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the future necessarily lack the complete knowledge and anticipation of possible consequences that result from each choice. Since consequences are in the future, imagination has to replace the want of actual experience in their assessment. Objective rationality would require a choice between all possible lines of evaluated action; in reality only a very few of all the possible alternatives are considered. Added to this is the limited human capacity to process information. In relation to the quantum of problems that would need to be solved for the realization of an objective and rational behaviour, such capacity is remarkably small. In the centrally planned economy that has nationalized enterprise and eliminated every business concern for correct investment and production decisions, a staff of officials struggles with more luck than judgement to reach its bureaucratic but nevertheless entrepreneurial decisions. These officials may be talented, loyal, diligent and completely committed. Unlike, however, the market entrepreneur their viability is not personally dependent on the accuracy of their prognoses and decisions. Nor are they tied with all the threads of their consciousness to the ‘business’. Above all in the centrally administered and centrally planned economy, there is not a real, automatically functioning organ or mechanism of feedback. Wrong decisions on investment and allocation may possibly emerge only years after, when the length of customers’ queues in front of the state-owned shops stretches unendingly. An authoritarian administration is also notoriously reluctant to accept complaints about supply deficiencies. This position is aggravated by the difficulties of establishing individual responsibility let alone accountability among the entrepreneurial bureaucrats. Contemporary systems theory gives a central recognition to the cybernetic or feedback mechanism of automatic control, as explained above. Though the language is less technical, the history of the idea in economics goes back to Richard Cantillon. He first recognized and described the specific role of the entrepreneur in the market economy based on a division of labour; and he saw clearly the corrective signals of the market to the entrepreneur in his Essai sur la nature du commerce en general, published in 1775. Adam Smith, curiously enough, did not holder of the public office whose task is ‘to examine national requirements and to induce national production accordingly’, and he accurately depicted the feedback function of the entrepreneur in the market economy. It is part of the tragedy of the non-Marxist theories of socialism that the teaching of Rodbertus remained without response. Adam Smith indeed, who failed to see the coming Industrial Revolution with its key contribution of the entrepreneurial innovative genius, condemned in his moral philosophy the ‘projectors and prodigals’ who started new branches of production, for which demand often enough arises ‘not chiefly from use or necessity’ but ‘from fashion and fancy’. In his view they were speculators hoping for excessive profits and possibly prepared to pay higher interest rates than ‘sober people’. Jeremy Bentham in his open letter Defence of Usury turned against this puritanical view of his friend, Adam Smith. Bentham pointed to the uninterrupted progress of the general wealth in England and asked the question: to whom is this owed in the first instance? He emphasized that it was precisely the new ‘projects’ and their creators, attacked by Smith as ‘projectors’ and ‘prodigals’, who had presented England with this new wealth by managing ‘to struggle through obstacles’, developing new ideas and affecting progress and improvement in pursuance of their personal aspirations to make money. This aspect of the process of economic innovation with its preconditions and consequences for the discovery of new markets, new needs, new methods of production and new outlets is taken further by Joseph Schumpeter, the Austrian-American economist, in his Theory of Economic Development. For Schumpeter the nature of the entrepreneurial function lies in the special role of leadership. In Schumpeter’s analysis the entrepreneur becomes the decisive ‘motor of innovation’. As such, and as the pillar of economic and technological progress and therefore of economic development, the Schumpeterian entrepreneur truly forms a fourth factor of production alongside land, labour and capital. The consequential breakthrough in economic analysis does not limit itself to the discovery of abstract ‘laws’ of economics and quantitative mechanics but makes the behaviour of entrepreneurs and the formation of entrepreneurial decisions the central subject matter. of small and medium-sized firms chose France for a survey that, inter alia, analysed entrepreneurial readiness to accept and carry out technical innovation. Results were very disappointing. Only about a half (53 per cent) of the questioned entrepreneurs of small and medium-sized firms stated that they would frequently try out new methods; the rest more or less preferred the old ‘proven’ methods. It made little difference to which sector the individual entrepreneurs and their firms