CHAPTER ONE

INTRODUCTION

The purpose of this chapter is to provide background information on the thesis. The chapter
presents the background of the study, statement of the problem; the objective of the study,
hypotheses, significance of the study, scope of the study consecutively and finally winds up by
presenting general structure of the thesis.

1.1 Back ground of the study

Yet there are various sources of revenues like borrowing, grants and fines, tax constitutes a very
most important source of government revenue in countries in order to finance public services
such as transportation, health care, education and others; however, many people do not
understand the crucial role of tax towards growth of the countries (Getacher & Abera, 2014).
There is no doubt that tax plays a very important role and matters the development of nations in
the world (Nguyen, 2017; Devos, 2014 and David, 2011). That’s why, to all the countries, tax
liability is compulsory to everyone, but many taxpayers have been intentionally and
unintentionally finding ways to evade the tax (Efeeloo & Dick, 2018). Policy attention to tax
evasion was spotlighted after the financial crisis of 2008, the Great Recession, and the large
deficits that followed (Slemrod, 2016).

Tax evasion is as old as taxes and it probably can be considered as the second oldest profession
in the world (Saruc, 2001). Nevertheless, it only started to receive attention from researchers in
the last 25 years (Nguyen, 2017; Saruc, 2001) yet is a long-standing, universal problem which
transcends national boundaries (Saruc, 2001). It takes place in developed as well as developing
countries, in virtually all societies and cultures (Yamen, Allam, Mustafa & Uyar, 2018). Thus,
the problem of tax evasion seems to be growing in Ethiopia.

Taxes and evasion have coexisted from ancient world to the modern times. From the corvee and
the tithe the earliest and most widespread forms of taxation to the very modern taxes on cars,
tobacco and other luxury goods, mankind was inclined to resist, hide and underreport wealth
(Abdixhiku, 2013).
Irrespective of its values, tax evasion drastically reduces the amount of state budgets every year
all around the countries globally and it denies every government the tax revenue due to the
system, which results in a gap between the potential and actual tax collection (Adebisi and
Gbegi, 2013) even it’s a global phenomenon that has been practiced in both developed and
developing countries (UN, 2018).

Tax administration in developing countries is often staffed with poorly trained and poorly paid
officials (World Bank, 2018 and Gupta, 2007). And they may have rigid structures that do not
encourage an integrated approach to different tax categories and the unsatisfied tax officer may
not have willingness to support the taxpayers’ and will not give sufficient services as required
(World Bank, 2018 and Tsegabirhan, 2010). As a result, most developing countries have not
been able to raise sufficient revenues for essential public infrastructure and human development
services (World Bank, 2018).

The problem of tax evasion is a major concern for developing countries like Ethiopia; as
economic development can be significantly hampered by poor tax revenues because of the
problem of tax evasion (OECD, 2018; Amina & Sinya, 2015; Workneh, 2013; Gupta, 2007).

Based on the trend analysis, Wollela, (2016) and Workneh (2013) found Ethiopia no significant
change in revenue collections; the revenue performance measured in terms of tax to GDP ratio
remains far below the average for Sub Saharan African and low income countries in general and
tax evasion contributes a lot to this poor performance (ERCA half year report, 2019; Abebe,
2016 and Martini, 2014).

According to the Constitution of Federal Democratic Republic of Ethiopia, revenue sources are
assigned between Federal government and Regional states. Regional states can endorse their
income tax proclamation and regulations based on the constitution in conformity with the federal
income tax proclamation. The Ethiopian Income Tax Proclamation No. 979/2016 article 3(1)
classifies business income taxpayers into three major categories based on their annual gross
income as category A, B and C. Accordingly, taxpayers with annual gross income of Birr
1,000,000 and above are categorized under Category “A” taxpayers, business income taxpayers
with annual gross income between Birr 500,000 and Birr 1,000,000 are under category “B” and
business profit taxpayers with annual gross income less than Birr 500,000 are under category
“C” taxpayers and the whole SMEs located in Bahir Dar city found under category “C”.

