The centre for tax analysis in developing countries
Search
Ethiopia publishes major new tax-to-GDP ratio report
Publication
The Ethiopian Ministry of Finance has published a major new report: Ethiopia’s tax-to-GDP ratio. Produced jointly by TaxDev researchers and the Ethiopian Ministry of Finance’s Tax Policy Directorate, the report makes extensive use of international comparison and administrative tax data to understand the roles that economic structure, tax policy and compliance have played in explaining the performance of Ethiopia’s tax-to-GDP ratio.
Key findings:
Ethiopia’s tax-to-GDP ratio, at 7.5% in 2022/23, is low relative to the sub-Saharan African (SSA) median of 13.2%, and has fallen substantially from its peak of 12.4% in 2014/15.
Ethiopia’s low tax-to-GDP ratio, relative to other SSA countries, is to some extent explained by structural features of the Ethiopian economy that make it difficult to raise tax revenue. This includes its high share of agriculture in GDP, low share of manufacturing in GDP, and low levels of urbanisation. Certain policy choices – including uncollected excises and VAT on fuel, the absence of excises on airtime/data and financial transactions, and a relatively low VAT rate – also help explain why Ethiopia’s tax-to-GDP ratio is lower than other SSA countries. Tax compliance, after accounting for these structural features of the economy, is also likely weaker in Ethiopia than other SSA countries.
The decline in Ethiopia’s can be explained, to a large extent, by the interaction between the changing structure of Ethiopia’s economy and its revenue collection system and tax structure.
Ethiopia’s high rate of economic growth in the early-to-mid-2010s was driven by public sector investment, including in projects such as the Grand Ethiopian Renaissance Dam and the Addis–Djibouti railway. This investment boom has now largely come to an end.
This investment helped generate tax revenues. VAT withholding was an important channel: all public sector entities in Ethiopia are required to withhold VAT on their purchases, effectively ensuring compliance among suppliers to the public sector. As public sector investment decreased, VAT compliance gaps widened – particularly in sectors like construction that were heavily reliant on public contracts.
A major contributor to the decline in corporate income tax revenues was the decline in profitability of the state-owned Commercial Bank of Ethiopia, which was heavily involved in financing public sector investment. The decline in public sector spending relative to GDP also explains much of the fall in personal income tax revenues, given the relatively large share of PIT revenues paid by public sector workers.
While the continued strong growth in GDP suggests that private sector activity and consumption has taken the place of investment as an engine of growth, that has not translated into equivalent tax revenues – because existing administrative systems are not as effective at collecting revenue directly from the private sector. In addition, our analysis suggests that tax compliance in the private sector may also have deteriorated, on top of these more structural factors. That is particularly true for VAT and corporate income tax where lower compliance may explain half of the fall in revenues relative to GDP.
Another major economic shift contributing to the decline in the tax-to-GDP ratio is decline in the ratio of imports to GDP, which led to an almost one-for-one decline in the ratio of import tax revenues to GDP. The decline in imports is partly linked to lower public sector investment: a large share of Ethiopia’s imports during the investment boom were capital goods used in infrastructure projects. From 2021 onwards, the overvaluation of the birr further contributed to the decline in the ratio of import tax revenues to GDP. It did this by depressing the value of imports and hence import taxes in Birr, relative to the value of domestically produced goods and services that make up GDP.
Changes in tax policy are unlikely to have contributed to the decline in Ethiopia’s tax-to-GDP ratio, as there have been few revenue-reducing policy reforms.
The report examined whether the measured tax-to-GDP ratio fell partly because GDP growth was overestimated. Reported GDP growth exceeds estimates from two alternative indicators – urban employment earnings and night-time lights – though both have serious limitations. A third measure, aggregate consumption from the Ethiopia Socioeconomic Survey, aligns with reported growth. Given this mixed evidence, it is not possible to definitively conclude that GDP growth has been over-estimated.
Ethiopia’s heavy dependence on import taxes and taxes remitted by the public sector – still about 60% of federal tax revenue despite recent declines – made it vulnerable to shifts in the structure of the economy. Going forward, sustainable growth in the tax-to-GDP ratio will require reversing the decline in tax compliance and boosting tax revenue collected domestically and from the private sector.
