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Accounting and Finance Thesis and Dissertations

2020-10-19

DETERMINANTS OF TAX EVASION:

THE CASE OF SMALL AND MEDIUM

SCALE ENTERPRISES IN BAHIR DAR CITY

ADANE AGEGN

http://hdl.handle.net/123456789/11425

Downloaded from DSpace Repository, DSpace Institution's institutional repository

DETERMINANTS OF TAX EVASION: THE CASE OF SMALL AND

MEDIUM SCALE ENTERPRISES IN BAHIR DAR CITY

A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE IN

ACCOUNTING AND FINANCE

BY:

ADANE AGEGN

ADVISOR: DR. FENTAHUN LEYKUN

BAHIR DAR UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

BAHIR DAR, ETHIOPIA

JULY, 2019

i

Statement of Declaration

I declare that the thesis entitled: “Determinants of tax evasion: The case of small and medium

scale enterprises in Bahir Dar city”, hereby submitted by me in partial fulfillment of the

requirements for the Degree of Master of Science in Accounting and Finance at Bahir Dar

University, is my original work and has not been presented for the award of any degree in any

other university or institution. I have undertaken it independently with the guidance of my

advisor, Fentahun Leykun (PhD). In performing the thesis I have used different sources and

materials which have been properly acknowledged.

Declared by:

Name: Adane Agegn

Signature _______________

Date ___________________

ii

BHIR DAR UINIVERSITY

College of Business and Economics

Office of Graduate Studies

This is to certify that the thesis prepared by Adane Agegn, entitled: “Determinants of tax

evasion: The case of small and medium scale enterprises in Bahir Dar city”, and submitted in

partial fulfillment of the requirements for the degree of Master of Science in Accounting and

Finance complies with the regulations of the University and meets the accepted standards with

respect to originality and quality.

Approved by:

Internal examiner: __________________ Signature __________ Date ______________

External examiner: _________________ Signature __________ Date_______________

Advisor: _________________________ Signature ___________Date______________

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Acknowledgement

First and foremost, I am heartily thankful to my advisor, Fentahun Leykun (PhD), Assistant

Professor of Accounting and Finance in Bahir Dar University whose encouragement, guidance,

and valuable suggestion from the very beginning to the final level enabled me to develop an

understanding of the subject matter and complete this thesis. I also appreciate the small and

medium scale enterprises of Bahir Dar city for understanding and providing me with all the

necessary information in data collection of this study.

I am also highly indebted for Bahir Dar University who taught me with a fully tuition fee

scholarship.

I owe my deepest gratitude to Firew Chekol (PhD), Head Department of Accounting and Finance

and Assistant Professor in Bahir Dar University whose father hood help has made this academic

success in a number of ways. I don‟t have a word to express about deep taught of Teramje Wale

(PhD), Assistant Professor of Accounting and finance in Bahir Dar University on the course

Advanced Research Methodology that gave me modus operandi of research everlasting.

I would also like to convey my sincere thanks to my parents, specially my father Agegn Engida,

my mother Adugna Tafere and my darling kin Mrs. Anguach Asemu whose unconditional love

and silent prayers encouraged me throughout my tenure at Bahir Dar University.

At last but not least, I am also indebted for my friends especially to Tsedie Mesfine, Mamar

Gizatie, Gedamnesh Workayehu, Simeneh Alimaw and Abraraw Chalie and for those who

helped me in any form of assistance.

ii

Abstract

The objective of this study was to examine the determinants of tax evasion in Bahir Dar city from

small and medium scale enterprise (SMEs) tax payers‘ point of view in 2019. An explanatory

research design was employed to examine five tax evasion determinants namely government

performance, tax policy fairness, deterrence, attitude and knowledge in tax issues. The study

revealed that deterrence, government performance, attitude and knowledge in tax issues

determine tax evasion negatively and statistically significant. On the other hand, policy fairness

has been found affecting tax evasion negatively but statistically insignificant. Accordingly, the

study recommends that government should improve the audit regime alongside imposing tough

tax penalties, improve its performance, raise awareness, and improve attitudes of SMEs through

tax education, training and press secretaries etc., if curbing tax evasion is to be the deriving

engines of tax revenue. Finally, the inclusion of additional variables like political affiliation,

cultural influence and religiosity may be potential extension of the present research.

Key words: Tax evasion, Determinants, Small and medium scale enterprises, Bahir Dar city

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Table of contents

Contents Pages

Acknowledgement ........................................................................................................................ i

Abstract ....................................................................................................................................... ii

List of tables and figures ............................................................................................................ vi

List of Acronyms ....................................................................................................................... vii

CHAPTER ONE: INTRODUCTION

1.1 Back ground of the study .......................................................................................................... 1

1.2 Statement of the problem .......................................................................................................... 3

1.3 Objective of the study ............................................................................................................... 6

1.3.1 General objective................................................................................................................ 6

1.3.2 Specific objectives.............................................................................................................. 6

1.4 Hypotheses ................................................................................................................................ 6

1.5 Significance of the study ........................................................................................................... 6

1.6 Scope of the study ..................................................................................................................... 6

1.7 Organization of the study .......................................................................................................... 7

CHAPTER TWO: RELATED LITERATURE REVIEW

2.1 Introduction ............................................................................................................................... 8

2.2 Theoretical review .................................................................................................................... 8

2.2.1 Deterrence theory ............................................................................................................... 8

2.2.2 The Allingham and Sandmo (1972) Model ..................................................................... 10

2.2.3 Fiscal Exchange Theory ................................................................................................... 11

2.2.4 Social Psychology Theory ................................................................................................ 12

2.2.5 Theory of planed behavior ............................................................................................... 13

2.3 Empirical reviews ................................................................................................................... 15

2.3.1 Empirical reviews on deterrence factors .......................................................................... 16

2.3.2 Empirical reviews on Government performance factors .................................................. 18

2.3.3 Empirical reviews on Policy fairness factors ................................................................... 20

2.3.4 Empirical reviews on Knowledge factors ........................................................................ 22

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2.3.5 Empirical reviews on Attitude factors .............................................................................. 24

2.4 Summary and Knowledge gaps .............................................................................................. 26

2.5 Conceptual frame work ........................................................................................................... 27

CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Introduction ............................................................................................................................. 29

3.2 Research Approach ................................................................................................................. 29

3.3 Research design ...................................................................................................................... 29

3.4 Population of the study ........................................................................................................... 30

3.5 Sampling technique and sample size ...................................................................................... 30

3.6 Variables and measurements ................................................................................................... 32

3.7 Data types and Collection ....................................................................................................... 33

3.8 Method of data analysis .......................................................................................................... 34

3.9 Model Specifications .............................................................................................................. 34

3.10 Validity and Reliability of the Instrument ............................................................................ 36

3.10.1 Validity ........................................................................................................................... 36

3.10.2 Reliability of the Survey ................................................................................................ 36

CHAPTER FOUR: RESULT AND DISCUSSION

4.1 Demographic characteristics ................................................................................................... 37

4.2 Descriptive statistics ............................................................................................................... 39

4.3 Correlation Analysis ............................................................................................................... 40

4.4. Tests for the Classical Linear Regression Model (CLRM) assumptions ............................... 41

4.4.1. Assumption one: the errors have zero mean (E (ε) = 0) .................................................. 41

4.4.2. Assumption two: homoscedasticity (variance of errors is constant (Var (ut) = σ2 < ∞) . 41

4.4.3 Assumption three: covariance between error terms over time is zero (cov (ui,uj) = 0) ... 42

4.4.4. Assumption four: normality (errors are normally distributed (ut ∼ N (0, σ2)) ............... 42

4.4.5. Assumption five: Multicollinearity Test ......................................................................... 43

4.5 Regression Result.................................................................................................................... 44

4.6. Discussion of the result .......................................................................................................... 45

Deterrence ................................................................................................................................. 45

Government performance .......................................................................................................... 46

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Attitude ...................................................................................................................................... 47

Knowledge ................................................................................................................................ 48

Policy fairness ........................................................................................................................... 49

CHAPTER FIVE: CONCLUSION AND RECOMENDATION

5.1. Conclusions ............................................................................................................................ 50

5.2 Recommendations ................................................................................................................... 50

Limitations of the study............................................................................................................. 51

Implications for further research ............................................................................................... 52

Reference ................................................................................................................................... 53

Appendix I: Questionnaire ........................................................................................................ 64

Appendix II: Output of SPSS and EVIEWS ............................................................................. 67

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List of tables and figures

List of tables

Table 3.1 Variables and measurements of the study ................................................................. 32

Table 4.1: Type of business activities of respondents ............................................................... 39

Table 4.2 Descriptive statistics.................................................................................................. 40

Table 4.3 Correlation Matrix ..................................................................................................... 41

Table 4.4 Heteroskedasticity Test: White test ........................................................................... 41

Table 4.5 Breusch-Godfrey Serial Correlation test ................................................................... 42

Table 4.6 Multicollinearity test: Variance Inflation Factors ..................................................... 43

Table 4.7: Regression result ...................................................................................................... 44

Table 4.8 Comparison of the test result with the expectation ................................................... 49

List of figures

Figure 2.1: Conceptual framework of determinants of tax evasion .......................................... 28

Figure 4.1: Gender of the respondents ...................................................................................... 38

Figure 4.2 Educational levels of the respondents ...................................................................... 38

Figure 4.3: Normality Test Result ............................................................................................. 42

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List of Acronyms

CLRM – Classical Linear Regression Model

ERCA – Ethiopian Revenues and Customs Authority

ETB – Ethiopian Birr

GDP – Gross Domestic Product

MoSHE – Ministry of Science and Higher education

MoTI – Ministry of Trade and Industry

OECD – Organization for Economic Co-operation and Development

SMEs – Small and Medium Scale Enterprises

TPB - Theory of Planned Behavior

UN – United Nation

WB – World Bank

UNDP – United Nations Development Program

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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

Taxes have existed since the earliest days of civilizations which dated to the ancient Egypt traced

the first dynasty of the Old Kingdom (3000-2800 BC) when corvee and tithe were common

(Abdixhiku, 2013).

Taxation has been the most realistic means of generating revenue by governments for funding

their development projects (Torgler, 2003). It 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 (Getacher & Abera, 2014). Even, tax it‟s the major source of income

for governments in financing public services as well as stimulating the economic growth of most

developing countries (Ameyaw, 2016). Thus, it is not surprising that it‟s believed playing a very

important role and matters the development of nations in the world (Nguyen, 2017), (Devos,

2014) and (Hyman, 2011).

However, many people do not understand the crucial role of tax towards growth of countries and

have been intentionally and unintentionally finding ways to not pay tax (Franzoni, 2000). In fact,

taxes and non-complying 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, tax payers have been inclined to resist, hide and

underreport wealth (Abdixhiku, 2013) which now a days is called tax evasion.

Accordingly, scholars defined tax evasion as an illegal practice of not paying taxes, by not

reporting income, reporting expenses not legally allowed, delaying taxes owed with the intention

at paying nothing or something lesser than one‟s tax liability (Hyman, 2011) and (Franzoni,

2000). Tax evasion drastically reduces the amount of state budgets every year all around

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countries globally and it denies every government tax revenue due to the system, which results in

a gap between the potential and actual tax collection (Adebisi & Gbegi, 2013) even it‟s a global

phenomenon that has been practiced globally (UN, 2018). And, it takes place in developed as

well as developing countries, in virtually all societies and cultures (Ahmed, Amir, Ahmed & Ali,

2018).

Consequently, policy attention to tax evasion was spotlighted after the financial crisis of 2008,

the Great Recession, and the large deficits that followed (Slemrod, 1989) and the need to

understand determinants of tax evasion remains as important as ever with tax evasion being a

globally spread disease that threatens the integrity of every tax system particularly of those that

are more fragile (Abdixhiku, 2013). Meanwhile, it started to receive attention from researchers in

1970s yet it‟s a long-standing, universal problem which transcends national boundaries (Saruc,

2001).

As a result, various researchers produced a large body of theoretical and empirical research,

especially following the publication of the Allingham and Sandmo (A-S) model in 1972 which is

sound under the assumption that an individual pays taxes only because of the economic

consequences of the evasion gamble and because they fear detection and punishment. But once

this idealized world is left and we turn to tax payers subjected to various factors such as

government policies and performance factors, attitude and knowledge factors (Nguyen, 2017).

Although the issue of tax evasion seems studied by various researchers across the globe, it come

up with inconclusive and contradictory judgments on the actual determinants of tax evasion

notwithstanding countless researches have been conducted.

Globally, tax evasion is being one of the major problems facing every country (Abdixhiku,

2013). In developing countries seems obvious because tax administration there is often staffed

with poorly trained and poorly paid officials (Gupta, 2017). 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 (Tsegabirihan, 2010). As a result, most developing countries have not been able to raise

sufficient revenues for essential public infrastructure and human development services (WB,

2018).

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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), (Tarekegn, 2015) and (Gupta,

2017). Based on the trend analysis, (Yesegat, 2016) and (Tarekegn, 2015) found Ethiopia having

lowest tax to GDP ratio (10.7%) far below the average for Sub Saharan African and low income

countries in general, and tax evasion contributes a lot to this poor performance (Abebe, 2019),

(Bayu, 2016) and (Martini, 2014)

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 (Zegeye, 2019), 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 (Derar, 2016). They are not required to have

sufficient filing and reporting (Tax Administration Proclamation No. 983/2016). But it provides

that a person commits an offence if the person, with intent to evade tax, conceals income, fails to

file a tax declaration, or fails to pay tax by the due date (Tax Administration Proclamation No.

