Tax Evasion and missing imports : Evidence using Transaction Level Data in Ethiopia

The literature on tax evasion and international trade taxes relies on the crucial assumption that trade costs (insurance, freight, and other related costs) are not related to tax rate. This assumption implies that failing to take trade costs into account do not affect the estimated effect of tax rate on tax evasion. In addition, it doesn’t sufficiently account for various exemptions in the tax code that create significant difference between the statutory and actual tax rates. In this paper, we test the robustness of the relationship between tax evasion and tax rate for the presence of trade costs and tax exemptions using transaction level administrative data. We find that ignoring trade costs overestimates the level of evasion. The amount of overstatement depends on the way the trade cost is included in the estimation. In addition, we find that taking exemptions into account makes a significant difference in the estimated evasion parameter. While we do not find any statistically significant relationship between evasion and the statutory tax rate, we find positive and statistically significant relationship between the two when we use the actual effective tax rate that takes into account exemptions in the Ethiopian trade tax system.