Business owners in Addis Ababa openly admit to engaging in largescale tax evasion, which exposes the shortcomings of the Ethiopian tax authority, write Camille Louise Pellerin and Johanna Söderström.
‘I think I pay taxes on 40–60 per cent of what I should’, the owner of a medium sized construction firm said, but according to a government tax advisor ‘if people tell you they pay taxes on 40–60 per cent of what they should, this is overestimated’.
Among small business owners in Ethiopia’s capital Addis Ababa tax evasion is the norm rather than the exception. It might seem odd that in a country where citizens used to be afraid of an authoritarian state, they now evade the law and openly talk about it. However, contemporary Ethiopia is a complex web of economic incentives, institutional and social factors, and norms and values, some of which encourage, many of which reduce tax compliance.
Taxation and politics in Ethiopia
Increasing tax revenue has been a priority of Ethiopia’s Prime Minister, Abiy Ahmed, since he came to power in 2018. The country had a low tax to GDP ratio, even by regional standards, of 6.2 per cent in 2020. Despite the country’s long history of authoritarian rule and state-led development models, Ethiopia’s tax authority lacks the capacity to enforce tax compliance.
Low tax revenues have affected consecutive governments’ ability to pursue development policies. In an attempt to make citizens more amenable to taxation and increasing capacity, Abiy’s government has run public relations campaigns and revised key tax laws. Despite this, taxation continues to be enforced more through threats than positive incentives, with tax officials menacing tax payers with general audits and government media covering cases of punishment for tax evaders. Despite these efforts, evasion remains the norm.
The business of avoiding taxes
Small and medium sized business owners in Addis Ababa see paying taxes is an inefficient allocation of resources and tax evasion as an economically rational decision.
Declaring and paying taxes often requires days spent at the tax office, resulting in a loss of time and revenue. Evading taxes allow people to spend more time with their businesses, allowing them to offer clients competitive prices and still make larger profits. Taxpayers admit to adopting different strategies for evading taxes, such under declaring profits and over declaring expenses, under declaring the quantity and quality of goods they import, and not declaring VAT.
If and when their tax does get collected, locals do not believe that their taxes are used to finance public services. Instead, the perception is that the money ends up in the pockets of politicians and high-level civil servants.
People suspect tax officials fabricate false tax claims to meet collection targets. As tax officials do not apply the tax law, taxpayers see little purpose in abiding by the same law. Business owners say that tax officials lack the technical capacity and goodwill to execute their jobs and are more interested in collecting bribes than serving citizens. Taxpayers describe the process of filing taxes as a negotiation, an individual tax bargain concluded between the taxpayer and the tax official. Bribes are often negotiated to reduce the amount of tax due, or to cover up an exposed tax evasion scheme. Until recently, such negotiations were mostly conducted by errand handlers outside of the premises of the tax office, to reduce the risk of being detected. However, rising levels of corruption have led to an institutionalisation and normalisation of such practices within public offices.
While admitting to large scale tax evasion, taxpayers also describe the tax authority as “the most scary government office for the business community”. Non-compliance, if detected, can lead to prosecution and severe punishment, including jail sentences.
The tax authority mostly tries to ensure tax compliance through deterrence and treats every taxpayer as a potential tax evader. This “guilty until proven innocent” approach is compounded by tax officials’ failure to distinguish between complying and non-complying taxpayers, which increases the emotional stress on taxpayers. Filing and paying taxes, according to taxpayers, is emotionally draining, includes hours of waiting, and being humiliated and threatened by tax officials.
As a result, business owners use a range of strategies to reduce interactions with the tax authority and to minimise the risks of punishment for tax evasion. Those who can afford it, use errand handlers to file and pay their taxes. Many also hire accountants to ensure that tax declarations look like they conform to the rules.
Profiting from citizens
Since Abiy Ahmed came to power in 2018, corruption in Ethiopia has been on the rise and the tax authority is not exempt from this phenomenon.
Citizens say that the tax authority has been more aggressive in collecting taxes since 2018, but increased corruption has counterbalanced these efforts. Some now argue that the option of paying taxes in an honest manner is increasingly difficult. Tax officials now demand bribes openly and make taxpayers pay them at the tax office, for everyone to see. The fear of being reported for corruption has nearly disappeared, such is the normalisation of the process. Taxpayers refusing to pay bribes say they have been threatened by tax officials.
“Before Abiy, if you did an honest mistake in your declarations, you could tell them: ‘I want to be penalised’. The tax officials had to calculate the official fine. Often it’s not that much. Now you can’t do this anymore. If you don’t pay the bribe they ask you for, they’ll tell you: ‘I’ll audit you next year’. And you know they will go after you, your money and your business. So, you pay.”
Despite efforts to increase the country’s tax revenue a difficult tax system and rampant corruption is incentivising people to seek out new opportunities for tax evasion, meaning money is leaking out of the system, and hindering the government’s ability to fund its policy priorities.
Photo credit: ODI used with permission CC BY-NC 2.0