CHAPTER ONE INTRODUCTION AND DEFINITION OF PROBLEM 1.1 Background to the Problem History has shown that there has always been a reluctance to pay tax not only in Africa where the need for increase of internal revenue to finance expenditure is highly needed to reduce external assistance but also in developed countries. A major reason for this attitude is that the taxpayer does not always perceive that he receives equal benefits from parting with his hard earned cash. Tax compliance issues are as old as taxes themselves and will remain an area of discovery as long as taxes exist. There is almost no civilization that did not tax (Adams, 1993). Most citizens, however, realize that state expenditure for the purpose of creating or maintaining national infrastructures, such as services and roads, is a necessity. But, citizens object to having to finance unnecessary state expenditure. In this regard, it is difficult to define necessity of expenditure as everyone
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CHAPTER ONE
INTRODUCTION AND DEFINITION OF PROBLEM
1.1 Background to the Problem
History has shown that there has always been a reluctance to pay tax not only in Africa where the
need for increase of internal revenue to finance expenditure is highly needed to reduce external
assistance but also in developed countries. A major reason for this attitude is that the taxpayer
does not always perceive that he receives equal benefits from parting with his hard earned cash.
Tax compliance issues are as old as taxes themselves and will remain an area of discovery as
long as taxes exist. There is almost no civilization that did not tax (Adams, 1993).
Most citizens, however, realize that state expenditure for the purpose of creating or maintaining
national infrastructures, such as services and roads, is a necessity. But, citizens object to having
to finance unnecessary state expenditure. In this regard, it is difficult to define necessity of
expenditure as everyone has his own understanding of what is unnecessary. Taxpayers feel that
whatever is contributed by them in a way of tax is mostly squandered away and the social
responsibility the government is expected to discharge is not exercised and gets neglected. The
government's bad image because of its failure to· discharge functions is a great disincentive for
paying taxes.
Most people feel that tax is a burden and should be avoided. Taxpayers feel that they are being
treated harshly and the punitive provisions in the tax laws are applied ruthlessly against them.
Hence, it is better to be away from the tax department and the number of non-filers of tax returns
is increasing."(Coetzee, 1996)
Tax revenue, from direct and indirect taxes, has been the Tanzanian government’s main income.
In 2008, tax revenue contributed 75.81% of the total national income (MoFE, 2006); while non-
tax revenue contributed 24.19% of the total income. Of the total tax revenue, direct tax has been
the biggest contributor at 50.37% while the balance was made up of indirect taxes at 25.44%.
Tax knowledge among taxpayers is a very important aspect of tax collection. To achieve higher
levels of tax compliance, taxpayers must understand all the laws and regulations that govern
taxation. This is necessary because knowledgeable taxpayer knows what, when and where to pay
taxes and he is more likely to voluntary complies than those with little or no knowledge on tax
matters (Mustafa, 1996).
As the country’s tax administration authority, Tanzania Revenue Authority (TRA) is responsible
for educating tax papers on tax matters. This responsibility falls under the Taxpayers Education
Department which is responsible for bringing tax knowledge to the public. This research will
explore the efficiency of tax education in enhancing voluntary tax compliance by comparing the
periods before departmental establishment, and after in relation to the level of compliance.
1.2 Statement of the Problem
Paying taxes is a legal responsibility of citizens, with penalties attendant on non-compliance. But
even in the face of penalties, tax evasion exists. According to Maliyamkono (2009), only 10% of
eligible tax payers in Tanzania pay taxes. Among the major causes of low level of tax
compliance in Tanzania is lack of tax knowledge among tax payers.
Malyamkono (2009) further argues that only 10% of eligible tax payers in Tanzania pay their
taxes on a regular basis. The rate of tax evasion is especially higher among tax payers operating
in the SMEs sector. Over half of the tax evasion incidence is attributable to underreporting of
business income. Particularly, high tax evasion rates are associated with self-employed income.
1.3 Objective of the Study
The main objective of the study is to look at tax payer education as a factor contributing to
individual voluntary compliance. The main focus will be on the following specific objectives of
the study
1.3 Specific objectives
1. To identify the extent of taxpayers knowledge on taxation matters
2. To asses the influence of tax knowledge on voluntary tax compliance
3. To identify better ways of dissemination of tax knowledge to the taxpayers.
1.4 Research Questions
The study will be guided by the following specific research questions;
1. What is the level of tax knowledge of the taxpayer?
2. What is the influence of tax knowledge on voluntary tax compliance?
3. How does the department responsible for education disseminate tax knowledge? And what are
the best ways of transferring knowledge to the public?
1.5 Significance of the Study
Tax collections play a very important role in facilitating economic development of the country.
By paying taxes, tax payers contribute to economic development. Thus, low level of tax
compliance among tax payers contributes to stagnation of economic development. Since there is
an existing knowledge gap on the impact of tax knowledge on tax compliance, findings of this
study will contribute towards filling that knowledge gap among members of the general public.
Findings of the study will enable members of Education department of TRA to understand the
extent of influence of knowledge on taxpayer’s behaviour to pay tax and best ways to
disseminate the message. Findings of this stud will also act as a stepping stone for future
researchers on the same or similar topics. Completion of the study will also enable the researcher
to fulfil partial requirements for the award of a Postgraduate Diploma in Taxation of Institute of
Finance Management.
1.6 LIMITATIONS OF THE STUDY
In doing this study, the researcher encountered the following limitations:
Time Constraint
This study will be carried out for a short period of time because of the time frame scheduled for
the project execution and reporting so that it can fit in Institute’s academic calendar.
Financial limitation
Financing is another limitation, money always not enough. It is expected that finance will be one
of limitation that will negatively affect the process. However the research have thought of ways
to reduce the limitations to be faced by reviewing previous researchers techniques in overcoming
the barriers.
