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The Impact of personal income Tax

On Employees’ Motivation to Work: The case of Ethiopia.

By: Bekele Gebisa

Submitted to: Dr. Berndt Andersson

Karlstad University Department of Business Administration

October, 2009

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Acknowledgment

I would like to pass my sincere gratitude to my wife Mrs. Rahel Assefa for

her valuable telephone interviews made to targeted employees’ income tax

payers during my data collection and suggestion to bring this paper up in to

existence. I also thankful to Ato Biruk Kidane for his constructive opinions

and providing valuable information. The last but not the least, I thank all

employees of different organizations for responding my questions through

telephone interviews from abroad and within the country and providing

unreserved opinion and comments.

The researcher.

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Table of Content Chapter one

1. Introduction...................................................................................................2

1.1 Background of the study ....................................................................2

1.2 Statement of the problem.................................................................3

1.3 Objective of the Study ......................................................................4

1.4 Significance of the study...................................................................4

1.5 Scope and Limitation of the study .....................................................5

1.6 Research Methods..............................................................................5

1.7 Organization of the paper .................................................................6

Chapter Two

2. Review of related literature .........................................................................7

Chapter Three

3. Data Interpretation and Statistical Analysis...................................................14

3.1 Preference of a country ....................................................................14

3.2 Assessment of progressive tax............................................................14

3.3 Impact on motivation .........................................................................16

Chapter Four

Conclusion .................................................................................................19

Recommendation ........................................................................................21

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CHAPTER ONE

1. Introduction 1.1 Background of the Study The new vision of Ethiopian Government is to bring rapid and sustainable development,

which is essential to retain the millennium development Goal (MDG) of reducing poverty

by half by the year 2015. The achievement of this rapid and sustainable development

mainly requires sustained and dependable domestic revenue mobilization which

otherwise be a dream to realize Government’s vision depending only on external finance

source and which is subject to uncertainty. Certainly, this doesn’t mean that external

finance source are not important rather it is to stress the fact that domestic resources

should take the largest share in financing.

In order to realize domestic revenue mobilization objectives the Ethiopian Government

acknowledged that the successful implementation of the over all tax Reform program

including the Personal income tax, which is vital to attaining the economic and social

objective.

The first income tax was appeared in Ethiopia in 1944, and income tax law of Ethiopia

was enacted during this year. The personal and Business tax proclamation No. of 1944

reform income taxation in that it provided a modern structural and legal frame-work to the

disorganized primitive system. Proclamation No. 107 replaced the first proclamation in

1949 and this proclamation was replaced by income tax Decree No. 19, in 1956. The

fourth income tax law was enacted by income tax proclamation No. 173, in 1961 and then

proclamation No. 255/1967 (Gebrie Worku, Page 5(2006).

The Government of Federal Democratic Republic of Ethiopia introduced a revised

personal income tax (Proclamation Number 286/2002) replacing the existing one.

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According to the revised proclamation, every person earning monthly income from

employment is liable to pay tax on that income bracket on rate of specified in schedule A.

To protect people Who are low income earners from falling below the poverty line, the

personal income tax has threshold of over Br 150.00 earning per month is subject to

taxation and below Br. 150 is exempted from tax. (1SEK= 1.81515 Birr). And also in order

to maintain relatively fair and equal distribution of income and wealth between low income

groups and high income groups and to promote educational, Medical and infrastructure

services in the country.

1.2 Statement of the problem

Personal Income tax is the oldest phenomenon for Ethiopian people and economy.

Therefore the implementation and impact of personal Income tax is not convenient for the

high income groups and employees motivation to work. The impact of personal income

tax intended it to be a tax on progressive income tax system in my country. In other words

when you earn more, you will be paying more. So the taxpayers become a case for a

problem since the personal income tax has an impact on employee to work and evasion

is still challenging this taxation.

Various problems including tax evasion were encountered during the introduction of

progressive tax system. A number of tax payers may be want to leisure rather than to

work more and getting more, while others may appreciate and work.

Unwillingness to pay income tax on timely basis and the impact of tax on employment

and hiding one self not to pay tax are some of the misdeeds performed by tax evaders.

