How the taxman can enhance compliance to boost coffers

Kenya like many other countries is facing the grim prospect of not meeting its tax collection target.

The Kenya Revenue Authority was reported to miss its revenue target for the third quarter of the year by Sh69 billion, signalling high prospects of missing its current year target.

The goal of the Kenya National Treasury is to finance Government recurrent expenditure from tax revenue and borrow only to meet development expenditure.

When tax collection targets are not being achieved, the Treasury is left with few alternatives of either cutting down recurrent expenditure or borrowing to meet recurrent expenditure or widen the tax net.

Shortfall in revenue performance can be explained by numerous factors but it largely depends on the level of tax compliance in an economy. It is therefore worth exploring what really drives tax compliance.

The term tax compliance is often misunderstood. It is simply the degree to which a taxpayer obeys (or fails to obey) the tax rules of his country.

While measuring tax compliance, we can consider two distinct categories of compliance—administrative and technical compliance.

The first refers to complying with administrative procedures of lodging and paying taxes while the other entails complying with technical requirements of the tax laws in calculating taxes or provisions of the tax laws in paying the share of the tax.

Admittedly, there is a lack of consensus as to why people do or do not pay their taxes. There are however numerous models that generally explain taxpayers’ compliance behaviour which ought to be considered while drafting an appropriate tax policy.

These models include economic deterrence model, optimal tax model, fiscal exchange model and social influence model.

The economic deterrence model posits that taxpayers’ compliance behaviour could be influenced by factors such as the probability of a taxpayer being audited or being detected (caught) and the penalties for tax frauds.

If the odds of detection are high and the attendant penalties are punitive, few taxpayers will evade taxes. In contrast, under low audit probabilities and low penalties, the expected return to evasion is high.

This principle has been widely embraced by many jurisdictions including Kenya when developing enforcement strategies that rely primarily on the fear of getting caught and the ensuing repercussions.

For instance, the recently enacted Tax Procedures Act, 2015 seems to employ this tactic. The aforesaid Act has introduced additional penalties and doubled others in a bid to crack down on outright fraud and rampant negligence by taxpayers and their agents.

As regards tax audits, revenue authorities tend to target a certain set of taxpayers thus establishing a predictable pattern. With such a pattern, taxpayers can easily decipher the odds of being audited or caught thus dictating their extent of tax compliance.

The second model is the optimal tax model which is based on the argument that taxation of individuals and businesses to finance government’s activities tends to distort economic choices of the payers.

The government has therefore to handle the delicate balance of maximising tax collections while minimising the tax burden.

As per this model, high taxes may not necessarily lead to more revenue and could actually be a recipe for tax evasion. Arguments of this theory appear to be currently relevant given the increasing rate of tax competition amongst jurisdictions.

Indeed, developed economies have in the recent past suffered massive tax losses as a result of an unprecedented rate of corporate inversions and other forms of reorganisations and policy makers have been compelled to review their domestic tax policies.

In Kenya, taxpayers have over the years complained of high rates of taxes and one would only interrogate the impact of reduced tax rates on tax compliance in Kenya— a topic for another day.

According to the fiscal exchange model, government expenditure may motivate tax compliance. Taxpayers are mainly concerned with the return for their tax payments in the form of public services (quid pro quo).

Compliance is therefore seen as a factor of (or the perception of) availability of public utilities hence governments can increase tax compliance by providing goods and services that citizens prefer in a more efficient and accessible manner.

Taxpayers may not accurately assess the value of public goods and services. However, the payers’ general impression and perception of the existence of positive benefits may increase the probability of them complying voluntarily.

As such, the government and public institutions can help their revenue authorities in improving revenue collection by ensuring that corruption is curbed and public resources are optimally employed.

Finally, the social influence model posits that tax compliance is influenced by the behaviour and social norms of an individual’s reference group.

It is reasonable to assume that human behaviour in the area of taxation is influenced by social interactions much in the same way as other forms of behaviour.

A person’s compliance behaviour and attitude towards a tax system may therefore be affected by the behaviour of an individual’s social circles such as peers, relatives, neighbours and friends.

Therefore, if a taxpayer knows many people or peers in his circles of influence who evade taxes, his commitment to comply will be weaker.

On the other hand, social relationships may also help deter people from engaging in evasion in fear of the social sanctions imposed once discovered and revealed publicly.

Generally, none of the above models can be said to enhance tax compliance on their own. Logic suggests that the most efficient way to design an effective taxpayer compliance programme would be to concentrate on the factors that appear to have the most impact on compliance levels.

Revenue authorities have to use the information available wisely in determining their appropriate tax policy and adopt the best combination of the various models to boost tax compliance and curtail rampant tax revenue deficits.

The author is a PwC tax advisor currently working in PwC New York office.