983/2016 Article 125 (1)).

Furthermore, various researchers come up with a variety of theories and empirical evidences

involved with the relaxation of A-S model and dealt with tax evasion including deterrence

theory, fiscal exchange theory, social psychology theory and theory of planned behavior. Yet

they are called by different names, but in reality they overlap and use many common explanatory

variables. Thus, this paper infers that none of these theories incorporates all predictors of tax

evasion single handedly.

The most famous quote, regarding taxation, from Benjamin Franklin, ―In this world nothing can

be said to be certain, except death and taxes‖, illustrates well the importance of this study.

Accordingly, this paper ultimately identified what determines tax evasion and examined to what

extent these factors determine tax evasion in Ethiopia, specifically Bahir Dar city from SMEs tax

payer‟s point of view.

1.2 Statement of the problem

Ethiopian SMEs have been observed with the highest degree of non-reporting of their sales to the

tax authority, especially when the transaction is conducted by cash (Mehari, 2017). The

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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), (Martini, 2014) and (Gupta, 2017).

In Ethiopia, the case sound the same, however, tax compliance practice has not been so effective;

as implied from the report of Ministry of revenue that out of 135 surveyed companies with a

hundred days operation Ethiopia has lost 14 billion ETB in tax evasion (Abebe, 2019). Thus, the

problem obviously calls research.

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 (Abebe, 2019). Here, leaving the performance of tax

collection the researcher contends that why tax payers retreated from paying voluntarily 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 the country has

been observed by (Amina & Sinya, 2015) in Jimma, (Tarekegn, 2015) in Dessie, (Derar, 2016)

and (Bayu, 2016) in AdisAbeba, (WB, 2018) and (Ethiopian Ministry of revenue, 2019). This is

a typical indication of non-compliance of tax payers in the country. Ipso facto, Bahir Dar city is

none exceptional to tax evasion due to the fact that, it is governed by the aforesaid ministry.

Following the publication of A-S model in 1972, various theories come up with a variety of

theories tangled with the relaxation of A-S model and dealt with tax evasion. However, none of

them concludes about tax evasion single handedly (Sifuni, 2017).

By studying on determinants of tax compliance behavior, (Aemiro & Dagnaw, 2014) conclude

that penalty is found to be statistically significant in complying with tax in contrary to the work

of (Assfaw & Sebhat, 2019). Also probability of audit is revealed to be highly significant

(Alamirew, 2016) in contrary to (Assfaw & Sebhat, 2019) and (Aemiro & Dagnaw, 2014).

Moreover, (Ali & Sjursen, 2013) conclude that tax knowledge and awareness are positively and

significantly correlated with tax compliance attitude which led tax payers not to evade. In

contrary (Kasipillai, Aripin & Amran, 2003), (Nguyen, 2017) and (Kirchler & Enachesu, 2018)

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documented that possessing tax knowledge would lead to higher evasion. Besides, (Kiri, 2016)

and (Arbex, 2013) concluded that high level of policy fairness can noticeably reduce tax evasion.

However, (Nguyen, 2017) found that policy fairness to have insignificant influence on tax

evasion.

Many scholars are implying and inviting different determinants affecting tax evasion. As

imparting, by obtaining data from 18 empirical studies across the globe (Marandu, Mbekomize

& Ifezue, 2014) implied that government performance as if to curb tax evasion is by no means

alike across countries which is not surprisingly instigated this paper to impart this variable.

Besides, (Gupta, 2017) confirmed that both economic incentives and social norms drive

individual‟s attitude towards paying tax yet they never are satisfied because of unlimited human

wants (Fochman & Kroll, 2016) conjointly with variations of providing among governments

(Armstrong, 2012) which call this paper to incorporate attitude as one of the variables to be

examined.

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. However, the issue of tax evasion of

developed countries by no means is alike with developing countries (Aumeerun, Jugurnath &

Soondrum, 2016), (Devos, 2014), (Asaminew, 2014), (Martini, 2014) and (WB, 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 best knowledge of the researcher some researches have been conducted on issues of tax

evasion in Ethiopia such as (Bayu, 2016), (Alamirew, 2016), (Amina & Sinya, 2015), (Tarekegn,

2015) and (Aemiro & Dagnaw, 2014). They are, however, by far different from 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.

Therefore, by mixing these 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

examining the determinants as well as the extent to which they affect tax evasion in Ethiopia,

specifically Bahir Dar city.

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1.3 Objective of the study

1.3.1 General objective

The main objective of the study was 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 were;

To examine effect of knowledge on tax evasion in Bahir Dar city SMEs.

To examine effect attitude on tax evasion in Bahir Dar city SMEs.

To examine effect government performance on tax evasion in Bahir Dar city SMEs.

To examine effect deterrence on tax evasion in Bahir Dar city SMEs.

To examine effect policy fairness on 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: Knowledge of tax payers significantly reduces tax evasion.

H2: Attitude of tax payers significantly reduces tax evasion.

H3: Government performance significantly reduces tax evasion.

H4: Deterrence significantly reduces tax evasion.

H5: Tax policy fairness significantly reduces tax evasion.

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 and implement 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 section 1.3, this paper was ultimately dedicated to examine determinants of

tax evasion among small and medium scale enterprises in Bahir Dar city in 2019 lone.

Accordingly this paper is delimited to the following issues because of various reasons as

presented here under.

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This study is delimited to small and medium scale enterprises. Perhaps, small and medium scale

enterprises are highly exposed to tax evasion (Kirchler & Enachesu, 2018) and (Derar, 2016).

Also Bahir Dar city was chosen for this study given there were many small and medium scale

enterprise taxpayers (Zegeye, 2019) and convenience to the researcher.

Furthermore, this paper is delimited to examine deterrence factors, knowledge factors, attitude

factors, government performance factors and policy fairness factors only, by contextualizing the

contemporary issues of the country, Ethiopia. To give a highlight, the contextualization accords

that Ethiopia has been characterized by poor performance of tax collection (Abebe, 2019), grand

corruption, high tax evasion, low public goods and services and low incentives to those who do

not evade tax (Ahmed, 2019).

Hence, this paper dedicated to examine determinants of tax evasion among small and medium

scale enterprises in Bahir Dar city in 2019 lone given the aforementioned and many unjustified

reasons for the delimitations.

1.7 Organization of the study

This study is organized with five distinct chapters in which the first chapter discussed 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 presented

results and discussions from which the collected data yields. Finally, the fifth chapter winds up

with conclusions drawn from the fourth chapter thereby forwarding possible recommendations.

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CHAPTER TWO

REVIEW OF RELATED LITERATURE

2.1 Introduction

The objective of this chapter is to review the theoretical and empirical literatures on the

determinants of tax evasion. This review of literatures helped in launching the framework for the

current study and to enhance the deficiencies of the previous studies, which in turn help in

clearly identifying the gap in the literature and formulating hypotheses for the study.

The next sections of the chapter constitutes four sections such as theoretical reviews, empirical

reviews, summary and knowledge gaps respectively and finally the chapter winds up thereby

building a conceptual frame work basing on defined variables and developed the hypotheses.

2.2 Theoretical review

The theoretical approaches of tax evasion have commonly been divided into deterrence theory

and the wider behavioral theory (Feld & Frey, 2002). The deterrence theory encompasses

punitive and persuasive theories including the A-S model whereas the behavioral theory

encompasses the fiscal exchange theory and social psychology theory (Ibid, cited by (Chauke &

Sebola, 2016). Accordingly, the study uses the deterrence and behavioral theories as charity as

the most relevant of others as a foundation for this study which are briefly presented here under.

2.2.1 Deterrence theory

Deterrence is a method of retrospective interference; by holding out threats that whenever a

wrong has been actually committed the wrongdoer shall incur punishment (Kenny, 1929) used

more restrictively, applying only to cases where a threat causes individuals who would have

committed the threatened behavior to refrain from doing so (Devos, 2014).

The deterrence theory of punishment traced to the early works of classical philosophers such as

Thomas Hobbes (1588–1678), Cesare Beccaria (1738–1794), and (Bentham, 1948). Together,

these theorists protested against the legal policies that had dominated European thought for more

than a thousand years, and against the spiritualistic explanations of crime on which they were

founded. In addition, these social contract thinkers provided the foundation for modern

deterrence theory in criminology as follows.

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Hobbes assumed that men are creatures of their own volition who want certain things and who

fight when their desires are in conflict. In the Hobbesian view, people generally pursue their self-

interests, such as material gain, personal safety, and social reputation, and make enemies without

caring if they harm others in the process. Since people are determined to achieve their self-

interests, the result is often conflict and resistance without a fitting government to maintain

safety. Hobbes also pointed out that humans are rational enough to realize that the self-interested

nature of people would lead to crime and inevitable conflict due to the alienation and exclusion

of some members of society. To avoid this, people agree to give up their own egocentricity as

long as everyone does the same thing approximately. This is what Hobbes termed the social

contract. To avoid war, conflict, and crime, people enter into a social contract with the

government so that it will protect them from human predicaments. The role of the state is to

enforce the social contract. Hobbes indicated that if one agrees to the social contract, that

individual authorizes the sovereign to use force to uphold the social contract. But crimes may

still occur even if after governments perform their duties. In this case, Hobbes argued that the

punishment for crime must be greater than the benefit that comes from committing the crime.

Building on the ideals of the social contract philosophers, in 1764 Cesare Beccaria published his

treatise, on Crimes and Punishments. He followed Hobbes and other writers that laws should be

judged by their propensity to afford the “greatest happiness shared by the greatest number. Since

people are rationally self-interested, they will not commit crimes if the costs of committing

crimes prevail over the benefits of engaging in undesirable acts. If the sole purpose of

punishment is to prevent crime in society, Beccaria (1963) argued, “Punishments are unjust

when their severity exceeds what is necessary to achieve deterrence”. In Beccaria‟s view, swift

and certain punishment are the best means of preventing and controlling crime. Thus, Legislators

should pass laws that define crimes and they must provide specific punishments for each crime.

As a result, he concludes that pleasure and pains are the motives of rational people and that to

prevent crime; the pain of punishment must outweigh the pleasure received from committing

crime.

Jeremy Bentham, a contemporary of Beccaria, was one of the most prominent 18th-century

intellectuals on crime. In 1780, he published An Introduction to the Principles of Morals and

Legislation, whereby he proclaimed his famous principle of utility. He argued that ―nature has

10

placed mankind under the governance of two sovereign masters, pain and pleasure‖ (Bentham,

1948). Bentham believed that morality is that which promotes ―the greatest happiness of the

greatest number‖ (Moyer, 2001) a phrase that was also common to Beccaria. The duty of the

state in Bentham‟s view was “to promote the happiness of the society, by punishing and

rewarding” (Bentham, 1948).

Now, it can be concluded that this theory is designed to prevent crime in the general population

and the theory can be achieved through a number of approaches and these could be both punitive

and persuasive. In the use of the punitive nature of the deterrence theory, it can take the form of

increasing the probability of being detected and increasing the tax rate or alternatively through

the imposition of tougher penalties. It can also take a form of providing better taxpayer education

and increased advertising of incentives in instances of being compliant (Feld & Frey, 2002),

(Schneider, Buehn & Montenegro, 2010).

The deterrence hypothesis remains a key intellectual foundation for Western criminal law and

criminal justice systems (Chauke & Sebola, 2016). Basing the deterrence theory, (Hobbes,

1651), (Beccaria, 1764) and (Betham, 1780) cited by (DiIulio, 1966) many theories have been

developed in relation to tax evasion. A typical example for an extension of these theories is that

the A-S (1972) model of tax evasion which is discussed below.

2.2.2 The Allingham and Sandmo (1972) Model

In 1968 Nobel laureate Becker theorized the economics of crime which become a foundation for

Allingham and Sandmo (1972) economic model of tax compliance. The model was

groundbreaking for it was followed by an enormous number of contributions to the literature

which extended the original model in a number of directions. In the model, the taxpayer is

assumed to have an income I and must choose the amount to declare to the tax (Alm & Mckee,

1992). Declared income D is taxed at the rate t; undeclared income is not taxed, but the taxpayer

will face a probability of detection p at which point a fine f will be imposed for cheating. The

taxpayer has the choice between two strategies: (1) He may declare his true income or (2) he

may declare less than his true income. If he chooses the latter strategy his payoff will depend on

whether or not he is investigated by the tax authorities. If he is not, he is clearly better off than

under strategy one. If he is investigated, he is worse off as the audit may lead to penalties. Thus

the taxpayer chooses D to maximize the expected utility of the evasion gamble. This framework

11

suggests that declared income depends upon I, p, f and t: D =f (I, p, f, t). This model shows that

declared income D varies directly with income, the probability of detection (audit rate) and the

penalty (fine rate), but inversely with the tax rate. There is however other factors that affect

compliance decision; while government receives and affords to people ( Kiow & Salleh, 2017),

(Hove, 2016), (Weber & Rockoff, 1980) and this surely exerts influence on compliance or

evasion. The declared income D may be modified to reflect individual‟s receipt of Government

expenditures G as follows: D =f (I, p, f, t, G). Thus compliance is also directly related to

individual‟s perceived benefits from public good funded by their tax payments.