• As a result, I want to consider the following points:

• Is the employment privileged from personal income tax de motivated

towards the work?

• What is the reason for inefficient tax administration?

• Is personal income tax implemented effectively?

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• Is personal income tax effect on employee?

• Does the society have good understanding about personal income tax?

• Why an employee unwilling to pay the tax on timely basis?

1.3 Objective of the study The main objective of the study is to assist and maintain the sound impact of personal

income tax and the possibilities of tax evasion especially on schedule ‘A’ tax payers. In

addition to the above condition the study uses to recommend on how the personal

income tax affect employees motivation to work and also identifies possible solution to

recover identified problems and speed up the payment of tax on timely basis. The specific

objectives involves

Assess the impact of a progressive income tax

Assess the sufficiency of personal income tax exemption threshold

Behavioral effect of high progressive income tax rate on motivation as well as

willingness to work in pastime employment attunement

1.4 Significance of the study

This paper will show clearly the impact of the personal income tax by creating awareness

to tax payers and the society. It shows how the Inland Revenue authority administers the

tax. It also gives you an idea about how the government revenue increases due to the

effective and efficient collection of tax from taxpayers, which help to fulfill the socio

economic needs of the society. I believe the result of my research work is:

Would enable the reader to see the impact of income tax on workers

motivation to work. May add to some existing literature and may serve as an additional source

of reference.

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Would enable the employee to see the condition of tax before they decide to

work more or leisure time. Enriches the knowledge of the reader on the impact of income tax on

employment motivation to work.

1.5 Scope and limitation of the study

The study is restricted to the implementation and impact of personal income tax for the

time period 2002 (the revised income tax proclamation) to the year 2002 as to schedule

‘A’ tax payers.

Due to time, money and financial constraint, it is difficult to asses all income taxpayers,

the study focuses on some selected schedule ’A’ tax payers in Addis Ababa. I believe that

Addis Ababa income tax payers are representing most of the Income tax payers in

Ethiopia. I will face some difficulty when I try to find published secondary data.

1.6 Research methods

For the purpose of this paper I use both primary and secondary data. In the primary data I

used telephone interviews with the concerned employees and to get information about

personal income tax among from Addis Ababa tax payers. In secondary data I use

references related with Income tax, like FIRA directives on income tax, Federal Negarit

Gazeta, Ethiopian Revenues & Customs Authority Web Site. www.erca.gov.et.

As a data analysis tools I used survey and descriptive methods. In this study survey

research based on telephone interviews are widely employed, to obtain both qualitative

and quantitative data from the income tax payers in Addis Ababa city. This research

methodology is used because it is probably too large to observe directly, and it is also

excellent for measuring attitude and opinion in a large population.

Since it is difficult to cover the whole population, I select 100 Income tax payers. After

determining the sample size, what is left to be considered is the sampling technique that

will be used to select sample and to obtain the appropriate data. Thus to select the

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sample the study were stratified random sampling technique. The data were stratify by

employee that is who worked for private limited company, sole proprietor, public

enterprises and share companies and non-government organizations. After stratified the

data the selection will be conducted randomly.

The researcher use descriptive analysis method. Based on this method first the

researcher has analyzed the attitude knowledge of the tax payers second, I have

analyzed Income tax impact on employees. In the final phase of the analysis the

researcher has analyzed the impact of personal income tax on employees.

1.7 Organization of the paper

The paper consists of four chapters. The first chapter deals with introduction, the second

chapter shows reviews of related literature, the third chapter provides data analysis and

interpretation and the fourth chapter contains conclusions and recommendations.

