Tax evasion occurs when a person or an organization illegally takes purposeful steps to avoid paying a tax liability . A criminal offense under federal and state statutes, tax evasion is considered fraud. Violators can be charged with a felony for tax evasion.
There is a distinction between tax evasion and tax avoidance in real sense; only the latter is legal. Tax avoidance, or using tax law to pay the least amount of taxes possible, is encouraged. In many cases, the tax code offers various tax credits, exemptions and deductions that may be used to reduce or offset taxable income.
Though the IRS may be displeased with the routes people take to lower their taxes, in the context of tax avoidance, these methods are fair game until Congress decides to close these loopholes. Some of these include selling your business to a family member, resulting in an exemption or deduction in estate or gift tax; establishing a company’s tax residence in a different country; and making charitable donations.
There is also a distinction made between tax evasion and negligence. Both are defined as a failure to reasonably attempt to follow tax codes, and both are illegal. The IRS takes into consideration honest mistakes, sparing someone who may have simply misinterpreted instructions. There are certain measures that expose taxpayers to being accused of negligence, such as taking deductions they are not eligible for or keeping inaccurate financial records.
Understanding Tax evasion deeper
There is some ambiguity as to what is considered tax evasion, but certain actions clearly fall under this umbrella. These include:
- Falsifying Internal Revenue Service (IRS) financial forms.
- Underreporting income.
- Compensating employees in cash.
- Using a fake social security number.
- Falsifying business income and/or expenses.
- Claiming a nonexistent dependent (e.g., a child).
- Using multiple financial ledgers.
- Underreporting cash tips (typically done by waiters and waitresses).
- Failing to file returns.
The International Monetary Fund (IMF)’s latest Regional Economic Outlook for sub-Saharan Africa (SSA) has important implications for African economies large and small. Apart from projecting that policies currently in place across the region will only yield an underwhelming average growth rate of under 4%, the IMF also estimates that governments throughout sub-Saharan Africa could boost revenue by 5% on average by optimizing the way in which they mobilize domestic resources.
This primarily involves reforming tax policies. African governments should bolster their national coffers by leveraging innovative technologies and simplifying overcomplicated procedures. The incentive to do so is clear-cut. It would result in more money available for critical public services, from health care to education.
An unacceptable deficit
According to IMF data, the average tax frontier (a country’s maximum achievable level of tax revenues) is 7.5% lower in SSA countries than anywhere else in the world. A separate report by the United Nations Economic Commission for Africa (UNECA) estimates African countries lose more than $50 billion each year to illegal financial outflows, most especially through tax avoidance and evasion.
Nigeria represents the epitome of poor tax compliance. That matters all the more as, with its 195 million people, Nigeria is the continent’s most populous country and has big needs. Even so, it has the lowest tax-to-GDP ratio of any nation in the IMF’s report — at just 5.9%.
To put that in context, South Africa has a population three times smaller than Nigeria, but a tax-to-GDP ratio of 24.7%. The result? South Africa collects $57 billion in tax revenues, more than double Nigeria’s $27.5 billion. It is easy to understand this discrepancy when you realize most Nigerians simply aren’t paying their taxes. Nigeria’s National Bureau of Statistics (NBS) indicates the country has a taxable workforce of around 77 million, but government figures show just 14 million pay income tax.Tax evasion is particularly rampant among the country’s wealthiest citizens: Only 214 people in all of Nigeria pay more than 20 million naira ($55,600) in tax.
Nigeria doesn’t fare much better with value-added tax (VAT) and corporate tax. A paltry 9% of Nigerian companies pay corporate tax, while only 12% of registered businesses comply with VAT obligations. With some estimates finding as many as 99% of small businesses are unregistered, those percentages are even lower in reality.
Nigeria has tried to address this problem by introducing the Voluntary Assets and Income Declaration Scheme (VAIDS), which offered temporary amnesty for those who had missed or evaded previous tax payments. While the scheme produced a small uptick in compliance and the government collected $47 million in back taxes in its last six months of 2017, the informal sector of Nigeria’s economy remains too great and tax enforcement remains too lax to harness the country’s full economic potential.