The argument behind the A-S model is that it is based on the assumption that an individual pays

taxes only because of the economic consequences of the evasion gamble and because they fear

detection and punishment. However, it is clear that compliance cannot be explained entirely by

such purely economic considerations and level of enforcement. Even it has been shown that the

percentage of income tax returns that are subject to a thorough tax audit is generally quite small

in most countries, almost always well less than 1 percent of all returns (Eleftheriou, 2019) and

(Aurelija & Rrūta). Also (Macharia, 2014) show that many other factors other than the A-S

factors such as corruption actually allow many taxpayers to take the gamble, as they are likely to

get away with it. Moreover, (Yitzhaki, 1974) show the fact that the penalty is usually imposed

not on the concealed income, but it is rather related to the unpaid amount of tax notwithstanding,

although the Allingham and Sandmo Model of 1972 are elegant in its simplicity, many

potentially relevant noneconomic factors are necessarily omitted and the determinants of tax

evasion become not amazingly puzzling.

2.2.3 Fiscal Exchange Theory

The fiscal exchange theory is well rooted in economics and political sciences like (Cowell &

Gordon, 1988) they noted that compliances increases with the availability of social services

borrowing both idea of economic deterrence and psychological theory. The theory suggests the

existence of a social relationship or psychological contract between the government and the tax

payer (Fjeldstad, Schulz & Sjursen, 2012). It suggest that the presence of government

expenditures may serve as the motivating factor for taxpayer compliance especially when the

government offers the quality and well improved goods and services that the society expect to

get (Alm, 1999). Therefore the society may consider the services they get from the government

12

as exchanging their purchasing power in the market return for government services. This means

that the exchange being largely conditional and varying as the government changes its services.

Therefore the taxpayers are likely to be willing to comply when they are satisfied with

government services even in the absence of detection and punishment (Torgler, To evade taxes

or not to evade, 2003). Moreover, (Ferrari & Salvatore, 2013) examined the contemporary

hypotheses on taxpayer and government service delivery and their influence on tax payment and

suggested that individual is highly influenced to pay when their satisfied with the government

service provided.

2.2.4 Social Psychology Theory

This theory was first used by (Snavely, 1990) who argued that it is reasonable to assume that

human behavior in the area of taxation is influenced by social interactions much in the same way

as other forms of behavior. Furthermore, the theory is based on social perspective of individual

from their behavioral intention. This is based on two basic determinants that include personal

factor and social influences on whether to comply with tax laws or not to comply (McKerchar &

Evans, 2009). Personal and social norms are the basis in studies explaining the taxpayer behavior

and they play very big role in determining the tax compliances (Franzoni, 1999) and (OECD,

2018). Moreover, (Ronan & Ramalefane, 2007) specifically noted that such variables like

stigma, reputation, and social norms have great effect on tax payers. Personal norms have been

defined as the deeply rooted convictions about what one ought or ought not to do (OECD, 2018).

They are in most cases difficult to change and often beyond the reach of public policy (Franzoni,

2000). In perspective of taxpayer behavior personal norms reflect the tax payer values, ethics and

morale, where by all these have influences on tax compliances attitude. (Sour, 2004), argued that

engagement in act of evasion may induce feeling of anxiety, guilt or negative self-image in tax

payer. The fear of experiencing feeling of guilt, along with the risk of social stigmatization has

greater effect than such external factors as the risk of detection and penalty. Therefore an

individual is most likely to comply with tax requirements if he believes that the member of his

reference groups also comply, just as he is also likely not to comply if he believes that members

of his referent group do not comply (Lewis, 1982).

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2.2.5 Theory of planed behavior

The Theory of Planned Behavior was proposed by (Ajzen, 1985) as an extension of the theory of

reasoned action by (Fishbein & Ajzen, 1975). The theory of reasoned action was first introduced

in 1967 by Martin Fishbein in an effort to understand the relationship between attitude and

behavior. It was born out of the frustration resulting from repeated failure to predict behavior

from traditional measures of attitude (Fishbein, 1993). According to (Fishbein & Ajzen, 1975)

the theory of reasoned action is based on the assumption that human beings are rational and

make systematic use of available information. (Ajzen, 1991), finally agreed up on the most

immediate determinant of people‟s behavior is their behavioral intention which is directly

determined by attitudes towards performing the behavior and the subjective norm associated with

the behavior.

The foregoing critique does suggest that the theory of reasoned action is not wholly adequate in

predicting and explaining behavior. In the seminal article in which he introduced the theory of

planned behavior, (Ajzen, 1985) concedes that the theory is “open to the inclusion of additional

predictors if it can be shown that they capture a significant proportion of the variance in intention

or behavior after the theory‟s current variables have been taken into account”. Accordingly, to

improve on the predictive power of the Theory of Reasoned Action, Ajzen added a new

component "perceived behavioral control" to help account for behaviors that arise where an

individual's control over the behavior is incomplete. By this, he extended the Theory of

Reasoned Action to include the role of non-volition in predicting behavior and extended version

is called the Theory of Planned Behavior. Consequently, it is determined that behavior is affected

by attitude, subjective norms and perceived behavioral control.

Synthesis

The deterrence theory of tax compliance assumes that compliance is influenced by economic

factors like tax rates, penalties for fraud and detection probability. The theory views an

individual tax payer as rational economic who asses the cost and benefit of evading tax. Fiscal

exchange theory suggests the existence of the social relationship between the government and

the tax payer. The tax payer consider the government services as the compensation of the tax

paid and their compliance level is likely to increase as the government services increased. The

social psychology theory is based on social perspective that individuals from their behavioral

14

intention, their compliance level are influenced by stigma, reputation and social norms. The

Theory of Planned Behavior suggests that there is one immediate determinant of behavior, called

the person‟s intention to perform or not perform it which in turn is determined by three things:

attitude, subjective norms and subjective control towards evading tax or not.

The various tax compliance theories presented above should be treated as complementary rather

than competing with each other. Each emphasizes different aspects of the various determinants

of compliance. Each aspect contributes towards a better understanding of compliance or evasion

behavior. No single theory has been invented which incorporates all predictors of tax

compliance. In addition, the various theories may not be as empirically distinct as they appear by

their names. They are called by different names, but in reality they overlap and use many

common explanatory variables. For example the use of deterrence theory in the A-S Model is to

some extent similar to the concept of subjective control in the TPB and the whole of social

psychology theory is similar to the concept of subjective norms in the TPB yet not absolutely.

Also, the fiscal psychology theory is to some extent similar with attitude in the TPB.

The general objective of this study is to examine the determinants of tax evasion in small and

medium enterprises in Bahir Dar city and thus from the different theoretical arguments it is

guided by these theories which are economic deterrence theory, fiscal exchange theory, social

psychology theory and the theory of planned behavior.

The justifications of using these theories are due to fact that each theory is limited to explain the

behavior of SMEs tax payers toward tax evasion. Hence, economic deterrence theory is based on

deterrence factors while fiscal exchange theory was based on individual comparison of the

benefits and amount of tax they pay (government performance factors, tax policy factors and

knowledge factors), and social psychological theory relied on psychological influence on tax

payer‟s perception toward tax evasion (policy fairness, attitude and knowledge factors). As well

the TPB also serve as a foundation for the behavior of tax payers towards deterrence,

government performance, policy fairness, attitude, and knowledge in different ways.

15

2.3 Empirical reviews

When we talk about evasion of tax, it could mean any kind of tax like tax on income, wealth,

commodity, sales, value added, excise, agricultural customs tax and any other activities that

enable any form of business to generate revenue regardless of the type of business to which it is

engaged (Hyman, 2011). In this paper however, the researcher uses the term tax to business

income tax alone unless other ways stated specifically. Income tax can be evaded by the

following ways:

Suppressing True Income; it is well known that a large part of black income comes through

illegitimate sources, whether it is bribes, smuggling, black marketing or other such sources.

Professionals like service providers, manufacturers, architects, traders and even film stars and

film producers are examples where the sources are legitimate but income is suppressed to evade

tax. In short, it is common that businesses knowingly fail to report income and under reporting

income by less income than they actually received from a specific source (Devos, 2014),

(Allingham & Sandmo, 1972).

Manipulating Business Expenditures and Profits: The corporate sector indulges in under

reporting of profits (Fochman & Kroll, 2016) overstating expenditures (Armstrong, Blouin &

Larcker, 2012), non-reporting of production and excise (Horodnic, 2018) raising fictitious bills

on companies (Horodnic, 2018) and (Armstrong, 2012). While under-reporting of profits helps

evade tax, non-reporting production helps generate black income in cash and generally increases

the promoters‟ wealth.

Misuse of Tax Exemptions and Deductions: By providing false information to the IRS

about their business income or expenses tax payers deliberately under pay tax (Horodnic, 2018),

(Armstrong, 2012). Substantially understating their taxes by stating a tax amount on their return

which is less than the amount owed on the income they reported (Hassen, 2016). For instance; it

is known that agricultural income is exempted from tax. Many people divert their income to

purchase of agricultural land, show high agricultural profits and avail tax exemptions. It is

possible that the profits come from non-agricultural operations and are taxable but misuse of a

facility helps evade tax and create black income.

According to (Nguyen, 2017), (Khlif & Achek, 2015) and (Belkaoui, 2004) the justifications for

the determinants of tax evasion are based on four theoretical perspectives such as general

16

deterrence, fiscal exchange, social psychology, behavioral theory. Also many empirical papers

dealing with the determinants of tax evasion such as; (Ali & Sjursen, 2013), (Picur & Belkaoui,

2006) and (Wright, 2010) have used the aforesaid theories yet most of the scholars took their

model from (Allingham & Sandmo, 1972) assumptions. For this study, based on theoretical

foundation and previous studies, determinant factors of tax evasion are classified into four

groups as follows; (a) Deterrence factors (b) Government performance factors (c) Policy fairness

factors (d) Knowledge factors. (Nguyen, 2017), also used this classification in studying the

determinants of tax evasion in Vietnam.

2.3.1 Empirical reviews on deterrence factors

These factors presents a model that describes taxpayers who evade taxes and a tax authority that

fights tax evasion in that the tax authority collects taxes and performs audits to enforce tax

compliance (Kuchumova, 2017). This group of factors based on the General Deterrence Theory

(Khlif, & Achek, 2015) and (Belkaoui, 2004). These theories refer to the capability of deterrence

regulations (penalty and audit) to reduce the phenomenon of tax evasion and enhance tax

compliance in one country.

Numerous studies have been conducted on deterrence factors to tax evasion and they supposed

tax audit and penalty as the major factors than can deter tax evasion. Accordingly scholars have

examined the impact of tax audit and penalty as discussed here under.

The first deterrence factor dealt by the researchers is tax audit which is studied well in many

countries as follows. (Alamirew, 2016), has attempted to examine the impact of tax audit on tax

compliance in Ethiopia; at federal level by using secondary macro data and he conclude that the

contribution of tax audit on improving tax payer‟s compliance is significant among other

measures taken by revenue authorities of the country. This conclusion is also supported by

(Kim, 2019), (Engida, 2014), (Soliman, Jones & Cullis, 2014), (Badra, 2012).

It is depicted that the probability of being audited was found to be the significant factor that

positively affecting level of tax compliance. This suggests that the compliance rate rises if the

tendency of being tax-audited is high. In contrary to this, (Aemiro & Dagnaw, 2014) revealed

that the chance of being audited does not have significant impact on tax compliance behavior. It

is also supported by (Assfaw & Sebhat, 2019).

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(Marta & John, 2012) in Slovak Republic, (Hebous & Lipatov, 2014) in Germany, (Gonzalez &

Velasquez, 2013 ) in Chile, (Hokamp, 2014) in Germany, (Soliman, Jones & Cullis, 2014) in

Egypt, (Amina & Sinya, 2015) in Jimma Ethiopia, (Bayer & Cowell, 2009) in Australia,

(Balufus, 2016) in Germany, (Kuchumova, 2017) in Petersburg, (Eleftheriou, 2019) in Greek

concludes that since the contribution of tax audit on improving tax payer‟s evasion is significant

among other measures, revenue authorities of the countries and other concerned parties should

give more emphasis on the role of tax audit by fulfilling the required staff and qualifications to

improve tax payer‟s compliance and thereby increasing countries revenue through tax. Here, they

justified the fact that an increase in the probability of audit, or the audit rate, makes the decision

to evade riskier. Under the assumption of risk-averse taxpayers this means that increasing the

audit rate reduces tax evasion and evasion is inversely related to the probability of being audited.

The second deterrence factor is penalty. A fine or penalty is money paid usually to a government

authority, as a punishment for a crime or other offence in general and tax evasion for this study

(Vihanto, 2003). Increases in tax deterrence sanctions pertaining detection likelihood and the

severity of penalties resulted in lower non-compliance among tax payers (Soliman, Jones &

Cullis, 2014).

(Alm, Cherry, Jones & McKee, 2017) show that public disclosure acts as an additional deterrent

to tax evaders, and that the deterrent effect is concentrated in the first stage of the two-stage

model (whether to evade or not) and found that the deterrent effect is similar in the U.S. and in

Italy, despite what appear to be different social norms of compliance in the two countries.

(Aemiro & Dagnaw, 2014), examined the determinants of Tax Compliance Behavior in Bahir

Dar Ethiopia and revealed that penalties significantly and positively related to tax compliance

intention; that is when taxpayers perceived that there is high penalty rate for any non-

compliance, the level of non-compliance will decrease. In contrary, (Assfaw & Sebhat, 2019)

examine determinants of tax evasion in SNNPR Ethiopia and revealed that penalties are not

statistically significant factors influencing compliance behavior of tax payers and evasion in

Ethiopia. In another way, (Slemrod, 2007) contends that penalties imposed on the tax managers

are more effective in reducing evasion than are those imposed on shareholders.