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CHAPTER TWO

LITERATURE REVIEW GENERAL OVERVIEW Countries use taxes for many purposes, such as to raise revenue to fund government services, to encourage or discourage certain types of behavior, to correct market imperfection and to change the distribution of income and wealth. The two main aims of taxation were generally seen to be, first, to raise substantial revenue to finance the state as the engine of the development and, second, to redistribute income and wealthy. At a fundamental level, however, the main reason for a tax system is to allocate the cost of government in some fair way. A country’s tax system is thus an important and highly visible symbol of its fundamental political and philosophical choice. Difference in the appropriateness of taxes will lead to different tax systems. Although tax systems very around the world, it is commonly accepted that each country has the right to tax income earned inside its borders. Sources of income are a complex issue that has domestic as well as international dimensions. The domestic side involves deciding when income has really earned and therefore subject to tax. As a result many countries have different kinds of income taxation. Some of the widely used are as follows: Personal income tax Business Income Tax Tax on Income from Rental of Building Tax on Royalties Income Tax on Income Tax, and others My major concern here is with taxation of personal income and its consequences, especially which relates to employee’s motivation to work; is a particular tax system applied in personal income creates a disincentives or work? Dose it affects the pattern of expenditure and savings? Or does it contribute to tax avoidance by unwilling tax payers and invaders who are motivated tax loopholes. HISTORY OF PERSONAL INCOME TAX Personal income taxes everywhere started small. Few people were taxed and tax rates were low. But wartime revenue needs turned this narrow class tax in to a mass tax. After war, central governments in developed regions continued and expanded their activities on the basis of high and growing revenues, especially from the progressive personal income tax. As the world economy slowed in the 1970s, however concern for growth began to trump equity, and toward the appropriate role and structure of personal income taxation began to change. By the end of the century, most analysts and policy makers had concern to believe that high tax rate not only discourage and distorted economic activity but also were largely ineffective in redistributing income and wealthy.

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In the late 19th and early 20th centuries, concern about both fairness and ability of tax system to generate sufficient revenue led to governments to enact income tax. In 1799 Britain enacted the first national income tax. The first progressive income tax which imposes a grater tax burden on people with high income was introduced in Prussia in 1853. Other countries introduced progressive income tax in subsequent decades, including income taxes generated little revenue at first; today they play a major roll in all modern tax system. HISTORY OF TAX IN ETHIOPIA The traditional taxation system of Ethiopia, as many argue, is an old as the ancient Ethiopian history. Historian asserts that the traditional taxation was practice by Axumite Kingdom by imposing taxes on crops, livestock and livestock products, hunting tax in the from of ivory tax, handicraftsmen production taxes and other form of taxes. The first important reforms which was carried out by Emperor Menilik II toward the end of the 19 th century, resulted in the establishment of a fixed tether rather than the undefined and ancient taxation system Many agree that the history of modern taxation in Ethiopia began with the measure taken in the aftermath of war liberation. Despite, the fact that various measures were taken for the taxation system to minimize three decades tax systems even after its institutionalization. . As regard the Income tax proclamation that was enforced, 30 years back, with a view to overhaul the whole system, a new tax structure has been introduced. As a result the Transitional Government of Ethiopia changed and amended the previous income tax proclamations. Therefore, Income tax proclamation No 30/1992 exempted the first birr 105 from the payment of personal income tax and from birr 106 and above with 9 personal income tax brackets ranging from 10%to 50%. Personal Income tax proclamation No. 107/1994 which replaced proclamation No. 30/1992 exempted the first birr 120 with 6 tax brackets ranging from 10% to 40% Currently the Federal Democratic Republic of Ethiopia amended and replaced proclamation No. 107/1994 by proclamation No. 286/2002 because the government believed that modernizing the tax system and broadening the tax base promotes economic growth by encouraging saving and investment. The proclamation provides for the taxation of income in accordance with four schedules Schedule ' A' income from employee Schedule ‘B’ income from rental of building Schedule 'C' income from business Schedule 'D' other income like royalties game of chance dividends, causal rental of property interest income specified non-business capital gains and income paid for service rendered outside of Ethiopia. The remaining part of this paper toughly discusses the personal income tax and its sound as well as adverse impact on employee.

