A new study recommends extending VAT withholding responsibilities to private companies, aligning them with the current requirements for public bodies. At the same time, the forthcoming implementation of VAT and excise taxes on fuel is expected to significantly reduce the gap between Ethiopia’s tax-to-GDP ratio and that of its regional peers.
The study identifies the decline in imports and reduced public investment—including large-scale infrastructure projects like railways and major dams worth billions of dollars in the 2010s—as key factors contributing to the drop in Ethiopia’s tax-to-GDP ratio.
These findings are part of a report titled “Ethiopia’s Tax-to-GDP Ratio: Benchmark Estimation and Performance Analysis Policy,” released by the Ministry of Finance on Friday, August 15. The report recommends designating large private companies as VAT withholding agents to enhance compliance and suggests increasing the VAT rate from the current 15 percent to match the Sub-Saharan African median of 17.5%.
However, the study warns that both policies present significant risks that require careful consideration. “Private sector withholding agents would need rigorous auditing to ensure proper implementation,” the report states. “Meanwhile, raising the VAT rate could widen the tax gap between compliant and non-compliant businesses, potentially dampening formal economic activity. Any decision on these measures must balance potential revenue gains against these risks.”
Currently, public entities are responsible for withholding VAT on their procurement transactions.
The report notes that nearly half of the disparity between Ethiopia’s tax-to-GDP ratio and the SSA average—along with the decline from 2015/16 to 2022/23—can be attributed to structural changes in Ethiopia’s economy. Policy differences accounted for nearly 40% of the gap compared to other SSA nations.
The study projects that recent government measures, such as stricter enforcement of VAT and fuel excise taxes, will significantly narrow this gap. “As VAT and fuel excises are collected more effectively, revenues are expected to rise substantially,” it states.
Conducted in collaboration with international partners like the Institute for Fiscal Studies, the research found that tax policy changes have had minimal impact on Ethiopia’s declining tax-to-GDP ratio since 2015/16. The remaining differences between Ethiopia and other SSA countries, as well as Ethiopia’s own performance over time, are largely attributed to variations in tax compliance.
The analysis, which assessed Ethiopia’s tax landscape up to 2023/24, emphasizes the need for stronger enforcement and structural reforms to enhance revenue collection.
The report indicates that Ethiopia’s tax-to-GDP ratio has declined by 4.6 percentage points between 2015/16 and 2022/23, primarily driven by structural economic changes and reduced tax compliance.
It highlights several contributing factors, including a decrease in public sector investment, declining imports, and weakened tax collection efforts. Approximately 2.2 percentage points of the decline are attributed to shifts in Ethiopia’s economy since 2015/16.
A significant reduction in public sector investment, along with a corresponding drop in imports as a share of GDP, has notably impacted tax revenues.
Additionally, slower growth in formal sector employment relative to GDP growth and reduced profitability of the Commercial Bank of Ethiopia (CBE), which has been heavily involved in lending to state-owned enterprises, further contributed to the decline.
The analysis revealed that policy changes had a minimal effect on the declining tax-to-GDP ratio. It noted that the temporary VAT exemptions introduced in 2020 for essential goods such as eggs, sugar, pasta, baby formula, and vegetable oils accounted for less than 0.1 percentage points of this decline.
A significant portion, 1.8 percentage points, of the decline is attributed to worsening tax compliance, which is not related to structural economic changes. Additionally, approximately 0.6 percentage points of the decrease are associated with taxes or periods not included in the analysis. Recent economic shocks, including the COVID-19 pandemic, escalating conflict—particularly in Tigray—and foreign exchange issues have likely impacted both tax collection and overall economic output.
The conflict in Tigray alone is estimated to have reduced tax collection by 0.25 percentage points, particularly from companies with high exposure to the region.
The analysis also suggested that the reported decline in the tax-to-GDP ratio may be somewhat exaggerated due to potentially overestimated GDP growth.
While official GDP figures indicate robust growth, alternative measures, such as urban employment earnings and satellite-measured night-time lights, suggest slower economic activity.
However, it noted that data from the Ethiopia Socioeconomic Survey aligns with official GDP figures, and there is no conclusive evidence to support claims of overestimation.
The analysis uses official GDP figures as the baseline and indicates that Ethiopia’s tax-to-GDP ratio is 5.5 percentage points below the median for Sub-Saharan African countries.
About 2.2 percentage points of this gap can be attributed to Ethiopia’s economic structure, particularly its large agricultural sector, which is dominated by subsistence and smallholder farming.
Policy differences, such as the absence of excises and VAT on fuel (until recently), taxes on airtime and financial transactions, and a relatively low VAT rate, account for another 2.1 percentage points.
Weaker tax compliance compared to other countries explains the remaining 1.2 percentage points.
The report states that Ethiopia’s tax system heavily relies on import duties and public sector taxes, which together comprise roughly 60% of federal tax revenue.
This reliance has made the country vulnerable to declines in imports and public sector activity. To sustainably increase its tax-to-GDP ratio, Ethiopia must focus on enhancing tax collection from the private sector, the report suggests.
