Ethiopia’s tax system plays a critical role in shaping its fiscal sustainability and economic development trajectory. Despite being one of the fastest-growing economies in Sub-Saharan Africa (SSA), Ethiopia’s tax-to-GDP ratio remains among the lowest in the region, highlighting persistent revenue mobilization challenges. The divergence between Ethiopia’s economic growth and its weak tax performance is attributed to a narrow tax base, high levels of informality, and inefficiencies in tax administration. Key findings include:
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Tax Revenue Structure and Trends: Ethiopia’s government revenue is heavily dependent on tax collection, with grants and non-tax revenues playing a minimal role. Direct taxes currently play the dominant role, with personal income tax (PIT), corporate income tax (CIT), and value-added tax (VAT) being the major revenue sources. However, unlike most SSA economies, Ethiopia has not seen a structural increase in income and consumption taxes despite experiencing a relatively fast pace of urbanization. Taxes on international trade and transactions have seen a sharp and sustained decline, mirroring Ethiopia’s shrinking trade openness.
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Tax Policy and Revenue Performance: Ethiopia’s tax system comprises PIT, CIT, and VAT, with notable gaps in efficiency and collection. Despite having statutory tax rates comparable to regional peers, revenue mobilization from these taxes remains among the lowest in SSA. PIT and CIT contributions are low by regional standards, and weaknesses in consumption tax collection further constrain revenue potential. VAT efficiency has historically been low, with a declining trend in recent years.
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Tax Revenue Elasticities and the Business Cycle: Ethiopia’s output gap turned positive in 2023 after years of economic disruptions. Personal and corporate income tax revenues exhibit weak responsiveness to economic fluctuations, diverging from other country groups. Consumption taxes exhibit a positive correlation with the business cycle, yet Ethiopia’s collections on goods and services remain below potential. International trade-related tax revenues are the most responsive to economic activity but have declined due to Ethiopia’s shrinking trade openness.
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Revenue Potential and Tax Gaps: Ethiopia’s tax revenue collections remain well below their estimated potential, highlighting scope for improving revenue mobilization. Using stochastic frontier analysis, the study estimates that Ethiopia could achieve a tax-to-GDP ratio of about 17 percent, well above the average level of approximately 8 percent, implying a tax gap of around 9 percentage points of GDP. This gap suggests significant room for improving tax collection through better efficiency in administration and compliance. Meeting the minimum tax-to-GDP threshold is essential for sustainable growth, and Ethiopia’s average tax-to-GDP ratio of about 8 percent remains well below this level.
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Policy Actions and Revenue Mobilization Under the ECF-Supported Program: The Ethiopian authorities are implementing ambitious reforms to address macroeconomic imbalances and enhance revenue mobilization. The National Medium-Term Revenue Strategy (NMTRS) prioritizes reforms in VAT, excise, corporate income tax, presumptive income taxes, and property taxation. Ethiopia has made significant progress in tax administration, closing gaps with peer countries, though further improvements are needed to align with international best practices. Despite ongoing reforms, Ethiopia’s revenue projections indicate a gradual recovery but remain below the tax-to-GDP threshold for sustainable development.
In conclusion, Ethiopia’s tax revenue performance remains below its potential, with the tax-to-GDP ratio among the lowest in Sub-Saharan Africa. A combination of tax policy refinements and strengthened administration is required to broaden the tax base, formalize the economy, improve compliance, and enhance governance. These efforts are essential to aligning Ethiopia’s revenue performance with its economic potential and ensuring the necessary resources to support infrastructure, social programs, and inclusive and sustainable growth.
