By Mulay W. Asegahegn
In July 2025, the House of People’s Representatives of the Federal Democratic Republic of Ethiopia passed an amendment to the Income Tax Proclamation, which had remained unchanged since last amended in 2016. This latest amendment has been wrongly misinterpreted by certain individuals as a “economic blunder” – in reality, however, the amendment constitutes a significant improvement. It reflects a deliberate attempt to rebalance the economy by addressing long-standing structural and policy issues. Misinterpreting such a deliberate policy change could misinform the general public. We believe that it warrants a response from policymakers. This note therefore highlights the key rationale for the amendment and its broader objectives, while clarifying some of the misconceptions.
As a responsible entity, the government should consider its fiscal space in times of implementing such revenue reducing reforms. This is important because reforms done without due consideration of the fiscal space at the federal as well as regional level could lead to job cuts (especially public service), reduction in the quality of public service provision, and/or to growing budget deficit. This could potentially worsen the cost of living, lead to increased poverty and further exacerbate the existing income inequality in the country. Such a reform, therefore, should be implemented in a stepwise and fiscally sustainable way. This, however, should not be considered as a contradiction of the argument against measures aimed at decreasing budget deficit instead ensuring feasibility of the reform without significantly deteriorating the fiscal prudence, which in other words is “balance of the economy”.
Regarding employment, personal income, and rental income, the amendment in fact leads to an increase in the fiscal deficit, as the upward revision of exemptions and tax brackets reduces revenue. Therefore, contrary to what these ‘commentators’ portray, the reforms are not about balancing the books or narrowing the fiscal gaps. Rather, they are intended to ease the tax burden, especially for low-earning individuals, without compromising the government’s revenue base, particularly that of the regional states.
Some have proposed raising the monthly exemption threshold to above ETB 8,000, citing the World Bank’s poverty line of US $2.15 per day as the basis for this figure. However, this proposed exemption is based on a wrong assumption. First, the calculation uses the official exchange rate rather than the more appropriate Purchasing Power Parity (PPP) rate. Second, the setting of an income tax exemption threshold involves broader policy considerations beyond the poverty line, including equity, efficiency, and administrative feasibility. Moreover, the government’s fiscal space is a critical factor in determining such thresholds.
The International Monetary Fund’s (the IMF) 2025 report, “Ethiopia’s Tax System: Structure, Performance, and Benchmarking”, analyzes the shortcomings of the prior tax law using data through 2024 and reflects conditions as of June 16, 2025. Its findings closely align with the government’s own diagnostics and have helped guide the July 2025 amendments. Contrary to some misunderstandings, the IMF does not critique the newly enacted legislation. Instead, the report establishes a pre-reform baseline and acknowledges that the reforms underway have the potential to address the identified weaknesses. Any assertion that the IMF is assessing or criticizing the revised law misrepresents the report’s intent. In succinct, the amendment is aimed at addressing the following key fundamental objectives:
Easing the tax burden on small businesses, individual businesses and rental income
To reduce the tax burden particularly on low earning individuals, the amendment has increased the employment income portion exempted from tax by 333% from what it was Birr 600 to Birr 2000 a month. Still, it is critically important not to misunderstand the Birr 2,000/month exemption as a minimum wage as this is merely the portion of income exempt from tax from the total wage received. Similarly, the amendment revises the exemption threshold for rental income and individual business income from ETB 7,200 to ETB 24,000 per year. Moreover, the tax burden of small businesses has been reduced by removing the turnover tax ranging 2% for goods and 10% for services and simplifying the tax regime which used to use about 2000 scenarios.
Despite the government’s limited fiscal space, this change marks a significant step in incentivizing savings and investment. As highlighted above, the reform is estimated to result in the decrease of government revenue by at least 0.21% of GDP; and it is worth noting that this is done in a time additional tax revenue is acutely needed.