belonged. It does, however, seem to depend on type of education and size of firms. This suggests that the special leadership role is not inherent but rather that the entrepreneur himself has to be made aware through appropriate education including information. Beyond this, the entrepreneur is obviously only prepared actually to take on the role of innovator if the attached economic risk appears bearable, considering the size of his firm. A further condition is likely to be that the entrepreneur concerned has to display a basic positive attitude towards risk; and he has to regard the entrepreneurial activity as an opportunity for self-fulfilment and as a worthwhile task. But he must not see risk as a pressing burden, as did about one-third of the French entrepreneurs questioned. These results cannot simply be transferred to German business, but also the claim that in Germany the exact opposite is true, can hardly be substantiated. Spectacular single entrepreneurial innovations, as for instance the Wankel engine or the PAL colour TV system, are in themselves certainly not sufficient to provide the proof. In a very rapidly changing world, the long-term dynamics of the economy are decisively dependent on the special innovatory leadership role being generally fulfilled. Ideological dogmatism would seem to inhibit and prohibit any such role contribution in centrally planned systems, much as such systems may try to orientate themselves towards the market. In Europe the denigration of, and smear campaign against, the entrepreneur comes, furthermore, in a period characterized by the erosion and disappearance of historically established values. ‘As useless as the aristocracy’ was the leading question the magazine Capital put to the historian Golo Mann; and in the same issue F.J. Straub was asked to comment on whether entrepreneurs, because of their flight from taxation, could be dubbed ‘unpatriotic’. This kind of journalism It is no surprise, then, that at least in Europe ‘the entrepreneurs’ are made to feel insecure and are searching for a new identity. There is the danger that they may resign themselves to an increasing neglect of their still indispensable function, especially in the changed social pecking order. Instead they may prefer to enter into an unholy alliance with their natural opponents, the trade unions, to dilute and eliminate inconvenient competition – and thereby seriously endanger the market economy. In this environment of ignorance and hostility, the entrepreneurs and their executives have still to fulfil their professional duties. In the back of their minds must be the sociopolitical function of the large enterprise as well as the daily operational task, pontificates a TV programme on the ‘secret elite’ in the West German economy. Entrepreneurs themselves, however, must share some responsibility for their vague and distorted public image. On the same programme as mentioned above, a Deutsche Bank spokesman said: The managers, including myself, share the blame. We do not do enough to inform the public of our work and responsibility as we see it. This is partly due to a traditional timidity and partly, strange as it may sound, to a hesitancy to push oneself into the forefront. We must have the courage to speak out in public about our work; we should also explain why our appearance is deceptive. Here is no clique for mutual promotion of assets but on the contrary, I would like openly to proclaim, a type of working elite. To establish a climate of opinion favourable to entrepreneurship in the market economy is essential but not easy. Up to now in the German Federal Republic, and Europe generally, only those who condemn the system have succeeded in mobilizing a critical but hostile public evaluation. Their global accusations indeed have the more far-reaching objective of revolution. Yet election results prove that public opinion remains unpersuaded about revolutionary change. Among shareholders, investment advisers and investment clubs – where opinion-forming impulses may originate – there is the stirring of an informed critique. Even in such groups, however, there is a hesitancy to oppose determinedly autocratic management that is ultimately damaging to market a more informed justification. In the United States there is a more sophisticated approach both to public relations and to corporate social responsibility. The search for new ‘social indicators’ alongside quantitative growth rates in GNP does yield concrete measures in place of image consciousness, as more and more American enterprises reorientate values towards the quality of life. There are lessons here for German enterprise and German entrepreneurs. Section 5.1 ‘Fiscal psychology: a new branch of public finance’ was first published in National Tax Journal, 12 (1959), pp. 340–5. Sections 5.2 and 5.3 are translated from Günter Schmölders, Finanzpolitik, 3rd edn, Berlin, Heidelberg, New York: Springer, 1970, pp. 323–48. Section 5.4 is translated from Günter Schmölders, Das Irrationale in der öffentlichen Finanzwirtschaft: Probleme der Finanzpsychologie, Hamburg: Rowohlt 1960 (Rowohlts deutsche Enzyklopädie 100), pp. 73–9. Section 5.5 ‘Tax mentality in international comparison – an overview’ was first published under the title ‘Survey Research in Public Finance – a Behavioral Approach to Fiscal Theory’ in Public Finance, 25 (1970), pp. 300–6. The last paragraph was turned into a footnote by the editors. Section 5.6 ‘A theory of incentive taxation in the process of economic development’ was first published in Il Politico, 31 (1966), pp. 788–800. 