Things are looking more positive elsewhere on the continent. Countries like Kenya are taking the IMF’s advice and testing innovative solutions to boost tax revenue. Indeed, the IMF recently lauded the Kenya Revenue Authority (KRA) for using cutting-edge technology like the Excisable Goods Management System (EGMS). It was developed by Swiss firm SICPA to tag and trace a wide variety of products and prevent both counterfeiting and tax avoidance. The scheme began by tracking alcohol and tobacco, but has since expanded to include non-alcoholic drinks and cosmetics. In parallel, the country’s revenue authority introduced its i-Tax scheme to facilitate online tax return submission by both businesses and private citizens.
Since the introduction of the two programs, the KRA reports tax compliance has risen by an impressive 45%. The revenue authority has also entered the world of smartphone applications with “Soma Label.” This app that allows consumers and retailers – as well as the police – to easily verify a product’s authenticity by just using their smartphones. Of course, these innovations have met with resistance with those who preferred profiting from the loopholes offered by outdated tax schemes. Kenya is not the only SSA country working to increase tax compliance. Authorities in Togo have also tightened up their own approach to tax evasion, although not so much through new technologies as through reassessing policies.
Inadequate of studies on the magnitude of tax evasion in Africa means that little documented information is available regarding its incidence or the use of policy approaches to improve tax compliance effectively and efficiently. A recent study sponsored by the African Development Bank has helped to fill this gap. The study, which was conducted in Ethiopia, used a fully randomised control trial approach to investigate the magnitude of tax evasion, as well as the best approaches to enhance compliance. The study was undertaken in collaboration with the Ethiopian Revenue Authority.
Field experiments elicited information from businesses by exposing well-defined treatment groups to two types of letters duly signed by the revenue authority. The first letter threatened an audit, while the second, more complimentary letter praised recipients for an exemplary job in paying their taxes on time and complying fully without evasion. The control group did not receive either letter. Researchers then monitored the tax returns of businesses before and after the experiment using available administrative data from the tax authorities. In total, 4 500 firms participated in the experiment. The results showed that the recipients of threatening letters increased their tax returns by about 38%, while those in receipt of complimentary letters increased returns by 32%.
The following policy implications can be drawn from these results:
• Tax evasion in Africa is widespread and perhaps larger than assumed by initial estimates (around 20-30%).
• Revenue authorities must be empowered to collect and analyse taxpayer data. For example, third-party information relating to value-added tax can be used to identify serial tax evaders.
• To significantly reduce the transaction costs involved in mobilising taxes and decrease tax evasion, authorities should work to improve relations with businesses, conduct periodic evaluations of the utilisation of taxes for social and economic development, and employ incentives to ensure full compliance.
The Togo Revenue Authority (OTR) is the first in the 14-member CFA franc zone to unify national tax and customs services. Since it was created in 2014, the OTR has successfully streamlined both processes and cut staff numbers by 17%.
This approach has exceeded the IMF’s expectations, as well as those of the Togolese government: Instead of seeing tax revenues drop by 10% as predicted, Togo saw tax proceeds increase by 23% the year after the OTR was created.
Of course, Togo still has considerable economic hurdles to overcome. The tiny nation is currently grappling with a political crisis that has caused growth to slide from 5.1% in 2017 to 4.4% so far this year. Togo is also in the process of replacing its obsolete tax code. The new legislation, scheduled to take effect in 2019, includes measures such as tax relief to encourage small- and medium-sized enterprises (SMEs) to honor tax obligations.
Tightening up tax protocol could pay massive dividends
The problem of state finances and public budgets in SSA countries has many causes. Most of the continent’s major economies are plagued by bureaucratic obstacles, outdated procedures and opaque parallel markets. Implementing a robust tax framework and ensuring enforcement is just one step in addressing this sprawling issue. Tax reform is not a silver bullet, but Africa’s economies could take a major step forward for their own growth by combining effective regulation with up-to-date technologies and increased transparency and efficiency.