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This blog was originally published on blogs.lse.ac.uk on 11 September 2025 here, and is reproduced with kind permission.
Despite its economy growing, Ethiopia tax base has not kept pace. This is due to a complicated legacy of former and current policy, writes Vedanth Nair, David Phillips, Edris Seid, Ben Waltmann and Mulay Weldu Asegehegn.
Ethiopia’s tax-to-GDP ratio is low and has fallen substantially over the last ten years, limiting the scope for investment in public services, social protection and infrastructure. Between 2014/15 and 2022/23, the ratio fell from 12.4 per cent to just 7.5 per cent. The largest contributors to the decline were VAT, which declined by 2.4 percentage points of GDP, followed by trade taxes (1.1pp), corporate income tax (0.7 pp) and employment income taxes (0.3pp).
Figure 1. Ethiopia’s tax-to-GDP ratio, actual and forecast
Usually, the tax-to-GDP ratio rises as countries grow richer. Expanding formal sectors and increasing administrative capacity should, in theory, raise the fraction of national income that is collected in taxation. However, some countries with robust GDP growth have experienced falling tax-to-GDP ratios, such as Kenya, Rwanda and Indonesia. This trend has been particularly pronounced in Ethiopia.
A key part of the answer is that the structure of Ethiopia’s economy has changed, and in a way that has made it harder to collect revenues given the country’s tax administration and tax structure.
In the early-to-mid 2010s, Ethiopia’s economy was driven by investment and especially state-backed investment in projects such as the Grand Ethiopian Renaissance Dam and the Addis–Djibouti railway. This investment boom has now largely come to an end. Investment as a share of GDP fell from 37 per cent in 2015/16 to 22 per cent in 2022/23, of which investment by the government and state-owned enterprises fell from 14 per cent to 7 per cent (in 2021/22), according to data from the World Bank.
Some of this investment flowed back into the government’s coffers in the form of tax revenues. All public sector entities in Ethiopia are required to withhold the VAT due on their purchases rather than pay it over to their suppliers. This helps ensure compliance amongst suppliers to the public sector. As public sector investment decreased and less VAT was withheld by public sector entities, VAT compliance gaps widened – particularly in sectors like construction that were historically heavily reliant on public sector contracts but which now do more private sector work.
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 personal income tax revenues (PIT) paid by public sector workers. This fall would have been steeper had personal income tax thresholds not been frozen in cash-terms for much of this period.
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. This is because existing administrative systems are not as effective at collecting revenue directly from the private sector. In addition, our analysis suggests that a decline in tax compliance within the private sector – including in the retail and wholesale sectors – has also contributed to the fall in Ethiopia’s tax to GDP ratio, on top of these more structural factors. Why this has occurred is not clear.
Another major economic shift is the 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 materials and machinery used in infrastructure projects.
The deliberate overvaluation of the Birr under the former exchange rate regime (which was government controlled) also contributed to the fall in the ratio of import tax revenues to GDP, especially from 2021 onwards. The overvaluation depressed the value of imports and hence import taxes in Birr. Defending the overvalued Birr also required the government to restrict the use of foreign currencies and hence imports, further reducing import tax revenues. Ethiopia’s 2024 currency devaluation, part of a broader economic liberalisation, has started to reverse the decline in import tax revenues: customs duty revenues between July 2024 and April 2025 were double those recorded a year earlier, even after adjusting for inflation.
First, tax-to-GDP ratios can be vulnerable when government revenue is highly reliant on a relatively narrow set of economic activities, especially if administrative capacity to tax other activities is not well developed. Ethiopia has been dependant on the relatively easier-to-tax public sector and imports for its tax revenues. Now that revenue has declined, the private sector has not yet made up the shortfall. In other countries, it could be extractive industries or the finance sector that is a particular reliance on. Sustainably raising the tax-to-GDP ratio requires a diversified tax base, and effective collection and enforcement mechanisms across the economy.
Second, trade, exchange rate and financial policies can have significant effects on tax revenue. Addressing over-valued currencies and reducing restrictions on foreign exchange transactions and capital flows are not painless – they push up the cost of debt in foreign currencies and can increase inflation and the cost-of-living – but they can generate additional government revenues, sometimes rapidly.
Third, it is important to recognise that explaining the trends in a country’s revenue performance is rarely straight-forward. There is no one-size-fits-all methodology. But one general lesson is the value of combining data from a range of sources - particularly tax microdata - with close attention to the specific features of the country’s economy and tax system. Insights provided by colleagues at the Ethiopian Ministry of Finance and other parts of the Government of Ethiopia were also vital. It helped to guide the analysis, develop hypotheses, and interpret the data. This data-driven but holistic approach allowed us to understand trends far better than relying solely on cross-country models of tax revenue potential – which have their uses, but cannot account for country specific factors.
Understanding the causes of a problem – such as declining revenue performance – is only the first stage in addressing it. But it is a vital first step, helping identify priorities for action and reform. In Ethiopia that includes investing in improved administration and enforcement activities for the private sector. With detailed analysis, other countries struggling with a combination of a fall in revenues and limited political space to increase tax rates, could also identify more promising avenues for change.
Published on: 12th September 2025
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