Can Increased Tax Authority Presence Improve Compliance Among Tanzanian SMEs?

A study by the World Bank and Tanzania Revenue Authority examined whether the presence of tax officials influences SME tax compliance and morale. While short-term compliance increased in major cities, long-term effects were uncertain, highlighting the need for a balance between enforcement and trust-building in tax policies.

Researchers from the World Bank and the Tanzania Revenue Authority (TRA) conducted a groundbreaking study to examine whether increasing the presence of tax officials could improve tax compliance and morale among small and medium-sized enterprises (SMEs) in Tanzania. Given the high levels of informality in the country's business sector, taxation remains a persistent challenge. This research sought to understand if businesses would react positively to tax authority engagement or if they would merely adjust their responses due to fear of scrutiny. Using a randomized field experiment embedded in a nationwide survey, the study explored whether the visibility of tax officials could encourage SMEs to pay their dues, shift their perceptions of tax enforcement, and foster trust in tax authorities.

A Nationwide Tax Experiment with SMEs

The study involved 1,210 SMEs across 119 urban and peri-urban wards in Tanzania. Businesses were randomly assigned to either a control or treatment group. In the treatment wards, TRA officials accompanied survey teams but did not directly interact with the businesses, serving only as observers. This method allowed researchers to determine whether the mere presence of tax officials influenced SMEs' attitudes and behaviors. The businesses surveyed represented various sectors, including retail, manufacturing, and services, ensuring a comprehensive picture of tax compliance in different industries. The primary survey took place in December 2022, with a follow-up survey conducted in 2024 to assess long-term impacts. Additionally, administrative tax data was analyzed to track changes in tax payments before and after the intervention.

Short-Term Gains, Long-Term Uncertainty

The presence of TRA officials produced mixed results. In Dar es Salaam and the broader Eastern zone, there was a temporary increase in tax payments. During the first quarter of 2023, businesses in treatment wards were 2.8 percentage points more likely to make tax payments, with the total amount paid rising by 31.4%. However, this effect faded over time, with payment levels returning to normal in subsequent quarters. In other parts of the country, particularly in areas where TRA enforcement is less visible, there was no significant increase in tax compliance. Interestingly, tax morale measured by self-reported willingness to pay taxes showed improvement in some regions but not in others. In rural areas where tax enforcement had historically been weak, businesses expressed a stronger commitment to tax compliance after the intervention, even though their actual payments did not increase.

Fear, Perception, or Genuine Change?

One of the study's most intriguing findings was the potential for businesses to misrepresent their tax attitudes when observed by tax officials. Some SMEs may have exaggerated their willingness to comply due to the perceived risk of enforcement rather than genuine belief in the tax system. However, the 2024 follow-up survey found that businesses in treatment areas continued to express higher tax morale, suggesting that at least some of the initial responses reflected real attitudinal shifts. Yet, this increase in tax morale did not necessarily translate into higher tax payments. The study suggests that while engagement with tax officials may improve perceptions of the tax system, it does not automatically result in increased compliance.

Rethinking Tax Strategies for SMEs

Tanzania's tax system relies heavily on a presumptive tax regime, where businesses with an annual turnover below TZS 100 million are taxed based on estimated earnings rather than detailed financial records. While this system simplifies tax collection, it does not necessarily foster long-term compliance. Many SMEs fail to return for tax reassessments, with dropout rates exceeding 50% from one year to the next. Between 2014 and 2019, only 41% of businesses that had been assessed for taxes in 2014 remained in the system five years later. This trend suggests that many SMEs either return to informality or deliberately avoid taxation due to financial constraints, tax complexity, or perceived unfairness.

The study's findings highlight key takeaways for policymakers. First, enforcement-driven approaches alone may not be enough to sustain long-term compliance, as evidenced by the temporary increase in tax payments that quickly faded. Second, building trust through non-coercive engagement may be more effective in improving tax morale, particularly in areas where SMEs have historically had little interaction with tax officials. Third, simplifying tax processes, expanding digital tax services, and improving taxpayer education could encourage more voluntary compliance.

A particularly revealing finding was the geographical difference in how businesses responded. In Dar es Salaam, where tax enforcement is more visible, the presence of TRA officials may have briefly increased the perceived risk of audits, leading to a short-term spike in payments. However, in regions with historically weak enforcement, businesses may have viewed the experiment as a one-time event rather than a shift in long-term tax policy. In some cases, such as in the Southern zone, tax compliance actually declined after the intervention, possibly due to frustration with TRA's sudden presence combined with skepticism about sustained enforcement.

While the study does not provide a definitive answer on whether tax official presence increases compliance, it highlights the complexities of taxpayer behavior. The fact that businesses in some regions reported higher tax morale without actually increasing their payments suggests that self-reported attitudes toward taxation do not always align with real behavior. This has important implications for policymakers, as interventions that appear successful based on survey data may not result in tangible revenue gains. Future research should explore whether ongoing engagement by tax authorities, rather than one-time visibility, could lead to more consistent compliance improvements.

Ultimately, the findings suggest that taxation strategies should strike a balance between enforcement and facilitation. Instead of solely focusing on audits and penalties, tax authorities may benefit from fostering a more cooperative relationship with SMEs. Encouraging compliance through education, transparency, and digital tax services could gradually shift Tanzania's tax culture from one driven by fear and evasion to one based on trust and voluntary participation.