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The (Allingham & Sandmo, 1972) model argues that an increase in the penalty rate increases

compliance as it has the same change in effect as the probability of audit i.e. making evasion

more costly. This model is also supported by the study of (Hebous & Lipatov, 2014) in

Germany, (Miskam et al., 2013) in Malaysia, (Bruttel, 2014) in Germany, (Amina & Sinya,

2015) in Jimma Ethiopia. Accordingly, the study hypothesized that applying deterrence methods

by applying high penalty rate and tough audit regime would help to reduce tax evasion.

2.3.2 Empirical reviews on Government performance factors

Government performance factors are based on the Theory of Fiscal Psychology and Economic

Deterrence Theory (Khlif, & Achek, 2015), (Belkaoui, 2004), (Damayanti, Sutrisno, Subekti, &

Baridwan, 2015). The Fiscal Psychology Theory suggests the importance of positive policies

that are developed by government to improve taxpayers‟ perception in government performance

in order to reduce tax evasion (Damayanti, Sutrisno, Subekti, & Baridwan, 2015). Truthfully

talking, this theory is conjoined with benefit theory which emphasizes that the government or tax

authorities should levy taxes on individuals according to the benefit conferred on them (

Stankevicius & Leonas, 2015). It stresses that the more benefits a person derives from the

government, the more he should pay tax to the state. Despite its covenant on fairness and equity,

this theory has been severely criticized by many authors for the following reasons: Firstly, there

can‟t be a direct connection between amount of tax paid and the benefits derived (Hyman, 2011)

as this negate the basic principle of the tax. A tax, as we know, is compulsory contribution made

to the public authorities to meet the expenses of the government and the provisions of general

benefit. There is no direct quid pro quo in the case of a tax. Secondly, it is impracticable to

estimate the benefit enjoyed by a particular individual every year from the state, as state

expenditures are usually for the generality of the citizens (Ibid, 2011).

Moreover, (Tsegabirihan, 2010) shows that trust in government performance is negatively

associated with tax evasion across countries. This shows, as if the government performs better,

the tax evasion behavior would be reduced. (Ali & Sjursen, 2013), found that tax compliance

attitude was positively correlated with the provision of public services by the government.

After tremendous reviews of theoretical and empirical studies, (Nguyen, 2017) concluded that

government factors in taxation issues are shown in providing public projects and services, anti-

corruption methods in taxation system, budget transparency and effectiveness, supporting service

19

and guideline, policy reform. In relation to these indicators many studies have been conducted in

various countries as discussed here under.

Economic Deterrence Theory basing on the cost and benefit analysis suggests tax evasion

decreases if a taxpayer finds the benefit of the public expenditures for public projects and

services as return for tax payments. This theory is supported by (Alexeev, Janeba & Osborne,

2004) in Washington, (Nguyen, 2017) in Vietnam.

According to (Adams, 2007), the relationship between corruption and tax evasion dates since the

existence of taxes themselves and he concluded that both are conjoined together. By examining

the implications of corruptibility and the potential abuse of authority for the effects and optimal

design of tax collection scheme, (Hindriks, Keen & Muthoo, 1999) purports that corruption,

evasion and the abuse of power and the possibility thereof are pervasive features of economic

activity. (Hebous & Lipatov, 2014), found that by supporting corruption and the concealment of

officials, bribes, tax havens discourage the provisions of public goods and services hence also

have a negative effect on welfare similarly with the work of (Pickhardt & Prinz, 2014).

(Balafoutas et al., 2015) found tax evasion attempts independently of whether they are successful

or not lead to efficiency losses in the form of too low quality and less frequent trade. Thus,

shadow economies may reduce welfare not only by inducing agents to incur costs to hide or to

uncover taxable transactions, by imposing risk on uncertainty averse tax evaders and by

distorting competition, but also by creating an additional efficiency loss in the underlying market

by forfeiting possible gains from trade and by inducing insufficient quality provision and they

call this the hidden costs of tax evasion. Consequently, they contended that poor government

performance in combating corruption fuels tax evasion.

(Balufus, 2016), in Germany found budget transparency and effectiveness to be the furthermost

prominent determining factor that led tax payers to comply with tax there by reducing tax

evasion. (Olsen, Kasper, Enachescu & Budak, 2018), in Turkey investigated that a combination

of high power in enforcement of tax law and high trust on officials in budget transparency and

effectiveness reduces negative feelings and increases intentions to comply while undermining the

readiness to evade.

(Amina & Sinya, 2015), suggested the fact that clear guideline and supporting service tax system

ought to be as easy as possible for the rationale that taxpayers are from varied background, with

20

totally different level of education, earning level, various culture and different tax awareness. In

serving to taxpayers to complete the tax returns accurately, the tax authorities need to have a

simple, but sufficient, tax return (OECD, 2013).

By assessing whether tax revenue matter for tax compliance behavior in Germany, (Doerrenberg,

2015) found that tax compliance depends on tax-revenue usage which usually is afforded by

governments like public goods and services including infrastructures.

By studying on why corruption and the unofficial economy can persist, (Cule & Fulton, 2009)

found that more cheating by firms is good for bribe-taking inspectors and more bribe-taking

inspectors are good for cheating firms.

(Mangoting, Sukoharsono, Rosidi & Nurkholis, 2015) show tax compliance thereby tax evasion

from social contract perspective as mitigation to tax evasion is an agreement between people and

state and prove as if can be improved through the perspective of social contract theory based on

the freedom, common interests and reciprocity. Keeping this in awareness, they recommend that

governments are required to reform their tax policy, have clear guidelines and supportive

services, and competent technology that can enable them to make people comply with tax.

Accordingly, the study hypothesized that as if government performs better, the tax evasion

would be reduced.

2.3.3 Empirical reviews on Policy fairness factors

These factors are developed based on the economic deterrence model and fiscal psychology

theory which mainly talk about the fairness of tax rates, appreciations governments made to loyal

payers and allowances made to improve the underground economy (Nguyen, 2017).

Many authors confirmed that tax policy has significant implication on the development and

evolution of the informal economy. A related issue is the loss of huge amount of tax revenue that

would have improved the fiscal balance over and above its investment use.

According to (Goumagias, Varsakelis & Assael, 2018) designing tax policies that are effective in

curbing tax evasion and maximize state revenues requires a rigorous understanding of taxpayer

behavior in relation to tax rate, incentives and allowances.

21

According to Waterhouse Cooper-PWC (n. d.), tax policy refers to what taxes governments

choose to levy, in what amounts and on whom. It concerns broad issues such as how much tax

the government needs to collect in order to pay for expenditures and the effect that taxes can

have on overall economic activity. It also concerns issues of fairness, by which who should pay

taxes with how much in tax rates, and which allowances and incentives are allowed to narrow the

gap of inequality.

(Waseem, 2018) Studied on taxes, informality and income shifting in Pakistan and found that

firms report significantly lower earnings, migrate into informality, and switch business form in

response to the increase in tax rate

Supporting the theory of ability to pay, (Doob, 1990) states that the taxes should be imposed

according to a person‟s ability to pay base on his or her earnings it is widely known that public

expenditure should be expected from those that have and not from those who have not. This

principle originated since the sixteenth century. It is believed that the ability to pay theory

underpins the foundation of progressive tax regime as tax rate increases, so also increases the

taxable amount and vice versa. In relation to this, (Fochman & Kroll, 2016) concludes that tax

payers who are incentivized and rewarded contribute less to tax evasion.

According to (Gills, 1998) the theory of underground economy state that knowing the size and

evolution of the underground economy is important for policy making, its very nature makes

anyone very skeptical of any attempt to measure its magnitude. It shows that a significant portion

of the underground economy can be converted to the recorded economy through optimal tax

policy. The finding also provides relevant policy lessons for tax authorities and responsible

bodies working for the development of formal SMEs as engines of growth (Gordon & Nielsen,

1997). While fiscal bodies should work to expand the tax base rather than installing discouraging

high tax rates, realizing the innovation, technology transfer, employment, and income and

growth roles of SMEs requires encouraging tax and subsidy policies through incentives and

rewards (Nguyen, 2017), (Gills, 1998) and (Gordon & Nielsen, 1997). Moreover, this theory

asserts that on top of higher tax rates as major cause of underground economy, there could be

other exogenous causes such as restrictions of entry into the formal sector and economic

hardship caused by a fall in real incomes (Dhami & Al-Nowaihi, 2010) and (Gordon & Nielsen,

22

1997). Here, we should understand that tax policies must address such factors that make the

informal economy flourish which obviously steer to tax evasion.

(Kiri, 2016) Suggested that the levels of tax compliance involved many contributing factors

including the perceived of tax system fairness by taxpayers. Additionally, it‟s concluded that the

high level of policy fairness, low tax rate, incentives and rewards can noticeably reduce tax

evasion (Arbex, 2013) and (Richardson, Determinants of tax evasion: A cross-country

investigatio, 2006).

(Radu, 2012), found the fact that the most significant impact in terms of tax evasion by means of

tax paradisurilor is the emerging countries of not owning the tools need to force an exchange of

strategies have created a climate conducive to the development of strong fiscal paradisurilor,

which, due to legislation and taxation super liberal system, very lenient tax shall, on the one

hand, a number of advantages countries of their location.

Most countries‟ taxpayers consider tax policy inequality regarding tax rate, tax allowance and tax

incentives because they consider tax policy as unfair because they suffer a high tax rates for their

income from their business (Nguyen, 2017), (Begolo & Cruces, 2014, (Chiarini, 2013), (Niepelt,

2005), and (Henk & Dick, 1997), too low tax allowances, so that they cannot afford their living

expenses after paying tax and getting deduction from tax allowances (Nguyen, 2017),

(Armstrong, 2012), (Blouin & Larcker, 2012), (Chiarini, 2013) and (Henk & Dick, 1997) and no

incentives for encouraging them to pay more taxes in comparison to those who do not pay taxes

or pay lower tax amounts (Nguyen, 2017), (Thanh, 2017) and (Fochman & Kroll, 2016).

Accordingly, the study hypothesized that as people perceive of better business income tax policy

fairness as if there are lower tax rates, higher tax allowances and more tax incentives would

reduce tax evasion.

2.3.4 Empirical reviews on Knowledge factors

More recent studies undertaken in knowledge of tax suggested tax knowledge as the most

influential factor to determine taxpayers‟ compliance behavior under the self-assessment system.

This is empirically examined by numerous scholars like (Kasipillai, Aripin & Amran, 2003) and

(Kirchler & Enachesu, 2018) who documented that possessing tax knowledge, would lead to

higher compliance rates. On similar note, the absence of tax knowledge may lead to

noncompliance behavior among taxpayers, either intentionally or unintentionally. This is

23

postulated by (Kirchler & Enachesu, 2018) who studied small business taxpayers in Australia.

She suggested that small business taxpayers are not even aware of their tax knowledge shortfall

and this may lead to unintentional non-compliance behavior. Such evidence was also

documented among individual taxpayers in Malaysia who unintentionally committed mistakes in

their tax return forms (Loo, McKerchar & Hansford, 2008).

(Amina & Sinya, 2015) in Jimma Ethiopia, (Nguyen, 2017) in Vietnam, (Saad, 2014) in

Malaysia, (Newman & Nokhu, 2018) in Zimbabwe, (Assfaw & Sebhat, 2019) in SNNPR

Ethiopia investigated that taxpayers‟ view on their level of tax knowledge, perceived complexity

of the income tax systems and found that the underlying reasons of non-compliance behavior and

taxpayers appeared to have inadequate knowledge on the technical aspects of the income tax

system in general and tax law, tax form, tax computation, tax return and regulation more

specifically. This issue was even critical among the self-employed participants who are expected

to deal with tedious tax matters. In dealing with these tax affairs, they may have to incur more

compliance costs. The income tax system was also perceived as inherently complex. Accordingly

they recommend that governments should give attention in creating awareness among its people

about tax laws, tax calculates, declaration of tax form, using online tax software, finalization and

return, regulations of tax evasion and other related importance of taxation than taking the

traditional instrument usually known as deterrence.

(Hassen, 2016), found there are many cases of unintentional non-compliance in Malaysia due to

taxpayers‟ limited knowledge about tax and poor familiarity with the new tax system. (Ali &

Sjursen, 2013), come into a conclusion that tax knowledge and awareness are found to be

positively correlated with tax compliance attitude. In contrary (Kasipillai, Aripin & Amran,

2003) and (Kirchler & Enachesu, 2018) documented that possessing tax knowledge would lead

to higher evasion. On the other hand, (Slemroad, 2017) found that the respondents‟ tax

knowledge is not significantly correlated with their tax compliance behavior in general. An

earlier study by (Harris, 1989) claim that tax knowledge has no direct significant impact on

taxpayers‟ compliance behavior.

(Shaar, Ali & Ismail, 2015), had examined student‟s awareness and knowledge on Goods and

Services Tax in Malaysia. By gathering primary data through questionnaire from 250 students

ranging from different years of study and they found that students believe government can gain

24

more revenues and obviously nations will benefit from these revenues if governments do more

on tax knowledge than deterrence.

(Newman & Nokhu, 2018) Studied if lack of tax knowledge contributed to high levels of tax

non-compliance amongst SMEs in Zimbabwe and concluded that SMEs there possess basic tax

knowledge about taxation but lack a deeper understanding like the difference between

presumptive taxation and income based taxation but this insignificantly influences their non-

compliance behavior. (Justicia, 2018) studied on the fundamental influence of education on tax

morale and tax morale on tax evasion in Spain in turn and found that educated persons are better

able to understand tax law and concludes that education can lessen tax evasion. Accordingly, the

study hypothesize that people having better tax knowledge are less likely to evade taxes.