In Ethiopia, since most business owners especially micro, small and medium businesses do not
have simplified access to and clarification on the tax laws and procedures, they lack awareness
on tax rules and regulations and this has an impact on the practicability of the tax compliance of
small and medium businesses (Ketema, 2016), they are not required to have sufficient filing and
reporting (Tax Administration Proclamation No. 983/2016) yet tax evasion occurs through
concealing income, failing to file a tax declaration, or fails to pay tax by the due date (Tax
Administration Proclamation No. 983/2016 Article 125 (1)).

Yet there are nine regional states and two city administrations in Ethiopia, Bahir Dar city
administration is chosen for this study given there are many small and medium scale enterprise
taxpayers found in Bahir Dar and convenience to the researcher.

1.2 Statement of the problem

Various literatures on tax compliance had produced a large body of theoretical and empirical
research, especially following the publication of A-S model in 1972. Consequently, various
researchers come up with a variety of theories tangled with the relaxation of A-S model and dealt
with tax evasion including the fiscal psychology theory, social exchange theory and theory of
planned behavior. Nevertheless, none of the aforementioned theory concludes about tax evasion
single handedly.

Also far-reaching empirical researches have been conducted on the topic of determinants of tax
evasion. Many scholars have built and empirically tested a great number of factors relating to the
said theories to explain why tax payers should comply to pay tax or not and others have surveyed
owner and managers of SMEs to learn what their thoughts are on the subject of tax evasion.
However, they come up with inconclusive and contradictory judgments on the actual
determinants of tax evasion notwithstanding countless researches have been conducted. Thus, the
issue of tax evasion calls further research.

Moreover, most of the leading theories, hypotheses and empirical studies are originally
developed based on developed countries. Indeed, it has been conducted in some developing
countries like Kenya, Pakistan, India, Malaysia and Ethiopia to some extent yet the issue of tax
evasion of developed countries by no means is alike with developing countries where poor public
goods and services, popular grand corruption, little or no incentives and reward, guerilla and
egoistic leaders, little knowledge about tax related scenarios are norms than expectations that led
the issue of tax evasion puzzling and much stronger than in developed countries due to various
factors such as political, social, economic and financial instability, inadequate disclosure, poor
laws and regulations, weaker corporate governance and out dated technologies which usually
adopted from developed countries (Aumeerun, Jugurnath & Soondrum, 2016); Devos, 2014;
Asaminew, 2014; Martini, 2014; OECD, 2013, 2018). Therefore, conducting this study on
developing countries specifically in Ethiopia seems logical and the researcher intended here to
test whether the said theories, hypotheses and empirical evidences are similar with developed
countries where they formerly originated from.

To the knowledge of the researcher some researches have been conducted on issues of tax
evasion in Ethiopia. They are, however, by far different with this one in various methodological
aspects like approach, design, data type and source, variables examined, study area and period
given the calls for further research they invited as briefly presented in chapter two. For instance:
Abebe (2016), Agumas (2016), Amina & Sinya (2015), Mulye (2015) and Tilahun & Yidersal
(2014).

Ethiopian SMEs have been observed by Mehari (2017) and Derar (2016) with the highest degree
of non-reporting of their sales to the tax authority, especially when the transaction is conducted
by cash. The experience in some of the countries in the Sub Saharan Africa; such as Kenya,
Uganda and Tanzania manage the non-declaration of sales by increasing the monitoring of sales
transactions through Electronic Fiscal Devices machines (UNDP, 2016; Asaminew, 2014;
Martini, 2014; Gupta, 2007). In Ethiopia, the case sound the same, however, tax compliance
practice has not been so effective; as was reported by the Ministry of revenue that out of 135
surveyed companies with a hundred days operation Ethiopia has lost 14 billion birr in tax
evasion in that the poor taxation service was part of the problem, as it made tax payers to retreat
from paying (Adanech, 2019) and the problem calls further research.

