Merkato market in Addis Ababa, Ethiopia: the largest open air market in Africa where taxpayer compliance is thought to be as low as 25%. (IMF, 2011). Credit: nazret.com Photograph: nazret.com
Economic conditions across much of sub-Saharan Africa have remained generally robust against the backdrop of a sluggish global economy. In 2012, the region held five of the world's 10 fastest growing economies and continues to power ahead, with the World Bank forecasting regional growth of 5% in 2014. However, despite such impressive growth, most sub-Saharan African countries still struggle to increase their tax revenues as a proportion of GDP.
This is partly due to the limited capacity of tax administration systems to tax small, medium and micro enterprises (SMMEs) which often account for the majority of economic output while operating largely within the informal sector, out of the reach of tax administrators. In addition, many countries provide concessions or exemptions for SMMEs, with a large number of sub-Saharan African countries taking this route as a means of helping fuel growth and employment.
There are strong arguments however, for tax design and enforcement that facilitates widespread inclusion of SMMEs in the tax net. For example, many would argue that it is simply 'fair' that SMMEs, despite their smaller incomes and workforce, should contribute financially to the public services they benefit from. More broadly, increasing tax revenues of course has the potential to improve people's economic and social welfare through improved public service provision.
Tax administrations in sub-Saharan Africa which do include SMMEs in the tax net are often ill-equipped to enforce compliance among the often very large number of SMMEs operating in their countries. Tax authorities often perceive it to be inefficient to enforce the tax liabilities of individual SMMEs, preferring to utilise scarce tax administration resources in pursuit of larger taxpayers.
This weak motivation on the tax administration side is often compounded by tax-related issues affecting SMMEs directly. Many SMMEs lack the capacity to maintain accurate accounts and calculate their tax liabilities correctly. SMMEs are also often faced with cumbersome tax assessment and payment procedures, which can take up precious time. Finally, SMME taxpayers are often demotivated by perceptions of corruption or a lack of understanding as to how their taxes are being used.
In Ethiopia, Adam Smith International is working with the Ethiopian Revenue and Customs Authority (ERCA) to identify the country's tax gap and to forecast future revenue streams. This work involves undertaking a detailed data collection assessment to provide a complete picture of current revenue streams, and generate recommendations on how to raise compliance levels among all taxpayers, including SMMEs. The project is playing an important role in assisting the government of Ethiopia's efforts to increase domestic revenues and help finance the country's ambitious Growth and Transformation Plan.
The project has identified that SMMEs are significantly less compliant than large corporations, paying approximately 20% of their theoretical tax liabilities in comparison with 70% for large businesses. These results are due to a combination of reasons, including the limited resources available to regional tax authorities to register and monitor the high number of SMMEs, limited SMME awareness of tax obligations and the tax system at large and inaccuracies of 'presumptive taxation' which sees tax officials calculating presumed SMME taxpayer liabilities due to limited taxpayer capacity to do so.
To help improve compliance among all taxpayers, especially SMMEs, we have provided ERCA with recommendations across their six strategic goals including human resource management, information systems and revenue collection. Recommendations in these areas thus far include transfer of ERCA employees between branches and regions to allow sharing of best practice and increased information exchange; the introduction of a comprehensive data management system to ensure consistent data is held across the different departments and directorates, and the development of record-keeping requirements appropriate to the size/sector of taxpayers. These measures will assist the Ethiopian tax authorities to build the capacity of their staff to administer taxes effectively, manage the vast information flows from SMME taxpayers, and support taxpayers to comply voluntarily.
Understanding the tax gap will help to improve SMME compliance and increase overall tax revenues in Ethiopia. This could be a model for other countries which have untapped SMME tax revenue resources in the informal sector that could boost overall tax revenue.
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