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Types of Tax system It is important and also, I strongly believe that to explain and describe the different types of tax system applied in personal income tax in order to help me to assess and evaluate the impact of personal income tax to employee and to arrive for the possible solution that will suggest latter in this paper. Generally, there are four types of tax system applied in personal income tax; also it can be applied to any kinds of tax. Progressive Tax Rate / system Regressive Tax Rate / system Proportional Tax Rate /system Flat Tax Rate / system 1) Progressive Tax The term "progressive" refers to the way the rate progresses from low to high. It can be applied to any type of tax frequently applied in reference to income taxes, where people with more disposable income pay a higher percentage of that income in tax than do these with less income, i.e., the tax rate increases as the amount to which the rate is applied increases. The opposite of a progressive tax is a regressive tax, where the tax rate decreases as the amount to which the rate is applied increases. In between is a proportional tax, where the rate is fixed as the amount to which the rate is applied increases. Progressive taxes reduce the tax incidence of people with smaller income, as they shift the incidence disproportionately to those with higher income. The reason why I briefly explain the progressive income tax is because the other remaining part of this paper thoroughly explains its nature and which is also implemented in Ethiopia. 2) Regressive Tax A regressive tax is a tax imposed so that the tax rate decreases as the amount to which the rate is applied increases. It can be applied to any type of tax, but frequently applied in reference to fixed taxes, where every person has to pay the same amount of money. The opposite of a regressive tax is a progressive tax, where the tax rate increases as the amount to which the rate is applied increases. The term "regressive" refers to the way the rate progresses from high to low. Regressive taxes reduce the tax incidence disproportionately to those with higher income. To determine whether a tax is regressive, the income elasticity of the good being taxed as well as the income-substitution effect must be considered. Advocacy and criticism of Regressive Taxes Supply-side economies advocated regressive taxes as a means to solve the problem of stagflation. In practice an in theory, however, there is considerable debate as to whether regressive taxes are such a solution. For example, the highest tax bracket in the United States before President Ronald Reagan was 70%, a percentage viewed by some as being too high, and thus straining the main argument for progressive taxes.

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Opponents of regressive taxation also state that a regressive tax effectively punishes the poor for being poor, pacing a higher burden on those least able to bear that burden. Advocates would state that every person should be treated equally under tax regardless of income and that progressive taxation amounts to class warfare, wealth envy, and Karl Marx communism with "From each according to his needs" 3. Proportional Tax A proportional tax rate is a rate between the progressive and regressive tax rates, where the tax rate is fixed as the amount to which the rate is applied increases. In other word, it is an income tax rate that taxes the same percentage of income everyone regardless of how much or little an individual earns. 4. A flat tax It is often called a poll tax that everyone at the same rate regardless of their income bracket. Supporter of a flat tax argue that it gives people incentive to earn more, because they couldn't be penalized by graduating to a higher tax bracket as they could in progressive tax rate. Relationship between Progressive and Regressive Taxes Before I go to relationship between a progressive and regressive tax system it is desirable to summarize the different implication of each systems in employees’ income. A progressive tax takes a higher percentage of income as the income rises which means rich people not only pay a large amount of money than poor people, but also a large fraction their income. A proportional tax takes the same percentage of income from all people. A regressive tax takes a small percentage of income as income raises. In comparison to rich people, poor people pay a larger fraction of their income in tax than rich people. A flat tax as a proportional tax takes the same percentage of income from all people but the percentage is not a proportional one it is fixed percentage or amount. Although, most discussions above are about the different types of tax systems applied in personal income tax, I would like to continue to focus on the relationship between progressive tax and regressive tax because their impacts on different group of employees - rich or poor, low-income or high-income earns - are in opposite direction. Strictly speaking, progressive and regressive taxes describe the tax table, not a political opinion. It is like a mathematical function. Most often these are called progressive or regressive tax table or taxes. In a progressive tax, the more you earn, the higher your tax rate. In a regressive tax, the less you earn, the higher your tax rate. The classical progressive tax is income tax-direct /on income/ while the classical regressive tax is sales tax -indirect tax /on expenditure/. Because most people are involved in preparing their progressive personal income taxes it is fairly well understood. And because most people are not involved in calculating their regressive taxes, it is fairly poorly understood.