2.3.5 Empirical reviews on Attitude factors

(Anno, 2009), found that tax evasion is largely explained by tax morale which is dependent on

the tax payers‟ intrinsic attitudes to honesty and social stigma. He found that this attitude is

influenced by tax payers‟ perception of the size of tax evasion as well as their perceptions of the

policy makers‟ effectiveness in exercising control over the relevant macro-economic variables

and safeguarding the interest of citizens and concluded that morality and reputation costs as

deterrents to tax evasion in Italy. Contrary, (Orviska & Hudson, 2002) found that people in

Slovak Republic to be deterred from tax evasion by attitude to the consequences of being caught.

By studying on why corruption and the unofficial economy can persist, (Cule & Fulton, 2009)

found that more cheating by firms is good for bribe-taking inspectors and more bribe-taking

inspectors are good for cheating firms. (Dzhumashav, 2014) and (Gonzalez & Velasquez, 2013 )

in Chile and (Hebous & Lipatov, 2014) also found the same result and this in turn affects the

perceptions of tax payers‟ towards tax authorities effectiveness and safeguarding themselves.

Using an experimental study, (Olsen, Kasper, Enachescu & Budak, 2018) studied on emotions

and tax compliance among 411 Turkish small business owners and suggested that emotions on

authorities‟ enforcement capacity and trust matter in shaping compliance. (Lillemets, nd), also

found the same result on the Estonian society and further suggested that the willingness level of

paying taxes is connected to the person-based independent indicators as gender and age.

25

(Erzo & Monica, 2014), found that the willingness to pay taxes depend reciprocity. Perhaps, the

promotion of voluntary compliance should be a primary concern of revenue authorities in its

principles for good tax administration, and it has highlighted the importance of tax morale more

generally (OECD, 2013). (Halla, 2010), confirmed that both economic incentives and social

norms drive individuals‟ perception towards paying tax supported by (Helhel, 2014).

Accordingly, the study hypothesized that taxpayers‟ attitude would improve tax evasion

behavior.

Synthesis

From different studies reviewed on tax evasion was found that higher tax rates and perception,

poor tax regulation, corruption and so on are the most important factor that encourage tax

evasion of SMEs. Other factors like multiple taxation and lack of proper enlightenment are also

affect tax compliance among the SMEs surveyed.

However, the researcher contended that still there are many variable that call further research yet

they are studied before by many researchers and found inconclusive. Some of those variables are

presented as follows as an instance.

Tax knowledge is found inconclusive based on the aforesaid empirical studies in that; (Hassen,

2016) and (Shaar, Ali & Ismail, 2015) claimed knowledge about tax is vital to comply with tax

contrary with (Kasipillai, Aripin & Amran, 2003) and (Kirchler & Enachesu, 2018) who

documented that tax knowledge would lead to higher evasion. On the other hand, (Slemroad,

2017) found that the respondents‟ tax knowledge is not directly significantly correlated with their

compliance behavior in general in an extension of earlier study by (Harris, 1989) claim that tax

knowledge has no impact on taxpayers‟ compliance behavior.

Penalties as a deterrent factor are also found to be inconclusive in those researchers such as

(Soliman, Jones & Cullis, 2014), (Aemiro & Dagnaw, 2014) and (Vihanto, 2003) including the

A-S Model argued that penalties significantly and positively related to tax compliance whereas

(Assfaw & Sebhat, 2019) revealed that penalties are not statistically significant factors

influencing compliance behavior.

26

Also probability of detection (audit) found inconclusive in that researchers such as (Amina &

Sinya, 2015); (Bayer & Cowell, 2009); (Alamirew, 2016) revealed the fact that probability of

auditing is vital in improving tax evasion whereas (Assfaw & Sebhat, 2019) and (Aemiro &

Dagnaw, 2014) revealed that the chance of being audited does not have significant impact on tax

compliance.

Also, by studding on the determinants of tax compliance in Ethiopia, (Mehari, 2017) found

corruption does not have an impact in contrary to (Yesegat, 2016) and (Bayu, 2016) in the same

study area.

2.4 Summary and Knowledge gaps

First, the literature on tax compliance had produced a large body of theoretical and empirical

research, especially following the publication of the A-S model in 1972 which is sound under the

assumption that an individual pays taxes only because of the economic consequences of the

evasion gamble and because they fear detection and punishment. But once this idealized world is

left and we turn to tax payers subjected to various factors such as government policies and

performance factors, attitude and knowledge factors. Consequently, various researchers come up

with a variety of theories involved 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 these the aforementioned theory concludes about tax evasion single

handedly.

Second, far-reaching empirical researches have been conducted on the topic of determinants of

tax evasion and or compliance. 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, the sections of the chapter shows inconclusive judgments on the

actual determinants of tax evasion notwithstanding countless researches have been conducted.

Thus, the issue of tax evasion calls further research.

Third, 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 and Malaysia and Ethiopia to some extent. But the issue of tax evasion of

27

developed countries by no means is alike with developing countries where poor public goods and

services, popular grand corruption which in turn affects transparency and effectiveness tax

authorities as well as affordability of public goods and services, little or no incentives and

reward, guerilla and egoistic leaders in setting up to date guidelines and supporting services and

tax reform, 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 the 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 (Devos, 2014) (Asaminew, 2014); Martini, 2014; (WB, 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.

Fourth, although countable research is conducted in Ethiopia, most of the researches focus on

category „A‟ and „B‟ tax payers than small and medium scale enterprises given calls for further

research and methodological variations. It could therefore be argued that determinants of tax

evasion in Bahir Dar city should be better understood if researchers could examine the major

determinants of tax evasion so that it is expected that it will add an important contribution to

knowledge.

2.5 Conceptual frame work

Therefore, after going through tremendous literatures (journals, articles, books and etc.) the

researcher has tried to build a conceptual frame work of this study in five pieces. Since the

objective of the study is examining determinants of tax evasion comprehensively, the researcher

has developed five hypotheses as discussed above so far through thorough understanding and

articulation of numerous literatures (theoretical and empirical) that finally is intended to be tested

on SMEs find in Bahir Dar city. Accordingly, this section presents the formulated hypotheses

and conceptual framework based on what is understood from the literature review about the

determinants of tax evasion as follows.

Based on the articulation of voluminous literatures discussed so far above the researcher

understand that deterrence factor, government performance, policy fairness, attitude and

knowledge are negatively associated with tax evasion which is intended to be tested.

28

H1: Knowledge of tax payers significantly reduces tax evasion.

H2: Attitude of tax payers significantly reduces tax evasion.

H3: Government performance significantly reduces tax evasion.

H4: Deterrence significantly reduces tax evasion.

H5: Tax policy fairness significantly reduces tax evasion.

Given the above hypotheses the following conceptual frame work is built.

Figure 2.1: Conceptual framework of determinants of tax evasion

Source: The researcher develops the above presented model based on Deterrence theory,

Fiscal exchange theory, Social psychology, theory of planned behavior and prior studies.

Tax

evasion

(TV)

Deterrence factors (-)

Government performance factors (-) factors

Policy fairness factors (-)

Knowledge factors (-)

Attitude factors(-)

29

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

The aim of this chapter is to describe the research methodology that have used in the study. The

chapter has been organized as follows; start with the highlight of approach, research design

followed by population and sampling procedure, measurements of variables, data type, source

and analysis and finally winds up there by model specification and operationalization of the

study data.

3.2 Research Approach

The study is conducted based on quantitative research approach. According to (Sekaran, 2016)

quantitative research is explaining phenomena by collecting numerical data usually to explain the

nature of certain relationships, or establish the differences among groups or the independence of

two or more factors in a situation. Also the quantitative approach puts more emphasis on the

results. (Creswell, 2009) Conclude it as a means for testing objective theories by examining the

relationship between variables. These variables can be measured, typically on instruments, so

that numbered data can be analyzed using statistical procedures The approach has been used due

to the fact that, the aim of the study is to generalize the truth found in the sample small and

medium scale enterprises regarding the determinants of tax evasion. This generalization under

quantitative approach can be obtained through a systematic way of seeking facts and causes of

phenomena, focus on analysis of numerical data and statistically analyzing to test the stated

hypotheses.

3.3 Research design

Explanatory research design has been employed because the aim of the study was to examine the

cause and effect relationships between the dependent and independent variables in order to

constitute a certain patterns. According to (Saunders & Thornhill, 2016), explanatory research

design examines the cause and effect relationships between dependent and independent variable.

Therefore, this research was designed to investigate the determinants of tax evasion in Bahir Dar

city by examining the relationship between the dependent variable (tax evasion) and independent

variables (knowledge factors, attitude factors, government performance factors, deterrence

30

factors and tax policy fairness factors). Undoubtedly these variables make explanatory research

design most appropriate. The study has also explained the results by comparing with empirical

evidences and theories. Hypotheses were formulated and have been tested on the basis of

empirical and theoretical reviews on similar subject matters.

3.4 Population of the study

Population is the total collection of all objects or people to be studied (Brooks, 2008) or it is the

entire group of people, events, or things of interest that the researcher wishes to investigate

(Sekaran, 2016). Besides, (Creswell, 2009) stated that in a research study, the study population

defines the entire collection of the units or the people that the researcher wants to use for the

purposes of drawing conclusions. To formulate a research design, the researcher needed to know

the scope of the audience in line with the objectives of the study as the target population included

the people or the population who have the information that the researcher intended to use for the

purposes of drawing conclusions.

Yet there are nine regional states with their capital cities and two city administrations in

Ethiopia, Bahir Dar city which is the capital city of Amhara region among the nine states was

chosen for this study given there are many small and medium scale enterprise taxpayers found in

Bahir Dar and convenience to the researcher.

Accordingly, the target populations of the study were all small and medium scale enterprises

registered by Bahir Dar city small and medium scale enterprises office and who were under

operation. Perhaps, small and medium scale enterprises are highly exposed to tax evasion

(Kirchler & Enachesu, 2018) and (Derar, 2016). According to Bahir Dar city SMEs office, there

were 1897 small and medium scale enterprises registered officially and who were under

operation then.

3.5 Sampling technique and sample size

Because either all of the observations for the entire population will not be available, or they may

be so many in number that it is infeasible to work with them, a representative sample of data is

taken for analysis (Brooks, 2008).

31

Sampling frame describes a complete list of all the cases in the target population from which the

researcher draws a sample (Creswell, 2009). In this study, the list consisted of 1897 SMEs

obtained from Bahir Dar city SMEs office.

Sampling techniques are the methods in which the sample will be selected (Kothari, 2004) and

there exist various types of sampling techniques which include; the probability and non-

probability techniques (Creswell, 2009). Probability sampling techniques are used for

quantitative studies where subjects of the sample are chosen based on known probabilities.

Probability sampling techniques include simple random, stratified random, cluster random,

systematic random and multi stage sampling techniques. Whereas, non-probability sampling

techniques are used for qualitative studies to develop theories where subjects of the sample are

not based on random sampling methods and include convenience, judgmental, quota and

snowball sampling techniques.

Accordingly, the study adopted a proportionate stratified random sampling technique since it

took into account of the different subgroups of SMEs in the population to guarantee that the

sample fairly represents the population on specific characteristics (Creswell, 2009). This was

achieved by dividing the population into categories according to some common characteristic

otherwise referred to as strata. In this case, it involved the classification of SMEs based on their

activities given by the city administration office in to trade, agriculture, service, construction,

mining and manufacturing. Within each strata or enterprise, individual owner or managers were

picked randomly. It is because stratified random sampling method enhances a representativeness

of samples since they were selected from each stratum to conduct the study.

According to (Smith, 2003), a smaller set of the larger population is referred to as a sample size.

The researcher employed Yamane‟s, 1967, cited by (Israel, 1992) statistical formula to select an

appropriate sample size from a finite population. This formula was employed to determine the

representative sample size from the owner or managers of SMEs operating in Bahir Dar city as

follows:

n = N / (1 + Nε2)

Where; n = required sample size

N = size of the population

ε = alpha level, that is, allowable error ε = 0.05 at 95% confidence interval

32

n = 1897/ [1+1897 (0.05)2] = 330.3439 ≈ 331

Accordingly, a proportionate stratified sampling was employed to draw the sample from each

stratum in proportionate to the relative size of that stratum in the total population provided by the

SMEs office.

3.6 Variables and measurements

Table 3.1 Variables and measurements of the study

Code Research variables and measurement items Reference

KNF Knowledge factors

KNF1 Tax proclamation TPB

(Newman & Nokhu,

2018)

(Kirchler & Enachesu,

2018) & (Nguyen, 2017)

KNF2 Tax calculates

KNF3 Using online tax soft wares

KNF4 Tax finalization and return.

KNF5 Regulations of tax evasion

ATF Attitude over tax

ATF1 Tax system is unfair. Fiscal Psychology

theory

Social Psychology

theory

(Kirchler & Enachesu,

2018), (Gupta, 2017)

(Nguyen, 2017)

ATF2 Paying tax is my responsibility.