All these changes to the income tax are believed to ease the burden on lower- and middle-income groups while ensuring a more equitable distribution of tax obligations. Reducing the tax burden for small businesses and easing the tax administration will increase employment mainly through self-employment and encourage investment to eventually reduce poverty and cost-of living.
Improving investment & business Environment:
The previous presumptive tax system, primarily affecting small businesses, was overly complex, nearly 2,000 scenarios, meaning 99 business categories with arbitrary profit margins and 199 taxable income brackets. Regions inconsistently applied these brackets, making the system unpredictable and burdensome. Additionally, small businesses were subject to a turnover tax rate of 2% on goods and 10% on services, based on gross revenue, complicating administration for both taxpayers and authorities. The latest amendment now simplifies the presumptive tax system by applying a progressive marginal tax rate to annual turnover.
Previously, inter-agency dividend transfers and payments for subscribed shares were subject to taxes, inadvertently discouraging collective and formal investment while promoting consumption and informal economic activities. The amendment exempts taxation of such investment related activities and introduces many other investment promoting measures. By creating a more favorable tax regime, the amendment promotes both domestic and foreign investment, fostering economic growth.
Closing tax administration loopholes and keeping fiscal stance prudent:
Recent Ministry of Finance’s estimate shows that over 63% of registered businesses are nil filers, loss filers and non-filers, suggesting that the growing tax compliance problem. To address this issue, the reform introduces a minimum alternative tax (MAT) of 2.5% of annual turnover for businesses with a profit-based tax liability of less than this amount. However, it should be noted that this MAT is creditable against future (up to five years) profit tax payments for businesses for a tax paid above the MAT.
Additionally, despite the growing importance of digital services to the economy, previous income tax legislation was unclear with regard to the taxation of such services, creating administrative challenges for the tax authorities. This latest amendment clearly defines the services and the tax bases for tax purposes. Hence these changes addresses tax avoidance and evasion practices commonly used by high-income earners, thereby promoting fairness and compliance.
Strengthening Ethiopia’s taxing rights internationally:
In Ethiopia’s growing integration into the global economy and its participation in multiple Double Taxation Avoidance Treaties, the amendment revises tax rates on passive income (interest, dividends, royalties, capital gains) to align with international practices and strengthen Ethiopia’s taxing and exercising taxing rights. Moreover, as the economy opens to the world economy large and more complex multinational companies will start investing and doing business in our economy. Such multinationals are known for tax avoidance and profit shifting to tax heaven countries. According to Tax Justice Network 2023 state of tax justice study report in the next 10 years about USD 4.8 trillion which is about USD 480 billion a year will leave Least Developed and Developing Countries to tax heaven countries, mostly to advanced countries. This is mainly because of wealthy individuals tax evasion and multinational companies tax abuse, contributing a share of 65% and 35% respectively.
The amendment, including the introduction of minimum alternative tax, reinforces Ethiopia’s sovereignty in international taxation and ensures the country secures its fair share of tax revenues from cross-border activities.
Concluding remarks:
The criticism that equates this expansionary reform to austerity or fiscal consolidation measures commonly coined as “balance of the books” overlooks these structural objectives and realities. Measures like reducing tax burdens and incentivizing business activity may initially lead to a decline in tax revenues, potentially widening the budget deficit in the short term. However, the long-term goal is to stimulate economic activity, enhance compliance, and build a more resilient and inclusive tax system. The amendment tried to address all gaps and loopholes that the law had before, as also explained in the IMF 2025 study report.
In this context, the reform should be accurately understood as a strategy to balance the economy, not a short-term fiscal adjustment to balance the government’s budget. It reflects a broader vision and commitment by the government to reduce tax burden, ease tax compliance cost, and encourage investment to ensure sustainable economic growth with fiscal sustainability.
Mulay W. Asegahegn is an economist by training and conducted his postgraduate studies in applied economic modelling and forecasting, with a specialisation in fiscal policy analysis, at Addis Ababa University.