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All known functioning systems of taxation have a balance of progressive and regressive taxes, which is balancing of income and wealth inequality. This idea is almost never debated, the debates are over where the balance point should be, how much burden should be on the 'rich' and how much burden on the 'middle' and 'poor'? Should balance lies with different income be taxed at the same rate? Or should it in different tax rates? Should progressively or regressively or even proportionality? Which one is fairness? Can IFRS designed on this regard? The answer for these and other questions actually depends on economical, social, political, ethical and philosophical judgments. Such as whether a government has the right to take income from one group of people and leave it to other class of people. Half of the tax is withheld from the employee's pay with the other half being paid by the employer. By contrast, self-employed individuals pay the entire amount of applicable tax on the annually adjusted amount. However, whether this tax should properly be called regressive is disputed because the untaxed income cannot be counted in the benefit formula for computing retirement benefits, meaning the redistribution of the tax is progressive, giving a higher percentage to those with low income. Therefore, this limit could be taken as a penalty on high-income earners, they are denied the ability to fully participate in the social security retirement program and receive no benefit from Medicare. Conversely, it is argued that they can invest the untaxed portion of their income and earn higher return that a majority of recipients earn on the money they contribute to that program. PROGRESSIVE TAX All the above points are concentrated in different tax systems that can be applied in personal income tax and the combined effect of other taxation system on different group of employee. Because many countries, including Ethiopia, uses progressive income tax I know turn back to this tax system. The important points to be raised here are: its origin, reason of implementation, argument for/against implementation, and other related tax rates. EARLY PROPONENTS The idea of a progressive income tax has garnered support from economists and political scientists of many different ideologies-ranging from Adam Smith to Karl Mark. Many authorities, however, trace the origin of modern progressive taxation to Adam Smith, who wrote in The Wealth of Nation:

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Reasons for Implementation Many of the arguments for progressive taxation are related to welfare economics. If the utility gained from income exhibits diminishing marginal returns as many psychologists assert, then for the tax burden to be shared in a utilitarian way the tax-bill must increase non-linearly with income. As income levels rise, levels of consumption tend to fall. Thus it is often argued that economic demand can be stimulated by reducing tax burden on lower income while raising the burden on higher incomes. It is also argued that people with higher income tend to have a higher percentage of than in disposable income, and can thus afford a greater tax burden (this is the "vertical equity" argument - it stated as follows: it is the idea that a tax system should distributed the burden fairly across people with different ability to pay. It implies that a person with higher income should pay more in taxes than one with less income). A person making exactly enough money to pay for food on housing cannot afford to pay any taxes without it causing material damage, while someone making twice as much can afford to pay up to half their income in taxes-ability to pay principle. A tax that actually took all income above some special subsistence level would imply a marginal tax rate of 100% (what I will see later) a case to which the arguments against progressive taxation apply most strongly. ARGUMENT AGAINST IMPLEMENTATION Some argue against progressive taxation because they believe it shifts the total economic production of society away from capital investment (tools, infrastructures, training, and research) and toward present consumption goods. Progressive taxes create a work disincentive. Consider someone who makes twice the minimum required living on but pays all income above the minimum living threshold in tax such a person had no monetary incentive at all to try to increases his or her income above tax base level it is presumed that the high- rate earner will therefore not work because leisure gives higher utility. In this case, high marginal tax rate will keep the most productive members of society from working. Ethiopia According to the Proclamation No. 286/2002, Article 10 & 12-1, every person driving income from employment in any government or other private organization or non-governmental organization (such as NGOs) and his/her is on due to pay tax. His/her income from employment includes any payments or gains in cash or in kind which he/she received from employees. The employment progressive income tax of Ethiopia described in the following table.

