Tax Evasion and the Business Environment in Uganda

• Published date: 01 September 2016
• Author: Joseph Mawejje,Ibrahim Mike Okumu
• Date: 01 September 2016
• DOI: http://doi.org/10.1111/saje.12132

TAX EVASION AND THE BUSINESS ENVIRONMENT IN

UGANDA

JOSEPH MAWEJJE*AND IBRAHIM MIKE OKUMU

†

Abstract

This paper examines the interaction between the different indicators of the business environment and

tax evasion. First, we develop a simple theoretical model linking tax evasion to the business environ-

ment. Second, we test the model predictions using the World Bank Enterprise Survey data for Uganda.

Findings indicate that the extent of tax evasion is associated with bureaucratic bribery, the quality and

efficiency of the legal systems, and the inadequate provision of public capital. Our results are robust to

alternative estimation strategy, choice of instruments, treatment of outliers, and missing data.

JEL Classification: D22, H26, O17, H32

Keywords: Tax evasion, bribery, public capital, business environment, Uganda

1. INTRODUCTION

Enhancing domestic resource mobilisation is of great importance for many countries in

Sub-Saharan Africa (SSA) (AfDB, 2010; IMF, 2011; Drummond et al., 2012). Domestic

resource mobilisation enhancement among SSA countries not only reduces reliance on

recently volatile and diminishing grants and concessional loans but also provides the

wherewithal for governments to provide quality public services which could induce factor

productivity growth thereby fostering economic growth, ameliorate poverty, and reduce

inequality. However domestic revenue mobilisation efforts in SSA countries are under-

mined by exemptions, informality and tax evasion (Gauthier and Gersovitz, 1997; Auriol

and Warlters, 2005; Gauthier and Reinikka, 2006; Fuest and Riedel, 2009).

In Uganda, for example, other than the post-2011 period where economic growth has

been sluggish, the economy recorded impressive growth rates averaging 7% per annum

in the 2000s (Hausmann et al., 2014). However, in spite of the impressive growth rates

the tax to GDP ratio has largely been inelastic (Muhumuza, 1999) stagnating at 13%

over the last decade (Ssewanyana et al., 2011) notwithstanding both tax policy and

administration reforms over the period. The inelasticity of tax revenue to Uganda’s eco-

nomic growth could be attributed to: the pervasiveness of the informal sector (Muwonge

et al., 2007), narrow tax base (Ssenoga et al., 2009; AfDB, 2010; Matovu, 2010), and

the effect of tax breaks (Gauthier and Reinikka, 2006).

Moreover citizens’ tax compliance attitudes in Uganda are low on account of unfav-

ourable perceptions about the quality of public services (Ali et al., 2014). This might

imply that tax compliance attitudes can be considerably improved conditional on suffi-

cient improvements in the provision of public capital and business environment (for

* Corresponding author: Research Analyst, Economic Policy Research Centre, 51 Pool Road,

Makerere University Campus, P.O. Box 7841, Kampala, Uganda.

E-mail: jmawejje@eprcug.org

†

College of Business and Management Sciences, Makerere University, Kampala, Uganda.

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South African Journal of Economics Vol. 84:3 September 2016

South African Journal

of Economics

example; efficient public infrastructure, legal and regulatory framework, and unambigu-

ous tax regimes, among others). However, where the business environment is unfriendly

(for example; red tape, infrastructural deficiency, and legal and regulatory framework

inefficiency among others) tax payers could develop incentives to evade taxes. Indeed

Dabla-Norris et al. (2008) and Tedds (2010) empirically show that the business environ-

ment has implications on firm level tax compliance.

Against that background this paper attempts to accountfortheeffectofthebusinessenvi-

ronment on tax evasion in Uganda. The paper is related to the empirical investigations by

Levi et al. (2009), D’Arcy (2011), Sacks (2012) and Ali et al. (2014) and, who equally

attempt to explain tax compliance among some African countries. Our study is also related to

the theoretical work of Goerke (2008) who examines the relationship between corruption

and tax evasion. Our point of departure is in the measure of tax evasion and the choice of

data.WiththeaidoftheWorldBankEnterprise Survey data for Uganda, we measure tax eva-

sion using the proportion of sales kept off the books of accounts by firms. By disguising sales,

firms seek to misrepresent their tax obligations to the fullest extent possible. However, Levi

et al. (2009), D’Arcy (2011), Sacks (2012) and Ali et al. (2014) use the Afrobarometer data

in their attempt to explain tax evasion. Besides, Levi et al. (2009), D’Arcy (2011) and Sacks

(2012) measure tax evasion by analyzing the response of firms to whether “the tax administra-

tion always have the right to make people pay taxes or not?” This measure of tax evasion has

however been criticised on the ground that it lays emphasis on enforcement. Also how

respondents perceive the tax administration itself is more of a measure of tax enforcement

than a proxy for tax evasion (Daude et al., 2012). While Ali et al. (2014) measure tax evasion

by analyzing respondents answers to whether it is: “not wrong at all;” “wrong, but under-

standable;” or “wrong and punishable” for people not to pay taxes on their income.

The unique feature of this paper is twofold: first, we develop a simple theoretical model

linking tax evasion to the business environment; second we test the model predictions on

Ugandan data while carefully accounting for endogeneity concerns. Our results show that

an adverse business environment characterised by: inadequate government provision of

public capital, bureaucratic bribery, and an inefficient legal environment could potentially

induce a firm’s behaviour towards tax evasion. These results are consistent with empirical

investigations by among others Hanousek and Palda (2004), Torgler (2005), Frey and

Torgler (2007) and Alm and McClellan (2012) who also show that the incentive to pay

tax decreases with a decreasing quality of public services. This implies that one of the ways

to mitigate tax evasion in Uganda could be through enhancing the business environment.

This can be achieved through ensuring a streamlined and efficient legal system, adequate

and efficient public infrastructure, and mitigating bureaucratic red tape and bribery.

The rest of the paper is organised as follows: Section 2 discusses the nature of the

business environment in Uganda. The analytical framework is discussed in Section 3

while data and estimation strategy are presented in Section 4. Section 5 presents the find-

ings and lastly the summary and conclusions are presented in Section 6.

2. THE NATURE OF BUSINESS ENVIRONMENT AND INFORMALITY IN

UGANDA

2.1 The Business Environment

Uganda is still classified as a factor driven economy, implying that the key pillars for

competitiveness are still the basic requirements such as adequacy of infrastructure,

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