ATF3 Large portion of the money collected is wasted

ATF4 Evasion is ethical if everyone is doing it

ATF5 Money collected winds up by corrupt politicians

ATF6 I do not object if one of my friends or family evades tax

DEF Deterrence factors

DEF1 Tax penalty rates are high Deterrence theory

(Nguyen, 2017) DEF2 The audit regime and examination rates are tough

GPF Government performance factors

GPF1 Continuous and timely tax reform Fiscal Psychology

theory

(Nguyen, 2017)

(Picur & Belkaoui,

2006)

GPF2 Clear tax guideline and supporting services

GPF3 Enough public goods and services

GPF4 Transparent and effective tax budget expenditure

POF Policy fairness factors

POF1 Low tax rate Fiscal Exchange theory

(Fochman & Wolf, 2019)

(Snavely, 1990)

POF2

POF3

Suitable tax allowance

Many incentives

33

TV Tax Evasion

TV1 No any problem in complying with tax obligations Ethiopian tax

proclamation number 979

& 989, 2016

TV2 Paying tax obligations on or before the due date

TV4 Willingness of paying tax obligation if chance is found

TV5

TV6

Declaring increase in tax costs or tax exempts

Paying tax obligations correctly and voluntarily

3.7 Data types and Collection

According to (Kothari, 2004), in deciding about the method of data collection to be used for the

study, the researcher should keep in mind two types of data viz., primary and secondary. The

primary data are those which are collected afresh and for the first time, and thus happen to be

original in character. Whereas, secondary data have already been collected by someone else and

which have already been passed through the statistical process. Thus, the researcher used

primary data to keep originality, perhaps actual tax payers can adequately understand and display

actual behavior of tax evasion than students, officials of tax authorities and others (Marandu,

Mbekomize & Ifezue, 2014).

For this study, yet there are several methods of collecting primary data like interview,

questionnaires, experiments and many other methods, questionnaire has been believed to be

vital. This is because; first, it‟s the most suitable way to predict taxpayers‟ evasion behavior, as

direct questions (face to face) might lead respondents to answer the questions dishonestly and

could be potentially embarrassing for respondents (Palil, 2010). Second, although finalizing tax

evasion is a difficult task due to lack of reliable information (Alm, 2012), surveys on tax

compliance are the most used methods to analyze tax compliance levels (Kirchler & Wahl,

2010). Third, it is quite popular, particularly in case of big enquiries by claiming the following

merits. First, it is free from the bias of the interviewer; answers are in respondents‟ own words

and give respondents adequate time to give well thought out answers (Kothari, 2004), second,

respondents who are not easily approachable, can be reached conveniently (Creswell, 2009),

third, it needs low cost as compared to the others even when the universe is large and is widely

spread geographically, and large samples can be made use of and thus the results can be made

more dependable and reliable (Sekaran, 2016).

Accordingly, a five point Likert scaled self-administered structured questionnaire were

distributed to 331 respondents who were owner/managers of SMEs officially registered and

under operation then in Bahir Dar city.

34

3.8 Method of data analysis

Basically, data analysis is different for different research designs (Sekaran, 2016), which usually

are dependent on the type of research method adopted for the study which is at the mercy of data

type (Smith, 2003). Therefore, to analyze the data collected through questionnaire based on the

aforesaid discussion in section 3.7, the following steps have been done.

Questionnaires collected from respondents were reviewed carefully and checked for

completeness and consistencies. Each item in the questionnaire was assigned a code and the

responses from each respondent were coded using a defined coding scheme. After completion of

coding, data has been entered into Statistical Package for Social Sciences (SPSS 20) and

analyzed using EVIEWS through descriptive and inferential statistics.

Descriptive statistics was employed to analyze the data with frequency and percentage

distributions, mean and standard deviation.

Moreover, after testing all the assumptions of the model to make the study fruit full, multiple

linear regression analysis was employed to test the statistical significance on the relationship that

existed between the independent variables (knowledge factors, attitude factors, government

policy factors, deterrence factors and tax policy fairness) and the dependent variable (tax

evasion). Conjointly, this multiple linear regression analysis was also used to determine the most

significant and influential explanatory variables affecting the tax evasion in Bahir Dar city. What

is more, the results of both descriptive as well as regression results are presented through

appropriate graphs and tables.

3.9 Model Specifications

According to (Brooks, 2008), the process of building a robust empirical model is an iterative one,

and it is certainly not an exact science. Often, the final preferred model could be very different

from the one originally proposed, and need not be unique in the sense that another researcher

with the same data and the same initial theory could arrive at a different final specification.

Bearing in mind the aforesaid concepts, Brooks show that in the process of model building, a

logical and valid approach would be to follow the steps such as; sufficiently capture relevant

variables stated in the general statement of the problem, collection of data relevant to the model,

choice of estimation method relevant to the model, statistical evaluation of the model, evaluation

35

of the model from a theoretical perspective and use of the model when a researcher is finally

satisfied. In light of the above proofs and on the base of selected variables, this study developed

the following conceptual model.

Y = F(X1, X2, X3, X4, X5)

Where; Y = Tax evasion

X1= Knowledge factors

X2= Attitude factors

X3= Government performance factors

X4= Deterrence factors

X5= Policy fairness factors

Based on the above conceptual model, the researcher employed the analytical model presented

here under.

TV= β0 + β1KNF+ β2ATF+ β3GPF+ β4DEF+ β5POFF+ ε; which later gave the

following equation.

TV= 4.9071 - 0.0944KNF - 0.1834ATF - 0.2574GPF - 0.2154DEF - 0.0977POFF+ ε

WHERE TV= Tax evasion

KNF= Knowledge factors

ATF= Attitude factors

GPF= Government performance factors

DEF= Deterrence factors

POF= Tax policy fairness factors

β0= constant term

β1= beta coefficients

ε = statistical discrepancy

The justification for using this model is that when a variable is influenced by more than one

variables, it is of greater interest and more valid to have more than one explanatory variable in

the regression equation at the same time, and therefore to examine the effect of all of the

explanatory variables together on the explained variable and the model that can enable a

researcher to do this is called multiple linear regression model (Brooks, 2008). Thus, given this

study constituted one dependent variable influenced by five regressors, the researcher found it

obvious of using this model. Besides, numerous empirical studies dealing with the determinants

36

of tax evasion have also used this model so far such as; (Newman & Nokhu, 2018), (Nguyen,

2017), (Mancharoen, 2015), (Ali & Sjursen, 2013) and (Picur & Belkaoui, 2006); as well as the

Allingham & Sandmo (1972), cited by (Marandu, Mbekomize & Ifezue, 2014).

3.10 Validity and Reliability of the Instrument

3.10.1 Validity

The researcher used a standard questionnaire used by previous studies (Nguyen, 2017), (Sifuni,

2017), (Helhel, 2014), (Palil, 2010) and (Saruc, 2001) but it‟s customized to Bahir Dar‟s context.

The customization was done through; first the drafted questionnaire was appraised by researchers

who have much experiences in conduct survey questionnaire researches and tax experts who

were working in ERCA who understand well the regulations and the reality of tax law

implementations to give comments on the survey design and contents.

After receiving comments from the experts some comments in the questionnaire are reworded to

make it become familiar with the life and less sensitive to answer. Moreover, the questionnaire is

translated in to Amharic Version to solve the problem of misunderstanding since all of the

respondents were necessarily Amharic speakers.

After that the researcher conducted the test with potential respondents who are actual tax payers

(owner or managers of SMEs) and the researcher finalizes the questionnaire after testing the

respondents.

3.10.2 Reliability of the Survey

The reliability of the survey means that it is consistent and stable, and hence predictable and

accurate (Gujarati, 2004). That is the degree to which the questions used in the survey bring the

same type of information each time they are used under the same conditions.

The research variables are constructed from two to six different variables of observation,

therefore, for reliability testing the common methodological factors is the Chronbach‟s Alpha

coefficient (Saunders & Thornhill, 2016) and (Gujarati, 2004). Using SPSS software to process

the survey, the Chronbach‟s alpha coefficients shows that the coefficients are greater than 0.7

which is about 0.88. This shows that the research concepts are appropriate and reliable.

37

CHAPTER FOUR

RESULTS AND DISCUSSIONS

This chapter presented the data analysis, presentation and interpretation of findings on the data

collected from small and medium scale enterprises taxpayers in Bahir Dar city. The main

objective of the study was to identify the determinants of tax evasion among small and medium

scale enterprises taxpayers‟ in Bahir Dar city.

The study sampled 331 small and medium scale enterprises taxpayers in Bahir Dar City. The

results are based on 296 questionnaires collected from the taxpayers. The responses of small and

medium scale enterprises taxpayers gathered through questionnaire were encoded in SPSS

version 20 and EVIEWS software. In this case, each factor collected from the respondents was

given a particular code. After that descriptive and inferential analysis was made and the results

are presented using percentages, mean, tables and charts.

Accordingly, sections 4.1 to 4.5 deals with the analysis and summary of results of the

questionnaire gathered from small and medium scale enterprises taxpayers in Bahir Dar city.

Sections 4.6 summarize the findings of all the responses from small and medium scale

enterprises taxpayers to answer the main research question: „Determinants of tax evasion; the

case of small and medium scale enterprises in Bahir Dar city‟.

4.1 Demographic characteristics

This section describes respondents‟ and their business general information such as gender,

educational level and main business activities of respondents.

Accordingly the demographic data of respondents such as gender, education levels and the

activities of the business they are engaged with are discussed under the following figures and

tables, figure 4.1.1, figure 4.1.2 and table 4.1.1. Concerning the gender of respondents, figure

4.1.1 below shows that 201 (67.9%) of the respondents were males and 95 of the respondents

which represents 32.1% of the total respondents were females. This shows that the majority of

the taxpayers of small and medium scale enterprises are males.

38

Figure 4.1: Gender of the respondents

Source: Survey of sampled SMEs and own computation, 2019

Concerning the educational qualification of the respondents, the following figure 4.1.2 illustrates

that 15 (5.1%) of the respondents are found learnt informal education, 21 (7.1%) of the

respondents are primary school and 54 (18.2%) of the respondents are secondary school

complete. On the other hand, the number of respondents who have diploma or certificate and

degree and above are 125 and 81; each of them representing 42.2% and 27.4% of the total

respondents respectively.

Figure 4.2 Educational levels of the respondents

Source: Survey of sampled SMEs and own computation, 2019

In order to pay appropriate taxes, small and medium enterprises must be knowledgeable about

the different evasion measures and requirements. Perhaps, tax knowledge is a specific part of the

general human potential entrepreneurs which increases the chances of business success (Haber &

Reichel, 2007). The extent of non-compliance arising from knowledge deficits because of the tax

complexity of reporting and returning requirements might be substantial among small business,

in the UK, for example, VAT non-compliance mostly results from errors that do not stem from

evasion intent (Webley, 2004).

According to the income Tax Proclamation No. 979/2016, there are different types of businesses

activities in Ethiopia. However, the types of business activities are summarized into six major

39

categories for the consumption of this thesis which is based on the data revealed by the city

SMEs office. Table 4.1 below shows the distribution of respondents according to the categories

of business activities. It shows that 108 (36.5%) of the respondents are engaged in general

merchandizing and trade, 119 (40.2%) are service sectors, 35 (11.8%) are manufacturing sectors

and the remaining 15 (5.1%) and 1 (0.3%) are construction and mining activities. This shows that

the majority of small and medium scale enterprises in Bahir Dar city are engaged in service and

trade businesses activities respectively.

Table 4.1: Type of business activities of respondents

Frequency Percent

Valid

Trade 108 36.5

Service 119 40.2

Manufacturing 35 11.8

Agriculture 18 6.1

Construction 15 5.1

Mining 1 .3

Total 296 100.0

Source: Survey of sampled SMEs and own computation, 2019

4.2 Descriptive statistics

Table 4.2 provides a summary of the descriptive statistics of the dependent and independent

variables for total of 296 observations. The table includes the mean, median, standard deviation,

number of observations, minimum and maximum for the independent and dependent variables of

the model. It shows the average indicators of variables computed from the survey questionnaire.

Accordingly the following table shows, knowledge factors have the mean score of 2.23, which is

the highest among other independent variables. The second variable which is deterrence factors

has a mean score of 2.01. The third factor which is perceived by respondents is policy fairness

which has a mean score of 1.96. Besides, attitude factors with average score of 1.93. Lastly,

compared to other variables the least popular influencing factor perceived by the respondents is

government performance factors which have the mean score of 1.81. Respondents aggregated tax

evasion from the following table is 3.25. From the data collected, most respondents in Bahir Dar

city perceived their enterprises` evade tax due to no or low knowledge about tax proclamations,

calculates, finalization and return etc.., deterrence factors like low detection and penalty rates,

40

lower government performance, less attitude on tax payment and related issues. They have

moderately agreed that these factors influence their business evade tax.

Table 4.2 Descriptive statistics

TV KNF GPF POF DEF ATF

Mean 3.25 2.23 1.81 1.96 2.01 1.93

Median 3.50 1.80 1.40 1.67 1.50 1.50

Maximum 5.00 5.00 5.00 5.00 5.0 5.00

Minimum 1.00 1.00 1.00 1.00 1.00 1.00

Std. Dev. 0.99 1.01 0.92 1.01 1.11 0.95

Observations 296 296 296 296 296 296

Source: Survey of sampled SMEs and own computation, 2019

4.3 Correlation Analysis

Besides, the correlations between the dependent (tax evasion) and independent variables

(knowledge factors, attitude factors, deterrence factors, government performance factors and

policy fairness factors) are singly handedly offered through table 4.3 presented here under.

Accordingly, table 4.3 provides the Pearson‟s correlation matrix for the variables used in the

analysis below.

As can be seen from the table, the result of correlation between evasion and knowledge factors

showed a negative coefficient -0.45. It indicates that the lesser the tax knowledge respondents do

have the higher the influence to evade tax. The correlation result between government

performance and tax evasion showed a negative sign with a coefficient of -0.68. This indicates,

if, government performs better, tax evasion among the SMEs will decrease obviously.

Besides, policy fairness had a negative correlation with tax evasion which is about -0.62. This

implies that the more fair the tax policy the less tax evasion. Further there was negative

correlation between deterrence and tax evasion and the coefficient was -0.63. This shows that as

deterrence increase tax evasion decrease. Meanwhile, the correlation result showed that negative

relationship between attitude and tax evasion and the coefficient was -0.65. This indicates

increase in attitude inversely affects tax evasion.