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Employment Income (per months) Over Birr To Birr

Tax Rate (%)

Deduction in Birr

0 150 Exempt Threshold 151 650 10 15.00 651 1,400 15 47.50 1,404 2,350 20 117.5 2,351 3,550 25 235.00 3,351 5,000 30 412.50 Over 5,00 35 662.00

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Chapter Three Data Interpretation and Statistical Analysis 3.1 Preferring a country due to tax rate Table 3.1

Sex Total Attitude Male = X Female = Y Country with no tax 55 34 89 Country with low tax

10 1 11

Country with high tax

0 0 0

Total 65 35 100

Twenty individuals were requested for telephone interview which comprises the following question “where do you want to work?” I provided three alternatives as mentioned below. Alternative 1. In a country with no personal income tax deduction Alternative 2. In a country with low tax rate Alternative 3. In a country with high tax rate Analysis in Average 89% of the population preferred to work in a country where tax is free (a country with no tax), of which 55% are male and 34% are female. These can show that countries which are free of personal income tax are more attractive to employees than countries that are not. On the contrary, nearly all of the employees do not like to work in any country which levies high personal income tax. This has a direct impact on the motivation of employees towards work. From the above analysis one can easily state that high personal income tax de-motivated employees to work. 3.2 Assessment of Progressive tax Table 3.2

Organization

Number of Staff agrees (X)

Number of staff disagrees (Y)

Total

Government 4 21 25 NGO 3 22 25 Private P.L.C

1 24 25

Share company

6 19 25

Other - - - Total 14 86 100

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Few of the respondents were found in light with the regressive tax system. In their opinion, regressive tax system motivates employees to work and earn more because as earning increases, the rate of personal income tax decreases. They also added that the system really encourages saving and investment through allowing employees to earn more (by down ceiling the tax rate). Most of the respondents suggested that employees in Ethiopia are suffering from tax burden. They are referring it as a big problem. The government imposes progressive tax to generate revenue than ever. I know that we are among the nations that are living under the poverty line. Some respondents states that the progressive tax system of the western block can not be easily applied (is not advisable) to Ethiopian context. They further explained, if this is continuing with the current inflation in the country, they may face difficulties to survive. Statistical Analysis of the above data Table 3-3

No

X

Y

__ x-x

__ (x-x)2

__ Y-Y

__ (Y-Y)2

1 4 21 0.5 0.25 -0.5 0.25 2 3 22 -0.5 0.25 0.5 0.25 3 1 24 -2.5 6.25 2.5 6.25 4 6 19 2.5 6.25 -2.5 6.25 Total 14 86 0 13 0 13

X =∑ x = 14 = 3.5 N 4 Y =∑ Y = 86 = 21.5 N 4 ______ ___ ∂X = √(∑ X-X)2 = √13 = 2.08 4-1 ∂Y = √ (∑ Y-Y)2 = 13 = 2.08 n-1 4-1 Co-efficient of Variation of (x) = ∂ * 100 X = 2.08 * 100 3.5 = 59.43% Co- efficient of variation of (Y) = ∂ * 100 Y = 2.08 *100 21.5 = 9.67%

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Coefficient of variation for the sample of which those who are agreeing with progressive tax system is 59.43% where as staff who do not agree with the progressive tax is 9.67%. “Data for which the coefficient of variation is greater is said to be more variable or conversely less consistent, less uniform, less stable or less homogeneous. On the other hand, the series for which coefficient of variation is less is said to be less variable or more consistent, more uniform, more stable or more homogeneous” (S.P. Gupta, page 171) From the analysis above, it is clearly understood that the data collected from Government, private limited companies, NGOs and share companies shows that almost all employees’ attitude towards progressive tax system is more homogeneous, or consistent, more uniform. This would mean the progressive tax system is not advantageous. In case of standard deviation, the two attitudes (agree and disagree) have the same value of 2.08. Standard deviation is the best measure of variation because of its mathematical characteristics. 4. The impact of personal income tax on employees’ willingness to work in extra time/ par time. The data I have collected is summarized and interpreted in relation with employees’ salary bracket and their attitude towards the impact of personal income tax on their willingness to work in extra time or part-time. The analysis focuses on “which salary group (bracket) is willing to work over time/part time and which are not willing due to progressive tax rate. Table 4.1

No Salary Range Willing to work

Not willing to work

Total

1 150-650 18 1 19 2 651-1400 15 1 16 3 1401-2350 32 2 34 4 2351-3550 10 5 15 5 3551-5000 7 4 11 6 >5000 2 3 5 Total 84 16 100

The research focuses on each salary bracket grouped in to six as per the Ethiopian Income tax law (Table A of Ethiopian Tax Proclamation 286/2002)

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I summarized the data in table 4.1 as follows.

