Impact of Tax Audit on Improving Taxpayers Compliance : Emperical Evidence from Ethiopian Revenue Authority at Federal Level

Tax audit can play a major role in improving tax administration and overall taxpayer compliance by impacting on taxpayer behavior. The study has attempted to examine the impact of tax audit on tax compliance in Ethiopia, at federal level by using secondary macro data. To analyze the data the partial coefficient regression statistical analysis method was employed. The Pearson correlation and bivariate regression result shows, there is a strong association between probability of audit detection and the level of tax compliance. The regression result also reveals that there is a strong association between the number of audited files and the level of tax compliance. Pearson Correlation and partial regression coefficient result shows that the there is a strong association between probability of audit detection and the number of audited files with the level of tax compliance. The partial coefficient regression result shows that the joint effect of probability of audit detection and number of audited files highly improves the level of tax payer’s compliance over the individual effect. The study concludes that since the contribution of tax audit on improving tax payer’s compliance is significant among other measures, revenue authorities of the country 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. Keyword: Tax, Tax Audit, Tax payer’s compliance. Introduction The development of any nation depends on the amount of revenue generated and applied by the government on public infrastructure for the benefits of members of that society. No economy can grow without adequate resources for infrastructural development and provision of power and public utilities and services. Taxes, and tax systems, are fundamental components of any attempts to build nations, and this is particularly the case in developing or transitional nations (McKerchar and Evans, 2009). As Brautigam (2008) stated that taxes underwrite the capacity of states to carry out their goals; they form one of the central arenas for the conduct of state-society relations, and they shape the balance between accumulation and redistribution that gives states their social character. In line with this, taxes build capacity (to provide security, meet basic needs or foster economic development) and they build legitimacy and consent (helping to create consensual, accountable and representative government) (McKerchar et.al, 2009). In addition, Azubike (2009) noted that a tax system is an opportunity for the government to collect additional revenue needed in discharging its present obligations. Okezie (2003) states that a tax is a burden which every International Journal of Accounting Research (IJAR) Vol. 2, No. 12, 2016 2 citizens must bear in order to sustain his or her government thus enabling that government perform certain basic functions to the benefit of those its’ governance. Thus, it is evident that a good tax structure plays a multiple role in the process of economic development of any nation, of which Ethiopia is not an exception. The government of Ethiopia has several options to finance its public expenditures and pursue its fiscal policy. These options include imposing of taxes on businesses and persons, and non-tax revenues such as service fees, money prints, loans (both domestic and foreign institutions), property and investment income, privatization of public enterprises, and domestic and foreign grants. Among others, tax along with customs collections is an important source of revenue for every government, and is a heart to a country’s well being (Damme et al. 2008). In Ethiopia, however, total tax revenue performance has been relatively poor that accounts an average of 10.9 percent of gross domestic product (GDP) during 1990-94 and 12.9 percent of GDP during 2000-06 (McKinley and Kyrili, 2009). The proper amount of tax must be collected on a timely manner for successfully improving and maintaining steady economic progress of a nation. To do this, the enforcement powers of the tax administration, including tax audit, must be applied judiciously and in an evenhanded fashion (Baurer, 2005). A tax audit is an examination of whether a taxpayer has correctly reported its tax liability and fulfilled other obligations. It is often more detailed and extensive than other types of examination such as general desk checks, compliance visits or document matching programs (OECD, 2006a). As Biber (2010) noted, the role of an audit program in a modern tax administration must extend beyond merely verifying a taxpayers reported obligations and detection of discrepancies between a taxpayer’s declaration and supporting documentation. Tax audit may increase tax revenue in two ways: directly through assessment of additional taxes, and indirectly by improving taxpayer compliance with the tax laws and regulations (Barreca and Ramachandran, 2004). Therefore, for taxation to be effective in achieving both short and long term goals in any economy, the level of tax compliance must be improved for efficient tax administration. Hence, one measure that can be used to improve the level of tax compliance is tax audit. Ola (2001) stated that tax audit helps to improve voluntary compliance by detecting and bringing into account those who do not pay correct amount of tax. In line with this, Slemrod, (2000) noted that tax audit is one of the most effective policies to prevent tax evasion behaviour. Therefore, the intent of this study is to examine the impact of tax audit on tax compliance in Ethiopia. Statement OF the problem One of the more vexing problems for policy makers in developing and transition economies is encouraging high levels of tax compliance. This issue is independent of the overall tax “take” from GDP. For, even if one begins from a position that government should be small, high tax compliance is necessary for efficiency and equity as well as for the development of social capital (Slemrod, 1992). The major economies of the world are built and supported by a sustainable system of revenue generation. One major sustainable means of revenue generation globally is taxation. The fundamental goal of any revenue authority is to collect taxes and duties payable according to the law (McKerchar et.al, 2009). However, when it comes to the obligations imposed on them by law, taxpayers are not always compliant. Therefore, for taxation to be effective in achieving both short and long term goals in any economy, the level of tax compliance must be improved for efficient tax administration. Hence, one measure that can be used to improve the level of tax compliance is tax audit. Audit can play a major role in improving tax administration and overall taxpayer compliance by impacting on taxpayer behavior. In addition to raising revenue directly from audit activities, by selecting the highest risk cases, efficiently detecting non-compliant taxpayers, applying appropriate sanctions, and publicizing results of audit activity (either generally or specifically), International Journal of Accounting Research (IJAR) Vol. 2, No. 12, 2016 3 taxpayers get the message that any attempt to avoid tax presents a high risk of detection and the penalty for non-compliant taxpayers is substantial( Kagina ,no date). Tax audits; as a result provides tax administration with significant leverage across the community. Tax audit is an independent examination of the returns submitted by taxpayers to the relevant tax authorities to ascertain the level of tax compliance by taxpayers. In connection to this notion, a tax audit is an examination of whether a taxpayer has correctly reported its tax liability and fulfilled other obligations. It is often more detailed and extensive than other types of examination such as general desk checks, compliance visits or document matching programs (OECD, 2006a). As Biber (2010) noted, the role of an audit program in a modern tax administration must extend beyond merely verifying a taxpayer’s reported obligations and detection of discrepancies between a taxpayer’s declaration and supporting documentation. An important issue for any government and revenue collecting authority is to obtain knowledge and understanding of the reasons for taxpayer non-compliance. However, measurement of the magnitude of intentional and unintentional non-compliance can be difficult as it involves estimating levels of uncollected tax, which by its nature is not detected by the revenue authority. The amount of tax lost through evasion is potentially enormous. The IRS estimated it to be $US 345 billion in 2006 which amounted to 16.3 percent of estimated actual paid plus unpaid tax liability (Slemrod, 2007). A considerable previous literature and much best practice knowledge and experience currently exist in respect of both tax administration and taxpayer compliance (see for example, Bird, 2004, and Franzoni, 1999), However, the reality is that much of these literature, knowledge and experience have emanated from developed countries and the extent to which they apply to developing economies is insufficient. As a result, Policy makers and revenue authorities in developing economies in general and in Ethiopian case in particular face quite different challenges and constraints. In Ethiopia, there are three studies reviewed regarding tax audit in different settings. Yesegat (2008) studied VAT administration problems at large, VAT audit in particular, Gebeyehu (2008) studied tax audit and its role in increasing government revenue in Ethiopia and Mihret (2011) examines tax audit practice in Ethiopia (the case of federal government). However, as far as the researchers’ knowledge, tax audit impact on improving tax compliance not yet widely studied in developing nations in general and in Ethiopian case in particular. Given this gap of knowledge, together with the fa