41

Table 4.3 Correlation Matrix

TV KNF GPF POF DEF ATF

TV 1

KNF -0.45 1

GPF -0.68 0.50 1

POF -0.62 0.44 0.81 1

DEF -0.63 0.44 0.70 0.64 1

ATF -0.65 0.49 0.82 0.74 0.64 1

Source: Survey of sampled SMEs and own computation, 2019

4.4. Tests for the Classical Linear Regression Model (CLRM) assumptions

This section presents the test for the assumptions of classical linear regression model (CLRM)

namely the error have zero mean, heteroskedasticity, autocorrelation, normality and

multicollinearity.

4.4.1. Assumption one: the errors have zero mean (E (ε) = 0)

According to (Brooks, 2008), if a constant term is included in the regression equation, this

assumption will never be violated. Thus, since the regression model used in this study included a

constant term, this assumption was not violated.

4.4.2. Assumption two: homoscedasticity (variance of errors is constant (Var (ut) = σ2 < ∞)

If the errors do not have a constant variance, it is said that the assumption of homoscedasticity

has been violated. This violation is termed as heteroscedasticity. In this study white test was used

to test for existence of heteroscedasticity across the range of explanatory variables.

Table 4.4 Heteroskedasticity Test: White test

F-statistic 1.539255 Prob. F(20,275) 0.0679

Obs*R-squared 29.79998 Prob. Chi-Square(20) 0.0732

Scaled explained SS 30.13091 Prob. Chi-Square(20) 0.0678

Source: Survey of sampled SMEs and own computation, 2019

The result in table 4.4 shows, the F-, X2, and scaled explained SS versions of the test statistic

give the same conclusion that reveals the absence of heteroscedasticity, since the p-values were

considerably greater than 0.05.

42

4.4.3 Assumption three: covariance between error terms over time is zero (cov (ui,uj) = 0)

This is an assumption that the errors are linearly independent of one another (uncorrelated with

one another). If the errors are correlated with one another, it would be stated that they are auto

correlated.

According to (Brooks, 2008), the Breusch-Godfrey Test for auto correlation suggests; if the test

statistic exceeds the critical value from the statistical tables, reject the null hypothesis of no

autocorrelation.

Table 4.5 Breusch-Godfrey Serial Correlation test

F-statistic 2.346832 Prob. F(1,289) 0.1266

Obs*R-squared 2.384313 Prob. Chi-Square(1) 0.1226

Source: Survey of sampled SMEs and own computation, 2019

The result in table 4.5 shows, the F-statistic and R-squared of the test statistic give the same

conclusion that reveals the absence of autocorrelation, since the p-values were considerably

greater than 0.05. Thus the null hypothesis of no evidence of autocorrelation was not rejected

and no significant residual autocorrelation was presumed.

4.4.4. Assumption four: normality (errors are normally distributed (ut ∼ N (0, σ2))

According to (Brooks, 2008), if the residuals are normally distributed the histogram should be

bell-shaped and the Bera-Jarque statistic would not be significant. This means that the p-value

given at the bottom of the normality test screen should be greater than 0.05 to support the null

hypothesis of presence of normal distribution at the 5 percent level.

Figure 4.3: Normality Test Result

0

5

10

15

20

25

30

-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5

Series: Residuals

Sample 1 296

Observations 296

Mean 4.65e-16

Median 0.052956

Maximum 1.602643

Minimum -2.230406

Std. Dev. 0.670722

Skewness -0.261315

Kurtosis 3.106753

Jarque-Bera 3.509302

Probability 0.172968

Source: Survey of sampled SMEs and own computation, 2019

43

The above diagram witnesses that normality assumption holds, i.e., the coefficient of kurtosis

was close to 3, and the Bera-Jarque statistic has a P-value of 0.17 implying that the data were

consistent with a normal distribution assumption. Also, it implies that the inferences made about

the population parameters from the sample parameters tend to be valid.

4.4.5. Assumption five: Multicollinearity Test

Multicollinearity in the regression model suggests substantial correlations among independent

variables. This phenomenon introduces a problem because the estimates of the sample

parameters become inefficient and entail large standard errors, which makes the coefficient

values and signs unreliable. In addition, multiple independent variables with high correlation add

no additional information to the model. It also conceals the real impact of each variable on the

dependent variable (Gujarati, 2004).

Therefore, checking co-linearity problem with the assumption of tolerance and VIF (Variance

Inflation Factor) statistics is important before regressing. (Andy, 2006) suggested that a tolerance

value less than 0.1 almost certainly indicates a serious co-linearity problem. (Liu, 2010) also

suggested that for a VIF value greater than 10, there is also serious co-linearity problem.

Accordingly, table 4.6 below shows the tolerance values of the independent variables of this

research are .720, .298, .476, .213 and .326 for knowledge factors, attitude factors, deterrence

factors, government performance factors and policy fairness factors respectively. Likewise, the

variance inflation factors (VIF) are 1.389, 3.359, 2.100, 4.689 and 3.063 for knowledge factors,

attitude factors, deterrence factors, government performance factors and policy fairness factors

respectively in the order of their appearance. Based on the result, there was no multi co-linearity

problem in determinants of tax evasion among SMEs examined under this paper.

Table 4.6 Multicollinearity test: Variance Inflation Factors

Model Correlations Collinearity Statistics

Zero-order Partial Part Tolerance VIF

1

KNF -.454 -.120 -.082 .720 1.389

ATF -.650 -.140 -.096 .298 3.359

DEF -.631 -.239 -.167 .476 2.100

GPF -.684 -.161 -.111 .213 4.689

POF -.621 -.084 -.057 .326 3.063

Source: Survey of sampled SMEs and own computation, 2019

44

In general, all tests illustrated above were testimonials as to the employed model was not

sensitive to the problems of violation of the CLRM assumption.

4.5 Regression Result

In this study, a multiple linear regression analysis was conducted to test the influence among

predictor variables. The research used SPSS and EVIEWS to code, enter and compute the

measurements of the multiple regressions.

Accordingly, the table 4.7 below reports regression results between the dependent variable (tax

evasion) and explanatory variables. The R-squared value measures how well the regression

model explains the actual variations in the dependent variable (Brooks, 2008).

The adjusted R2 value in table 4.7 below indicates that 52.97% of the total variability of tax

evasion of the SMEs was explained by the variables in the model. The regression F-statistic

(67.46) and the p-value of zero attached to the test statistic reveal that the null hypothesis that all

of the coefficients are jointly zero should be rejected.

Thus, it implies that the independent variables in the model were able to explain variations in the

dependent variable.

Table 4.7: Regression result

Variable Coefficient Std. Error t-Statistic Prob.

C 4.907087 0.107 45.891 0.0000

KNF -0.094366 0.046 -2.059 0.0404

GPF -0.257403 0.093 -2.775 0.0059

POF -0.097726 0.068 -1.435 0.1525

DEF -0.215381 0.051 -4.190 0.0000

ATF -0.183424 0.076 -2.405 0.0168

R-squared 0.537703 Durbin-Watson stat 1.816171

Adjusted R-squared 0.529732

F-statistic 67.46035

Prob(F-statistic) 0.000000

Source: Survey of sampled SMEs and own computation, 2019

45

From the explanatory variables, deterrence, government performance, attitude and knowledge

had a negative and statistically significant effect on tax evasion at 5% significance level. In

contrary, policy fairness was found being statistically insignificant and negative effect on tax

evasion.

4.6. Discussion of the result

This section of the chapter discusses some of the main implications of the results. The analysis is

based on the results of the regression between the dependent variable and the independent

variables presented in table 4.7 above.

Deterrence

As shown in section 1.4 this study hypothesized that deterrence significantly reduces tax evasion.

The result is in line with the hypothesis. In particular, the coefficient on deterrence factors was

negative and statistically significant at one percent level with a p-value of 0.00. This means that

the less deterred small and medium scale enterprises in Bahir Dar city are more likely to evade

tax. This result is consistent with the deterrence theory and the Allingham & Sandmo (1972)

Model which suggested that an individual pays taxes because of the economic consequences of

the evasion gamble and because they fear detection and punishment which in turn is supported

by (Amina & Sinya, 2015), (Bruttel, 2014), (Hebous & Lipatov, 2014) and (Miskam et al.,

2013). Therefore, the less deterred the SMEs are, the higher the possibility to evade tax which

come against (Assfaw & Sebhat, 2019) and (Nguyen, 2017) who found tax penalty and

probability of detection nothing determines tax evasion.

This signifies that low deterrence factors such as low penalty rates was less likely to influence

tax compliance as perceived by respondent there by increasing the likely hood of tax evasion,

provided that other factors remained constant. This may be explained that tax penalty creates

burden to tax payers which forces tax payers to incur more cost in doing business. An increase of

penalty lead to an increase of business cost which makes SMEs to decide way of minimizing cost

so that SMEs can continue to operate. In contrary, it conquers the work of (Assfaw & Sebhat,

2019) that tax audit were not statistically significant factors influencing compliance behavior of

tax payers. (Cowell & Gordon, 1988), in deterrent theory argued that an increase of penalty

decreases the benefit of tax evasion. The present study concurs with (Aemiro & Dagnaw, 2014)

who suggested that when taxpayers perceived that there is high penalty rate for any non-

46

compliance; the level of non-compliance will decrease which obviously decreases tax evasion

similarly with the work of (Slemrod, 2007) and (Vihanto, 2003).

Moreover, this study found the same result with the work of (Eleftheriou, 2019), (Amjad,

Hijattulah & Munusamy, 2018), (Kuchumova, 2017), (Balufus, 2016), (Alamirew, 2016),

(Engida, 2014), (Hokamp, 2014) and (Bayer & Cowell, 2009) who conclude that since the

contribution of tax audit on improving tax payer‟s evasion is significant among other measures,

revenue authorities and other concerned parties should give more emphasis on the role of tax

audit by fulfilling the required staff and qualifications to improve tax payer‟s compliance thereby

reducing tax evasion to generate the most essential source of revenue for governments. However,

this study confronts the study of (Assfaw & Sebhat, 2019) and (Aemiro & Dagnaw, 2014) who

found probability of being audited have no significant impact on tax compliance behavior.

Generally, it can be summarized that, deterrence is considered as an important factor in

influencing tax evasion. This result clearly supports the hypothesis that deterrence factors would

reduce tax evasion.

Government performance

As shown in section 1.4 this study hypothesized that government performance reduces tax

evasion. The result is in line with the hypothesis. In particular, the coefficient on government

factors was negative and statistically significant at one percent level with a p-value of 0.0059.

This means that the more satisfied small and medium scale enterprises by government

performance in Bahir Dar city are the less likely to evade tax.

This result is consistent with fiscal exchange theory and economic deterrence theory which

suggests that the existence of a social relationship or psychological contract between the

government and the tax payer (Fjeldstad, Schulz & Sjursen, 2012). This theory suggest that

taxpayers pay taxes in the pursuit of getting the benefits from tax budget expenditures for many

fields which are implemented and managed by the government. Therefore, government

performance is of importance to build up or damage people‟s trust in the government in order to

decide whether paying taxes or evading taxes.

The study found when government performs better in various activities; the SMEs will less likely

be to evade tax in Bahir Dar city. Meanwhile, it is concurred with numerous studies who

suggested that obviously tax payers comply to pay tax even in the absence of detection and

punishment (Torgler, 2003) when government performs better in relation to tax reform

47

(Gemechu, 2014) and (Nguyen, 2017) quality and improved projects, goods and service (Ahmed,

Amir & Ali, 2018), (Ferrari & Salvatore, 2013) and (Nguyen, 2017) transparent and effective tax

budget expenditure (Tsegabirihan, 2010), (Nguyen, 2017) and (Balufus, 2016) tough method to

combat tax corruption (Adams, 2007), (Pickhardt & Prinz, 2014) and (Nguyen, 2017) clear tax

guideline and supporting services (Alm, 2012), (Alexeev, Janeba & Osborne, 2004), (Amina &

Sinya, 2015) and (Nguyen, 2017).

Accordingly, it may be summarized that in Bahir Dar city, SMEs call for the government to

apply stronger methods for anti-corruptions to improve their trust into the government.

Moreover, they also ask for further tax reform, improving tax services and public services and

providing more public projects for taxpayers.

Hence, government performance is considered as an important factor in influencing tax evasion

in Bahir Dar city. This result clearly supports the hypothesis that better government performance

significantly reduces tax evasion.

Attitude

As shown in section 1.4 this study hypothesized that attitude significantly reduces tax evasion.

The result is in line with the hypothesis. In particular, the coefficient on attitude factors was

negative and statistically significant at two percent level with a p-value of 0.0168. This means

that the better attitude over tax issues SMEs have they are the less likely to evade tax.

The study revealed that SMEs in Bahir Dar city have scarcer attitudes over tax issues because of

unfair tax system, wind up of collected money in the pockets of corrupted politicians, wastage of

large portion of collected money, ethics of tax evasion and weaker referral groups which in turn

led the SMEs paying tax is not their responsibility there by influence them to evade tax.

This result is consistent with the theory of planned behavior and social psychology theory which

suggest that tax evasion is largely explained by tax morale which is dependent on the tax payer‟s

intrinsic attitudes to honesty and social stigma. Also it is concurred with the work of (Inna, 2009

) who found that attitude is influenced by tax payer‟s perception of the size of tax evasion,

policy makers effectiveness in exercising control over the relevant macro-economic variables

and safeguarding their interest and concluded that morality and reputation costs as deterrents to

tax evasion than the traditional deterrence factors.