5.1 Fiscal psychology: a new branch of public finance∗ I Two important results of some 1958 surveys conducted in Germany under the auspices of the Cologne Centre of Empirical Economics Research in the new line of research on fiscal psychology are: (1) that fiscal policy, the idea of deficit spending in a depression and surplus hoarding in a boom, has hardly any chance of practical application ∗ Dr Schmölders is Professor of Public Finance at Cologne University, Germany. As early as 1932, he started research work on human behaviour under taxation; today he heads the Cologne Institute of Public Finance and the attached Centre of Empirical Economics Research. 157 national parliament, the Deutsche Bundestag, was tested by modern methods of opinion research as to the economic knowledge of its members (67 interviews). In addition, all the members of its finance committee were also examined (27 interviews). At the same time, the attitude of the general public towards taxation was analysed in a modern survey investigation, carefully conducted by one of the leading publicopinion research institutes of Western Germany. Even this latter type of research, digging down deeply into the motivational and emotional layers of the mind of taxpayers and other citizens, seems to have no precedent in traditional public finance. In the Old World, the roots of this new branch of public finance go back to the Machiavellian philosophy of public law. Working along these lines, some Italian authors developed, at the turn of the century, a political theory of government finance, based largely on highly cynical concepts of political and administrative power.1 One of these authors, Amilcare Puviani, Professor of Law at the University of Perugia, even succeeded in writing a complete ‘theory of fiscal illusions’, in which he contrasted the illusions of taxpayers concerning the noble motives of their rulers with the illusions which the latter held about the loyal feeling of their subjects.2 In simple hedonistic terms of satisfaction and dissafisfaction, Puviani described most of the phenomena modern fiscal psychology embraces. These include ways of camouflaging taxation under other names, or levying taxes under conditions under which the taxpayer is inclined to minimize or even fail to perceive any burden, e.g. death duties imposed upon heirs. Further, he dealt with the skilful misuse of noble feelings like patriotism, confidence and religious faith through the issue of public loans which later might not be repaid, or, if repaid, only in depreciated money. Taxpayers’ reactions against such fiscal tyranny, including some comments on the social background of revolutions, were also systematically recorded by Puviani years before modern psychology or social psychology had been developed. Italian Fascism and German Nazism, though broadening the field of experiences, did not permit scientific research along these lines. Only after the Second World War was it possible to recount such experiences and to formulate in terms and categories of modern psychology the conclusions drawn from Mussolini’s fiscal measures and Dr Goebbels’ propaganda. meant to protect the taxpayer against fiscal arbitrariness and injustice. Smith, for some time a customs inspector, knew much about the weakness of human nature under the temptations of power. In the course of the nineteenth century, French public finance derived some general principles of budgeting from the same experience.4 The principles of publicity, of completeness, specialization, and truthfulness in budgeting, for instance, are only so many mirrors reflecting suspicion of the integrity, good faith and fairness of an administration. Even the economic effects of taxation in general, and of income taxation in particular, have been analysed in certain behavioural aspects by traditional public finance. The British economist, A. C. Pigou, developed his so-called ‘tax announcement effects’ by showing that taxpayers’ reactions against a new tax quite logically start long before the tax is actually levied.5 Fears of loss and expectations of possible profit are among the factors that lead businessmen to premature reactions from tax alterations, which have only been proposed or suggested. It was only a small step from that development for modern fiscal psychology to penetrate more systematically into taxpayers’ motivations and reactions. Resistance against, and evasion from, taxation were studied not only in the field of the income tax, but even in the area of excise, sales and outlay taxation and customs duties. For, even if taxation as such passes unnoticed by the final taxpayer, in so far as the tax is included in the price of the commodity, the elasticity of demand for the product becomes the decisive factor limiting its fiscal results. But what is elasticity of demand? It is, after all, nothing more than a psychic (or even physiological) measure