Salary Range Percentage of willing employees to work

Percentage of unwilling employee to work

Total Percentage

150-650 94.7% 5.3% 100% 651-1400 93.75% 6.25% 100% 1401-2350 94.1% 5.9% 100% 2351-3550 66.67% 33.33% 100% 3551-5000 63.64% 36.36% 100%

The analysis clearly shows that employees whose salary range from Birr 150 to 2350 are more willing to work over time or par time than employees who are earning above Birr 3550. It is clearly showed that this is due to the progressive tax system and the high rate of maximum limit of tax deduction percentage that is 35%. It might be important to see that employees who are earning more than Birr 3550 are unwilling to work over time/ Part time. In most cases of the current Ethiopian salary payment situations, these individuals are team leaders or at managerial level. Even though it needs more investigations, my analysis shows that the impact of progressive income tax on employees who are earning more salary per month is discouraging. Moreover, this discouraging situation may lead to distorted and disordered working conditions. In relation to the above issue I gathered data on whether the personal income tax rate of 35% is justifiable or not. The analysis puts that most of employees do not agree with this maximum tax rate limit. In other words, the maximum tax rate limit should be lowered more in order to help employees save their salary from being taxed much. Table 4.2 Organization Agree with 35%

tax rate Disagree with 35% tax rate

Total

Gov’t 1 24 25 NGO 2 23 25 Private (P.L.C) 0 25 25 Share Co. 3 22 25 Total 6 94 100

As shown in the above table, 94% of sample employees disagree with the maximum tax rate of personal income tax. This may have another impact on employees’ motivation and attitude towards work. It is possible to say that employees who are taxed a lot from what they sweated much for are left dissatisfied.

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There are interrelated problems like staff dissatisfaction in one hand and de motivation in working environment on the other hand. So, it needs certain analysis regarding the impact of personal income tax on the motivation of staff towards work. My findings state that the impact of the maximum tax rate (35%) is highly correlated with de motivation and discouragement of staff. Hence, applying high tax rate on employees has a negative impact on staff motivation.

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CHAPTER FOUR Conclusion All independent countries use tax for many purposes such as raise revenue to fund government service, to encourage or discourages certain types of behavior, to correct market imperfection and to change the distribution of income or wealth. Income taxes, especially personal income tax at the center of the tax universe and has long been viewed as the primary instrument to achieve these goals. The government of Ethiopia also believes that personal income tax plays a major role to promote economic growth, to encourage savings and investments, to reduce income inequalities and effective mechanisms to radically reduce and alleviates poverty from the country. Nonetheless, personal income tax appeared to have progressive incident in Ethiopia, however, the magnitude of the contribution that can be achieved through personal income in is small, given the magnitude and the nature of income. Relying on progressive income tax to a accomplish any desired goal many often amount too little, Because one can realistically estimate the enforcement and compliance cost or real progressive personal income tax as well as the behavioral effect of high effective tax rate on employee motivation to work, operation in economy and investment either coming into or leaving the country. The cost and risks of following this strategy are simply too high relative to its chance of success, whether considered in revenue, growth or other purpose. In Ethiopia personal income tax are neither comprehensive nor very progressive, they often amount too little than with holding taxes on labor income in the formal employment sector. So it would be unrealistic to believe that this tax could have a meaningful impact on contribution rather it would have an adverse impact on employee. The Ethiopian progressive tax system has a great tax burden on employees since most of the employees in Ethiopia are in low income group. As I showed in the previous section the percent tax paid rises very steeply from the low through middle income range and then tends to flatten out over the high incomes. This indicates that there is a high tax burden shifted on the low income earners. So, the poor pays a large portion of their income needed for bare necessities. Because many as so poor they couldn’t even afford to pay progressive tax. The table also shows that disproportionately shifts the tax burden toward the high income earners dramatically reduces when they already reaches the high tax rate. But the tax burden still fail on lower income earners while the exemption thresholds are sufficiently low to don not cope with the tax burden. The burden from the taxation is not just the amount or tax paid but also the magnitude of the lost income. For example if the government required employers to provide, say ,with health care, the burden of this will almost entirely on the employee because the employer will pass on the burden in the form of lower wage. Businesses are also more sensitive