Meanwhile, this result go well together with previous studies in that tax payers retreated from

paying tax because they believe unfair tax system (OECD, 2018) and (Olsen, Kasper, Enachescu

48

& Budak, 2018), no/low responsibility of paying tax (Kirchler & Enachesu, 2018) and (Rangan,

2008), wastage of collected money for unnecessary projects (Nguyen, 2017) and (Erzo &

Monica, 2014), ethics of tax evasion (Tarekegn, 2015) and (Palil, 2010), corruption (Gonzalez

& Velasquez, 2013 ) and (Cule & Fulton, 2009) and weaker referral group (Helhel, 2014),

(Halla, 2010) and (Palil, 2010).

Hence, attitude is considered as an important factor in influencing tax evasion in Bahir Dar city.

This result clearly supports the hypothesis that better attitude in tax issues would reduce tax

evasion.

Knowledge

As shown in section 1.4 this study hypothesized that better knowledge in tax issues would reduce

tax evasions. The result is in line with the hypothesis. In particular, the coefficient on knowledge

factors was negative and statistically significant at five percent level with a p-value of 0.0404.

This means that the more the SMEs are knowledgeable about tax issues they are the less likely to

evade tax.

The study revealed that tax payers had deficient knowledge of tax issues concerning tax

proclamations, calculates, finalization and return. Surprisingly it is revealed that the SMEs are

not awaked with the regulations of tax evasion which influence them to evade tax not only

intentionally but also not deliberately even they are not using online tax software.

The result is consistent with theory of planned behavior which suggests that an individual's

control over the behavior is incomplete; that means possessing tax knowledge would lead to

higher compliance rates or absence of tax knowledge may lead to noncompliance behavior

among taxpayers there by influences them to evade tax. It is also coincided with the study of

(Kirchler & Enachesu, 2018) who suggested that SMEs taxpayers are not even aware of their tax

knowledge shortfall and this may lead to unintentional non-compliance behavior. It‟s also

concurred by the study of (Newman & Nokhu, 2018) while confronted the study of (Nguyen,

2017).

It is found consistent also with the work of (Hassen, 2016), who come into a conclusion that tax

knowledge and awareness are found to be positively correlated with tax compliance attitude

supported by (Amina & Sinya, 2015), (Saad, 2014) and (Palil, 2010).

Hence, knowledge is considered as an important factor in influencing tax evasion in Bahir Dar

city. This result clearly supports the hypothesis that knowledge significantly reduces tax evasion.

49

Policy fairness

As shown in section 1.4 this study hypothesized that better policy fairness reduces reduce tax

evasion. The result seems somewhat in line with the hypothesis in that is negatively related with

tax evasion. In particular, the coefficient on policy fairness factors was negative and statistically

insignificant at ten percent with a p-value of 0.1525. This means that the policy fairness over tax

issues had not influence SMEs to evade tax in Bahir Dar city.

Many prior works concluded that the high level of policy fairness such as low tax rate, incentives

and rewards can noticeably reduce tax evasion. However, it seems to be different in Bahir Dar‟s

context. The regression result from survey data in Bahir Dar shows tax policy fairness is an

insignificant factor to determine tax evasion thereby better tax policy fairness would not reduce

tax evasion. This may be explained in that as compared to other factors the SMEs are not

affected by the tax policy fairness to evade tax but rather it was the flimsy deterrence, lower

government performance, pathetic attitude over tax issues and scared knowledge they had about

tax issues then.

Hence, policy fairness nothing influences SMEs tax evasion in Bahir Dar city. This result clearly

comes out against the hypothesis that better policy fairness will reduce tax evasion.

Generally this chapter presented the results of the survey and then discussed the analysis of these

results jointly. Table 4.8 below summarizes the comparison of the test result for determinants of

tax evasion with the hypothesized expectations. As shown in the table 4.8, the test result of the

variables was consistent with the hypothesis presented in section 1.4 except for the policy

fairness which was found to be statistically insignificant.

Table 4.8 Comparison of the test result with the expectation

Independent

Variables

Expected Relationships

with Tax evasion

Actual result

Statistical

Significance test

Deterrence factors - - significant

Government performance - - significant

Attitude factors - - significant

Knowledge factors - - significant

Policy fairness factors - - insignificant

Source: Survey of sampled SMEs and own computation, 2019

50

CHAPTER FIVE

CONCLUSIONS AND RECOMMENDATIONS

The preceding chapter presented the results and discussion, while this chapter deals with

conclusions and recommendations based on the findings of the study. Accordingly this chapter is

organized into two subsections. Section 5.1 presents the conclusions and section 5.2 presents the

recommendations.

5.1. Conclusions

The regression results show that deterrence, government performance, attitude and tax

knowledge are determinant factors which have real impact on tax evasion in Bahir Dar city. In

contrary, policy fairness does not have any significant influence on tax evasion. Accordingly, the

study has drawn the following conclusions.

This study observed that an existence of ineffective deterrence encouraged tax evasion,

especially the probability and the associated risk of detection of evasion is lower than paying

taxes and thus significantly affects tax evasion.

The SMEs call for the government to apply stronger methods for anti-corruptions to improve

their trust into the government. Besides, they also ask for further tax reform, improving tax

services and public services as well as providing more public projects. Even, they seems

yearn transparent and effective tax budget expenditures. Thus, it seems to significantly

influence SMEs to evade taxes.

SMEs believe that the large portion of the money collected is wasted and winds up in the

pockets of corrupted politicians that made them to feel evasion is ethical and of paying tax is

not their responsibility. Moreover, they believe even the tax system is unfair. Thus, their

attitude over tax seems lost because of grand corruption, wastage and unfairness of the tax

system which significantly influences them to evade tax.

The SMEs do not appear to have tax knowledge especially about tax proclamations,

calculates, finalization and return as well as the regulations of tax evasion which significantly

inspires them to evade tax.

5.2 Recommendations

On the basis of the findings of this study, the researcher has forward the following

recommendations.

51

The tax authority be duty-bound to work hand in hand with federal auditor general in

improving the audit regime and had better widen their sample of audited taxpayers alongside

imposing tough tax penalties as a valuable policy aimed at discouraging tax evasion.

Government should improve its performance such as its anti-corruption efforts, tax reform,

transparency and efficiency as well as public services considering the contemporary

challenges and opportunities of globalization and innovation. To do this, it should utilize

elites, intellectuals, professionals and other stake holders who can influence the system with

their own differentiation. In other words, the issues shall be seen from system approach and

integration of available human, institutional and material resource is advised.

The tax authority should monitor more closely those who lost their attitude over tax and trust

worthiness on the government by publicizing through press secretaries about state budget‟s

collection and expenditures to improve misconception.

Government must be accountable and transferable for people‟s money and should change its

attitudes i.e., corrupt the money collected, waste to much money and unfair in tax system;

through gauging its administrative mechanism and tax policy there by aware and train its

officials not be atheistic.

An introductory tax course should be delivered to all higher education students, perhaps as a

common course at the beginning of higher learning education, so that students are aware of

their responsibilities as future taxpayers. Moreover, the government needs to impart SMEs in

areas of training so that they can be aware with basic tax knowledge.

Limitations of the study

It is acknowledged that this study has a number of limitations. First, the tax evasion

determinants, questions and the scope of questions asked in the questionnaire were only limited

to the scope of the study presented in section 1.6. The section only covers some determinants of

tax evasion. It was unable to examine all the determinants of tax evasion as it would made the

questionnaire lengthy, hence low response rates would potentially occurred.

Secondly, the use of a self-report survey might be less reliable, especially when the information

sought on tax is sensitive, potentially incriminating or embarrassing (Richardson, 2008) and

actual behavior of the subjects may vary from the responses given. Acknowledging this

constraint, however, it is believed that this is the most suitable way to predict taxpayers‟

52

compliance behavior, because direct questions (face to face) might lead respondents to answer

the questions dishonestly and could be potentially embarrassing for respondents (Palil, 2010).

Third, improved survey measures of tax evasion determinants and various potential tax evasion

determinants such as cultural influence, political affiliation, and religiosity could improve the

reliability of the empirical results and further reduce the risk of measurement error. This study

was unable to include those variables at the same time. Ipso facto, to balance this issue, the study

contextualized the issues to the contemporary Ethiopia and gauged the measurement items by tax

experts who know the reality then as well as used both direct and indirect questions. Moreover,

the questionnaire has been translated in to Amharic version and it‟s believed that it was

considered sufficient to validate the results.

Fourth, the types of approaches used (modus operandi) in examining tax evasion determinants

which used a survey might provide limited results, and different research designs like and

experiment could produce different results. However, regardless of these limitations and

weaknesses, the findings of this study could contribute to the tax literature and provide policy

implications in developing countries, Ethiopia specifically.

Implications for further research

Future research could be directed towards various directions. First, the inclusion of additional

variables like political affiliation, cultural influence and religiosity could be examined. Second,

the application of longitudinal study in which a comparison of more years and using other data

sources like interviews and experiment is another potential extension of the present research. On

the other hand, the same study could be researched from other sectors perspective not only in

Bahir Dar city but also at regional and national level.

53

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Appendix I: Questionnaire

This questionnaire is to be filled in by owners/managers of small & medium scale

enterprises operating in Bahir Dar city.

Dear Respondents,

Good Day!

I, students of Accounting and Finance in College of Business and Economics at Bahir Dar

University am currently working on my thesis entitled "determinants of tax evasion" in Bahir

Dar City. In line with this, I would like to ask your good office to grant my humble request by

answering this questionnaire for at most an hour. This will enable me to gather significant

information in fulfilling my study.

It will be rest assured that whatever information I gathered will be used only for thesis purposes

and be treated with uttermost confidentiality.

Your cooperation will be highly appreciated!

Part I: Demographic information

1. Gender: Male Female

2. What is your highest level of education?

Informal education Primary Secondary

Certificate/Diploma Degree & above

3. What kind of business are you in?

Trade Service Manufacturing

Construction Agriculture Mining

Part 2: The Influence of knowledge, attitude, deterrence, government performance and policy

fairness factors on tax evasion in SMEs.

Please kindly indicate your level of agreement or disagreement by ticking (√) to measure

the extent to which knowledge, attitude, deterrence, government performance and policy

fairness factors influence tax evasion. Use a scale of 1-5 where: 1 = fully disagree, 2 =

65

disagree, 3 = undecided, 4 = agree and 5 = fully agree to answer the whole questions

stated below.

Code

Statement Fu

lly

dis

ag

ree

Dis

ag

ree

Un

dec

ided

Ag

ree

Fu

lly

ag

ree

A. Knowledge factors 1 2 3 4 5

KNF1 I know the tax proclamation in detail.

KNF2 I can calculate my tax obligation thoroughly.

KNF3 I am using online tax software.

KNF4 I am fully aware about tax finalization and return.

KNF5 I know the regulations of tax evasion in detail.

B. Attitude over tax

1

2

3

4

5

ATF1 I believe that the tax system is unfair.

ATF2 I believe that paying tax is my responsibility.

ATF3 I believe that the large portion of the money collected is wasted.

ATF4 I believe that evasion is ethical if everyone is doing it.

ATF5 I believe that money collected winds up in the pockets of corrupt

politicians.

ATF6 I do not object if one of my friends or family evades tax.

C. Deterrence factors 1 2 3 4 5

DEF1 I pay my tax correctly because the current tax penalty rates are high.

DEF2 I do not evade tax because the audit regime and examination rates are

tough.

D. Government performance factors 1 2 3 4 5

GPF1 The tax authority reforms the tax system continuously and timely.

GPF2 The tax authority has clear tax guideline and supporting services.

GPF3 I receive enough public goods and services from the tax I pay.

GPF4 The tax authority has transparent and effective tax budget

expenditure.

GPF5 Government has good methods for tax anti-corruption.

E. Policy fairness factors 1 2 3 4 5

POF1 I believe that the current tax rate is low and reasonable.

POF2 I believe that there is suitable tax allowance to motivate tax payers.

POF3 There are many incentives and rewards to motivate taxpayers.

F. Tax Evasion 1 2 3 4 5

TV1 I have no any problem in complying with my tax obligations.

TV2 I have been paying my tax obligations on or before the due date.

TV3 I have been providing inappropriate information in tax declaration

dossiers.

66

TV4 I will not pay my tax obligation if I got the chance.

TV5 I have been declaring increase in tax costs or tax exempts.

TV6 I have been paying my tax obligations correctly and voluntarily.

Thanks indeed for your collaboration!

67

Appendix II: Output of SPSS and EVIEWS

Ramsey RESET Test

Equation: UNTITLED

Specification: TV KNF GPF POF DEF ATF C

Omitted Variables: Squares of fitted values

Value df Probability

t-statistic 1.405324 289 0.1610

F-statistic 1.974935 (1, 289) 0.1610

Likelihood ratio 2.015890 1 0.1557

Case Processing Summary

N %

Cases

Valid 296 100.0

Excludeda 0 .0

Total 296 100.0

a. Listwise deletion based on all

variables in the procedure.

Reliability Statistics

Cronbach's

Alpha

N of

Items

.888 5

Item-Total Statistics

Scale Mean

if Item

Deleted

Scale

Variance if

Item Deleted

Corrected

Item-Total

Correlation

Cronbach's

Alpha if Item

Deleted

KNF 7.7048 12.564 .524 .909

ATF 8.0136 11.334 .803 .848

DEF 7.9275 10.893 .713 .869

GPF 8.1325 11.207 .860 .836

POF 7.9787 11.074 .780 .852