Personal income taxation in Zambia

Context and primary motivation

Direct taxes, including turnover and PIT, represent an important share of total tax collection in Zambia. While this testifies to the strong initial enforcement capacity of the Zambia Revenue Authority (ZRA), there remain important sources of non-compliance in direct taxes. In particular, an important source of non-compliance is the failure of tax agents that file and possibly pay TOT, to simultaneously file and pay the liabilities under Pay as You Earn (PAYE). The missing sources of filing and payment on PAYE include the relevant liability of the owner of the firm and, if the firm has employees, the relevant liability of the firm’s employees. The findings from this project will shed light on the trade-offs of distorting inputs versus outputs of a firm, in the context of taxation of small and medium size firms with limited enforcement capacity.

Policy relevance

The engagement seeks to answer critical questions for the ZRA in the area of Personal Income Tax (PIT) and Turnover Tax (TOT), with the chief aim of providing policy recommendations that serve to increase compliance of potential taxpayers and subsets of current taxpayers. The project is derived from a direct request by the Research and Planning Department of the ZRA. The Research and Planning Department will use the project findings in order to define future areas of focus for tax enforcement capacity building. In addition, the results will be of interest to other sections such as the Domestic Taxes Division that focus on the operational implementation of PIT and TOT policies. The aim is to disseminate the project findings with senior management of the ZRA through a series of presentations.

Design and methodology

In order to investigate the potential non-compliant base, the first step of the empirical design is to assess the success of different merging strategies between the TOT and the PAYE database. The filing requirements for the PAYE and TOT databases differ, and these differences must be accounted for when constructing a merged sample. In a second step, the analysis identifies a set of ‘compliant’ taxpayers, for whom the tax returns in both the PAYE and the TOT database can be found. In turn, a ‘target’ non-complier group will be constructed by defining the set of firms which most closely resemble the compliers in terms of observable characteristics (that is, the characteristics which are reported on the TOT returns). In a final step, several assumptions will be made to provide indicative estimates of the returns to enforcement upon the ‘target non-compliers’. The number of potential un-reported employees will be estimated, along with the potential un-reported amount of PAYE taxes. Different enforcement strategies will be discussed, which account for the administrative collectors’ current capacity to locate with precision and follow-up in person with the targeted non-compliers.