Tax compliance costs in developing countries: Evidence from Ethiopia

Headnote

Abstract

This paper estimates tax compliance costs for business taxpayers in Ethiopia; it also assesses factors affecting the magnitude of tax compliance costs. The paper uses survey data from a scientific sample of 1,003 Ethiopian businesses.

Total tax compliance costs in the year 2012/13 were estimated to be about 4.5 percent of tax revenue collection. Tax compliance costs were found to be regressive and there was a higher burden for smaller businesses in Ethiopia than those in Kenya or Nepal. Business profit tax, value added tax (VAT) and turnover tax (ToT) constituted the largest share of tax compliance costs.

Simplifying the tax regime for smaller businesses, reducing the frequency of VAT filing for relatively small businesses, raising the VAT threshold and revisiting mandatory VAT sector specific registration requirements were suggested areas of reform.

Key words: tax compliance costs, cost structure, cost burden, cost drivers

1. Introduction

In Ethiopia, tax revenue collection in absolute terms is increasing. Currently, tax revenue covers about 70 percent of government expenditures. However, in terms of the tax to GDP ratio, revenue performance is still at a very low level.2 This low revenue performance measured in terms of tax to GDP ratio is likely to create pressure3 on the government to meet its revenue collections, and may lead to unfair procedural practices and also increase the burden on compliant taxpayers (relative to informal businesses). Such pressures on honest taxpayers are likely to lead to increased taxpayer resentment, which may have an adverse impact on taxpayers' willingness to comply voluntarily which in turn is instrumental in enhancing the efficiency and equity of the tax system as a whole (IFC, 2009).

To mitigate tax compliance 'quasi-voluntary compliance' problems (IFC, 2009, p. 24), reducing the burden of compliance requirements (as measured by tax compliance costs) is crucial. This paper offers an estimate of tax compliance costs in Ethiopia and identifies areas in the design and administration of taxes that are associated with excessive tax compliance costs in the country.

The paper is organised into six parts. Part two provides a theoretical framework along with international empirical evidence on tax compliance costs. This is followed by research objectives, questions and hypothesis in part three. Data sources and methods used are presented in part four,...