tax evasion. A structured survey was distributed to get a response and 367 respondents were used to analyze the data. Constructs including peer influence, institutional trust, perceived deterrence, and evasion behavior were measured using validated scales. Structural equation modeling (SEM) was employed to assess direct and mediated relationships. Reliability and validity were established through confirmatory factor analysis, while procedural controls helped minimize common method bias. Results confirm that peer influence significantly increases the tax evasion. However, this effect weakens when trust in tax authorities is high, demonstrating the mediating role of institutional legitimacy. Perceived deterrence negatively mediated the relationship, suggesting that stronger enforcement perceptions can suppress the contagion effect of peer behavior. Trust and deterrence explain a substantial portion of the indirect effects. These findings suggest that enhancing taxpayer trust and making enforcement more visible can jointly reduce peer-driven evasion. The study contributes to the behavioral tax literature and offers practical insights for regulatory bodies in emerging markets.