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
This chapter presents the theoretical literature review, empirical literature review, and research
gap and conceptual framework of the study.
2.1 Theoretical Literature Review
Theory of Taxation
The best-known theory of taxation was developed by Allingham (1972) who applied the
economic theory of revenue collection. According to the model, the main challenge in tax
collection is information asymmetry between the tax collector and the tax payer where by the
taxpayer may decide to evade taxes by reporting less income, hence resulting in less than
expected tax collections.
The Theory of Taxation also assumes that that the tendency to avoid paying tax can only be
detected by a audit. When audited, the taxpayer is forced to pay the evaded tax plus a penalty,
with the size of the penalty depending on the amount of understated tax rather than understated
income. True income is assumed fixed, so the only choice variable for the taxpayer is how much
to report (Allingham, 1972).
According to the Theory of Taxation, tax avoidance also occurs when taxpayers and tax
collectors collude to evade taxes and report less amount of taxable income. Also, since tax is
only levied on detectable income, the failure of tax collectors to detect taxable income may tempt
the tax payer to report and pay taxes only to the detectable income (Allingham, 1972).
Also, it is not realistic that taxpayers have perfect information over the enforcement of tax laws
and over what can be detected by tax inspectors, lack of awareness on tax issues can also
contribute to tax avoidance. The Theory of Taxation stipulates that the higher the level of
awareness on tax issues, the higher the level of tax compliance among tax payers.
Tax audits affect behavior by changing perceptions regarding consequences of an audit. This
may lead taxpayers to make honest mistakes and sometimes to overstate taxable income.
Because it is very hard to draw the line between an honest mistake and deliberate fraud in
taxation, using the use of penalties as a deterrence to tax avoidance is constrained (Allingham,
1972).
Another theory of taxation is the Modern Theory of Tax Evasion put forward by Kaplow (1972).
A critical assumption of the theory is that the cost borne by tax evaders in the process of
reducing tax liability is equivalent to the tax burden. The higher the tax burden, the higher the
possibility of tax payers trying to avoid paying tax as long as the cost of tax avoidance is less
than the cost of tax compliance.
2.1.2 Tax Administration
A country’s tax administration is one of the few public sector organizations which touches the
lives of a country’s citizens and businesses on a daily basis and, arguably has the greatest impact
on their livelihood. Tax administrators are amongst the most frequently contacted government
officials and often represent to the public what is right or wrong about their government (Alt,
2003).
Revenue collected from taxes along with customs collections represents the major funding
source for governmental expenditures. An effective and efficient tax administration system is
integral to any country’s well being. The proper amount of tax must be collected in a timely
manner and the enforcement powers of the tax administration must be applied judiciously (Alt,
2003).
Tax administration must provide an even playing field for taxpayers by ensuring that all
taxpayers meet their tax filing and paying requirements. This requires efforts to increase the tax
base. Failure to bring business activity from the shadow economy into the tax system puts
compliant taxpayers at a disadvantage, and ultimately leads to an erosion of the tax base (Fisher
and Michael, 2005).
But now day’s tax administration is under semi-autonomous bodies known as revenue
authorities, especially in Africa and Latin American countries. Under these revenue authorities,
tax administration function has been taken out of the Ministry of Finance and granted to a semi-
autonomous entity labelled in public finance literature on revenue authorities.
2.1.3 Characteristics of Tax Administration
According to Fisher and Michael (2005), all registered taxpayers and all tax liabilities are
“controlled” on a regular basis. The reliance is on the known universe of taxpayers who are
subjected to frequent and intrusive tax inspections regardless of their past compliance history or
loss of revenue risk they may pose. Little attention is paid to identifying non-filers and bringing
them onto the tax rolls.
Most tax inspections do not represent thorough or professional financial audits practiced by
modern tax administrations and do not meet international standards. There is no limit on the total
amounts of penalties that can be assessed in addition to tax. The actual amount of tax due may be
less than penalties assessed. The emphasis of tax administration is to meet a pre-determined
revenue target (Sandford, 2005)
In Tax administration, internal communications are less and there is a top-down management
approach which discourages employee suggestions or feedback. An overall management practice
is poor and is considered an overhead activity which does not justify much attention or resources.
There are few or no professionals’ staffs. The emphasis is on teaching contents of tax laws
(Sandford, 2005).
2.1.4 Tax Administrator/Taxpayer Interface
There are a number of points of contact between taxpayers and tax administrators. The initial
contact between the taxpayer and tax administration usually occurs when registering to secure a
Taxpayer Identification Number (TIN). However, the taxpayer may first contact the tax
administration to secure information about tax requirements (Crocker and Joel, 2005).
Follow-up contacts may be made to request additional information or tax forms, publications, or
assistance. Assistance may be requested to check on the status of the taxpayer’s account and
other inquiries. If the taxpayer has not provided all the information requested on the tax return, or
if there is a mathematical or other error on the return, there will be a follow-up contact by the tax
administration (Ibid.).
If the information provided on the tax return does not match other information in the tax
administration’s files that it is cross-checked against, the taxpayer will be contacted. If the
taxpayer is selected for an audit or control, the taxpayer will be contacted. If the taxpayer
disputes the results of a tax audit, there will be an attempt to resolve the dispute (Crocker and
Joel, 2005).
2.1.5 Tax Administration Processes
Tax administrators perform various activities which directly relate to the mission of the tax
administration while other activities provide the support framework to properly carry out this
mission. Core business processes are interrelated communications and coordination between
these processes is essential (Slemrod and Yitzhaki, 2006).
Activities performed by tax administrators include; collecting information about tax payers, tax