Tax evasion, informality and the business environment in uganda

Uganda has recorded impressive economic growth rates over the last two decades. How¬ever despite the sustained period of growth, the tax effort measured by the tax-to-GDP ratio has stagnated between 10-13 percent of GDP over the same period. Non-empirical evidence has identified the pervasiveness of the informal sector, tax evasion, narrow tax base, and tax breaks variously given out by the government as some of the factors that might explain the inelastic tax system in Uganda. While the informal sector has implications for tax effort, there is limited research on the microeconomic level determinants of informality and tax evasion in Uganda. This paper provides some empirical evidence on how a poor business environment causes tax evasion. In particular, the paper examines specific components of the business environ¬ment that include the efficiency of the legal systems, bureaucratic bribery and the provision of public capital such as adequate provision of electricity and transport infrastructure which is complementary to firm performance and how they relate to tax evasion. I construct an instrument for bureaucratic bribery as the interaction between a firm’s ability to pay and corruption as a business constraint. I compute an individual firm’s ability to pay bribes as the total cost of labour, including wages, salaries, bonuses and social payments adjusted for the level of annual sales. I use instrumental variable OLS and Tobit estimation procedures separately and find that the extent of tax evasion is determined by the quality and efficiency of the legal systems, bureaucratic bribery and inadequate provision of public capital. In addi¬tion I find that the business environment has implications for tax evasion. These results sug¬gest that ameliorating the business environment, strengthening the legal system, adequate provision of public capital such as transport and electricity infrastructure as well as reigning in on bureaucratic bribery will reduce tax evasion and ultimately lead to increasing Govern¬ment revenue collections.