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to wage than employees, payroll taxes, employee mandates, and other taxes collected from the employer end up being born by the employee in the form of lower wage. Progressivity of progressive income tax also has on adverse impact on high income earners motivation to work. The work effort decreases with high tax rates because he/she required paying all income above some specified level of income. In effect high marginal tax rates keep the most productive employee from working. Therefore high progressive taxes can create a work de motivation as income rises. I can conclude that a high progressive income tax rate may influence behavior: The Choice between full time and/ par time employment arrangement. The decision to operate in the formal/informal economy which attribute for tax avoidance and evasions. The decision of where to locate capital investment or to hide capital abroad to relocate a country when there is a tax heaven or tax free. Therefore, a high progressive in come tax has the potential to alter decisions made by individuals. The resulting change in behavior likely reduce the efficiency with which resources are used and potentially lower the out put and well being of the country economy as a whole so, this tax system may lead people to alter their work effort, Saving pattern, and investment decisions which gives rise to efficiency loss. International Financial Reporting standards (IFRS) mainly concentrated only business income tax rather than employee tax system. Of course, IFRS main objective is to address that the way deferred tax liability treated in relation to taxation. The impact of employees’ income tax motivation to work will be quite varied with IFRS in relation to taxation.

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Recommendation While I recognize the limitations of using the personal income tax toward the development of the country and sound impact on employee, I believe that personal income tax plays an important role in developing the country economy if effectively and efficiently reformed. However personal in come tax can not leave up contribution role. What matter are the distributional consequences of all taxes, not just personal income tax. The personal income tax often constitute too little, if any, while the impact on employee is high as compared with other income taxes and consumption taxes. As I noted I do not call for elimination or minimizing the personal income tax to reduce its impact on employee, I also believe that despite its limitation, personal income tax can create a work motivation, encourage savings and investment and contribute toward the development of the country economy. Although the tax policy option, particularly for the personal income tax in my case, remains for the government of Ethiopia I strongly recommend the following in order to minimize the impact and high burden of personal income tax on employee. The government should design a modestly progressive tax on employee and comprehensive gradual low tax rate along with a broad scheduler base to encourage and maintains a good work motivation as well as to reduce the tax burden. Improvement in tax administration to broaden and expand the income tax base, such as to include types of income that were previously exempted from taxation, for example interest on government bond, to increase the number and types of individual subject to withholding regimes on labor income tax by impending the definition of employee for purpose beyond the requirements of employment law (such as diplomatic & consular representatives. Increasing the number of medium and large enterprise and shift from substance agriculture to a formal service and manufacturing sector to make it easier to tax other than employee income to provide a relatively high exemption thresholds that remove the poor- low- income earners from high tax burden. Adopting a tax system from developed countries to fall the marginal rate as income rises such as negative income tax credit, refundable income tax credit and other mechanizes. In my opinion, I can’t see any reporting standard recommended by IFRS on this regard. Rather it gives emphasis to post employee benefits plans in relation to financial reporting. I hope in the future the standard setters come up with the study give attention to the impact and its consequence of progressive income tax system on employees’ motivation

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to work. In fact, Ethiopia is among African countries which are not yet implementing IFRS for tax and financial reporting purposes. Even if the scope of this study cover the major areas of personal income tax and addresses the effect of income tax on employee, I strongly recommended further study should be conducted intensively in a more comprehensive manner to identify other important factors along with its best alternative solution to effectively benefit from this tax system.

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References Gebrie worku, Tax Accounting in Ethiopian context prepared for reference material Addis Ababa University College of commerce 2006. Federal Negarit Gazeta, Council of Ministers Regulations No. 78/2002, Proclamation No. 286/2002, Proclamation No. 227/2001 income tax (Amendment) Ethiopian Revenues & Customs Authority web site www.erca.gov.et. http://en.Wikipedia.org/wiki/progressive_ta (2009-10-08)