Improve business climate to ensure tax compliance

Uganda has recorded impressive economic growth rates over the last two decades. However, over the same time periods, the tax effort measured by the tax-to-GDP ratio has stagnated at between 10-13 percent. One of the factors that could explain the stagnated revenue performance is tax evasion.  Other factors are related to corruption and inefficient service delivery. As a result, Uganda has continued to struggle with inadequate funds to finance its budget.

Recently donors, who contributed as much as 25% of the budget, unanimously decided to withhold their support due to allegations of corruption in various government departments. This has affected the performance of the Ugandan economy, with major implications on service delivery and business growth. In response, the Uganda Revenue Authority (URA) has had its tax collection targets elevated to close the financing deficit. However, the biggest challenge remains ensuring tax compliance, especially considering the size of the informal sector in the country. 

The key issue in improving Uganda’s tax performance, therefore, is tapping into the informal sector. Recent estimates indicate that the informal sector accounts for about 50 percent of Uganda’s gross national income. But why would firms operate informally and evade taxes? Before we answer this question, we need to understand why businesses exist in the first place. Businesses primarily exist because the owners want to maximise profits and thrive in an environment that guarantees security of existence, growth and expansion.

However, recent research has shown that the business environment in Uganda has been deteriorating over the past years. For example, the latest World Bank survey indicated that Uganda’s competitiveness ranking deteriorated from 108 in 2009 to 123 in 2013.   This is largely due to insufficient progress made to address infrastructure bottlenecks, lack of innovation and inadequacy of technology readiness, legal and regulatory weaknesses, bureaucratic corruption and bribery, non-tariff barriers to trade, and constrained access to credit and seed capital.

The above factors contribute to tax evasion in various ways. For example, businesses are less inclined to pay taxes when they are inadequately supplied with public goods such as electricity and transport infrastructure. In this case business executives do not see value for their money and therefore withhold the tax cheque. Intuitively, when electricity is not available, a business may invest in a generator which inevitably increases the cost of doing business. Likewise a business that faces a bad road may have to replace vehicle parts more frequently which also increases the cost of doing business. Faced with increasing costs, firms may under declare their actual performance, so as to avoid taxes and maintain a given level of profitability.

In addition, businesses that pay bribes are more likely to evade taxes. The effect of bribery on tax evasion is twofold: on the one hand, businesses that evade taxes may pay bribes to officials so as to cover up or not get reported to the authorities. On the other hand, businesses may evade taxes if officials ask for informal payments “to get things done quickly” and in this case the informal payment is perceived as a tax on the business.

Businesses evade taxes when the legal and regulatory environment is weak and can easily be manipulated. In this case, businesses evade tax either because they know that they will not be caught or because they know that they can manipulate the legal processes.

In the final analysis, in order for government to reduce tax evasion and increase revenue collections, the business environment has to be improved. This would entail strengthening the legal system, adequate provision of public capital such as transport and electricity infrastructure as well as reigning in on bureaucratic bribery.

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Joseph Mawejje is a Research Analyst at the Economic Policy Research Centre