The Ethiopia’s Ministry of Revenue half report (2019) shows that following the political
instability the country went through over the past few years, the tax collection of Ethiopia has
not been growing as planned and revealed that growing of illegal contraband trade and trade
licenses with fake identification cards have also contributed to the poor performance of tax
collection. Here, leaving the performance of tax collection the researcher contends that why tax
payers retreated from paying given they are going to trade with contraband, fake ID and soon,
and it is not surprising that the determinants of tax evasion calls for research.

Moreover, a serious tax evasion among business community in different parts of country has
been observed by Amina & Sinya (2015) in Jimma, Mulye (2015) in Dessie, Ketema (2016) and
Abebe (2016) in Adis Abeba, OECD (2018), WB (2018) and Ethiopian Ministry of revenue
(2019). This is a typical indication of non-compliance of tax payers in the country supported by
the poor management and popularly corruptive administration.

However, Bahir Dar city is none exceptional to tax evasion due to the fact that, it is governed by
the aforesaid ministry besides the SMEs have been reluctant in paying their tax as per the set tax
laws and regulations of Federal Income Tax Proclamation No. 979/2016 as revealed by office of
the city tax revenue authority half year report of 2018. For instance; according to tax revenue
authority office of Bahir Dar city, tax collection report of 2015, 2016, 2017 and 2018, revealed
that only % %, %¸% and % respectively targeted tax revenue has been achieved or collected in
each consecutive period as the result of tax payers failure to comply with the tax laws and
regulations concurrently with various challenges on the authority behalf. Thus, it seems
interesting to understand the determinants tax evasion in Bahir Dar city SMEs.

Therefore, by mixing those of the aforementioned practical problems with gaps in literatures, the
researcher is intended to add further insights on the topic entitled determinants of tax evasion and
identifying the determinants as well as examining to what extent these variables affect tax
evasion in Bahir Dar city specifically and in Ethiopia in general.

1.3 Objective of the study

1.3.1 General objective

The main objective of the study is identifying what determines tax evasion and examining to
what extent these factors determine tax evasion in Bahir Dar city SMEs.

1.3.2 Specific objectives

The specific objectives of the study are;

 To examine whether deterrence factors influence tax evasion in Bahir Dar city SMEs.
 To examine the relationship between government performance factors and tax evasion in
Bahir Dar city SMEs.
 To examine whether policy fairness factors influence tax evasion in Bahir Dar city SMEs.
 To examine whether knowledge factors influence tax evasion in Bahir Dar city SMEs.
 To examine whether attitude factors influence tax evasion in Bahir Dar city SMEs.

1.4 Hypotheses

Based on thorough understanding of voluminous of literatures discussed so far in chapter two the
researcher has formulated the following hypotheses.

H1: Deterrence factors would reduce tax evasion behavior.

H2: Better government performance will reduce tax evasion behavior.
H3: Better policy fairness will reduce tax evasion behavior.
H4: Better knowledge in tax issues would reduce tax evasion behavior.
H5: Better attitude in tax issues would reduce tax evasion behavior.

1.5 Significance of the study

This study is expected to be significant in various dimensions in that; first the awareness of these
hypotheses will help the government (Federal, State and Local level) and their agencies to
formulate adequate tax policies with respect to tax revenue administration. Second, it will add
further insight for future researchers, academicians through providing further literature on the
concept of tax evasion, particularly among small and medium scale enterprises.

1.6 Scope of the study

As it is discussed in the objective of the study, this research is ultimately dedicated to small and
medium scale enterprises in Bahir Dar city perhaps it will be more fruit full if it were conducted
including other sectors.

1.7 Organization of the study

This study is organized with five distinct chapters in which the first chapter discusses about the
introduction, problems statement, objective, hypotheses, scope, significance and the organization
of the study while the second chapter is mainly devoted with the literature review section which
includes theories, empirical evidences, conclusions and knowledge gaps as well as conceptual
frame work. The third chapter deals about the methodology of the study. Chapter four will
discuss results and discussions from which the collected data yields. Finally, the fifth chapter
will be culminated with conclusions drawn from the fourth chapter thereby forwarding possible
recommendations.