of the urgency of wants. The main task of fiscal psychology remains, however, to analyse the direct resistance to direct taxation of individuals and nations according to their general ‘tax mentality’. Such tax mentality can be shown to differ widely between different peoples of Europe. Whereas, in the Latin world, the word ‘tax’ means something felt as an ‘imposition’ upon the citizens (impôt, imposto, impuesto), the German word, Steuer, means ‘support’ and the Scandinavian, skat, the common treasure destined for common purposes. On the basis of such different national tax mentalities, which are closely connected with the citizens’ community-mindedness in general, individual tax-mindedness develops by personal experiences. to the individual cases. Measuring tax compliance means to assess, by voluntary cooperation of the taxpayers involved, the correct amount of their statutory tax obligation. Compared with the actual amount paid, a percentage of tax compliance can be determined. In the United States, some experimental research along these lines has been done by Harold M. Groves6 and G.F. Break.7 The compliance ratio of rent income (ratio of reported net rent to estimated net rent) varied, according to Grove’s Wisconsin study, between 17 per cent (renter subletting) and 78 per cent (garages) with an average of 51 per cent. The compliance ratio of farm income was between 46 per cent (poultry and eggs) and 86 per cent (dairy products), and averaged 75 per cent. Non-compliance by farmers, however, seems to be greater than these figures reveal because of heavy overreporting of farm expenses deductible from reported income. For income other than rent and farm income, similar investigations remain to be carried out. In most cases, this way will be closed to further research by lack of cooperation on the part of taxpayers or tax-dodgers. Then, the only other way of measuring the degree of negative compliance or tax resistance is to compose a true picture of the tax-mindedness of people by ascertaining its elements. There are certain relations between a person’s community-mindedness, generosity in family, club or social matters, understanding of and cooperation in public affairs, and personal readiness to comply with the painful common obligations of a similar nature, such as taxpaying. Patterns of general tax mentality are discernible on the basis of neighbourhood, social class and profession to which the taxpayer belongs. In other words, the individual citizen or household can be enmeshed in a net of admissions that will add up to a true picture of his personality as a taxpayer. If this so-called projection test is applied, the victim can even be brought to confess his secret opinions on tax-dodging (by others!) and his personal feelings about tax-dodgers as social companions, business partners, or members of his family. II A survey concentrating on such a many-sided analysis was conducted, as mentioned above, in the early summer of 1958 in Germany.8 The ‘defendants’, a large representative sample of citizens from all walks of of responsibilities – by family members and more remote relatives, club members, room- and work-mates, or strangers, etc. – he was asked: ‘Is, in your opinion, the so-called church tax really a tax? Or how would you prefer to define it?’9 Most people likened the church tax, which is levied in Germany together with the income tax and by the same authorities, more to a tax than to a voluntary contribution or a fee. The interviewer could then turn inconspicuously from this question to some more on the difference between taxation and fees, and voluntary contributions. Tax-dodging was introduced in quite neutral terms: ‘Are there many people, in your opinion, willing and able to keep the fiscal authorities from collecting something legally due them?’ The person interviewed was asked to decide on one of two possible viewpoints on tax-dodging: Would he accept or reject a tax-dodger as his business partner, son-in-law or cashier? Most people compared tax-dodgers neither with criminals nor with common-sense folks, but with clever businessmen. But tax-dodging was unfamiliar to most of them. For 90 per cent of the German population, income tax is withheld at the source together with social security taxes, church tax and other deductions. Only businessmen and the professions were held able and willing to dodge their taxes. These groups, in turn, blamed farmers (who actually are practically exempt), but could not help being caught on slippery ground themselves. Another investigation is planned to concentrate on these groups, whose representation in the general population sample naturally was not sufficient for exact conclusions. III Another hunting-ground for fiscal psychology is decision-making in parliament, particularly in matters of fiscal law and policy. While in the law field enough experts are at hand (many members have come from the bar or from high functions in administration), questions of fiscal policy do not find competent answers in the German Bundestag. This was proved by a survey concentrating on the unique experiment made involuntarily by the federal government during the years 1953–58 when a budget surplus was accompanied by a cash accumulation