Explaining Customs Tax Evasion in Ethiopia: The Effect of Trade Tax, Law Enforcement, and Product Characteristics

Abstract

Low-income African countries face significant customs tax evasion due to undervaluation and smuggling of imports by registered traders. This study uses trade policy, law enforcement, product misclassification, and product differentiation to examine customs tax evasion in Ethiopian imports from Kenya. Using “missing imports” data disaggregated at the harmonized system 6-digit level, the econometric model employs the trade gap as a measure of evasion. This study seeks to explain two types of evasion: undervaluation-based evasion, and smuggling- and product misclassification–based evasion. According to the econometric estimates, 1% increase in the taxes imposed on imports increases evasion by 1.12% for undervaluation-based evasion and 2% for entirely “missing imports”. Based on a quantitative measure of law enforcement, the findings show that expecting higher fee as a penalty for tax evasion is negatively associated with both forms of evasions. Regarding the extent of evasion, customs tax evasion is significantly higher for differentiated items than for homogeneous goods. Furthermore, mislabeling products from higher to lower tariff categories explains a large portion of evasion in goods that are either entirely smuggled or misclassified. The findings validate the importance of reducing evasion by judiciously lowering tariffs and enforcing the law at the border.