It looks like the officials in charge of tax policy directorate at the Ministry of Finance have had a pretty tough time over the past two years. As the nation loses billions of birr in tax income and grants that would have helped to reduce the deficit created by the conflict in North Ethiopia and macroeconomic troubles, the directorate was tasked with finding a way to address the issue.
Almost every tax legislation, whether income tax, excise tax or Value Added Tax (VAT), is being revised, and officials are working behind closed doors to finish the process in order to bridge the gap between expanding government spending and a dwindling external source of finance. It is a series of steps aimed at broadening the tax base and enabling the federal government in generating more taxes.
Given the government’s historic-high budget deficit of almost 308 billion birr for the current fiscal year, the move by authorities to diversify sources of tax collection appears understandable. The removal of government subsidies for fuel and wheat are only a few examples of how severe the financial crisis is. Even though the peace agreement in North Ethiopia means more external aid since it allows authorities to reestablish relations with the West, less foreign aid is anticipated because the restoration of peace has yet to yield fruit. The fighting in northern Ethiopia is expected to cost more than USD 28 billion, putting a huge strain on the government’s budget.
During the current fiscal year, it is anticipated that the government’s revenues will increase by 37 percent, reaching 439 billion birr. As is customary, the largest contributor is the income tax, which accounts for 28 percent of the total. After that comes the value-added tax, which makes up 25 percent of the total. The balance comes from duties imposed by customs. Authorities believe the targets can only be achieved if it is backed by tax reforms.
The Council of Ministers adopted a draft of the amended excise tax proclamation a week ago that will enter force once ratified by the House of People’s Representatives (HPR). The amended draft VAT and income tax proclamations have yet to be tabled to the Council, with the Finance Ministry working on the drafting of the legal frameworks.
Stakeholder consultation has already started.
Four months ago, the MoF convened with tax experts to discuss how the VAT proclamation could be amended. It is also intended to increase the yearly income threshold for VAT eligibility from one million birr to five million birr. New economic sectors and commercial activities are now subject to VAT. E-commerce, telecommunications services, and other creative commercial ventures are included. E-commerce giants such as Alibaba, Amazon, and others will be eligible for VAT and will need agents in Ethiopia, in addition to other financial requirements, if they operate in Ethiopia.
However, there are exceptions. Businesses in the public transportation industry, for example, are exempted from VAT. Experts wary of inflationary pressure have also recommended that the exemption for electricity be maintained, encouraging authorities to reject the proposal of the Ethiopian Electric Utility to impose a value-added tax on the purchase of electricity. Concerns have been raised about the issue as the country approaches the one-year mark of recording an inflation rate of more than 30 percent.
The effort to increase tax collections is not limited just to value-added tax (VAT), which is a kind of tax that is incurred by consumers.
On January 11, 2023, the joint session of the House of Federation (HoF) and the HPR also enacted a new tax bill that will allow tax authorities to impose property tax. Municipalities will soon begin collecting evaluation-based taxes from owners of properties. This, however, is not as easy as it appears. It was a topic of heated debate for a long period of time whether or not regional governments and the federal government should divide the money with the municipalities.
The two houses came to a conclusion on who should be responsible for collecting property last week, and they voted that it should be the regional states and municipal governments. It is a step that is anticipated to lessen the burden that the federal government must bear in subsidizing regional governments. Only for the current fiscal year, the federal government has provided 210 billion birr to regions as a form of subsidy.
In spite of the many initiatives taken over the last decade to boost tax collections, the most recent of which targeted property owners, the revenue generated has been dissatisfying in comparison to the expansion of GDP. Ethiopia’s tax revenues as a percentage of GDP is still relatively modest at about 11 percent, having dropped from 13 percent only a few years ago. It is a marked decline from the average rate of 17 percent for sub-Saharan Africa.
Experts believe that the government has never used the collected taxes properly. Many believe that the value is not preserved, citing the government’s recent pricey parks, office renovations, and non-productive investments.
Though the government’s spending is expanding significantly, investment in productive industries and their return remain negligible.
“Rather than increasing tax obligations on the taxpayer, the government should reduce expenditure and control the widening budget deficit,” Desalegn Chane (PhD), opposition party leader and member of parliament, said during a debate on the property tax proclamation, adding, “The economy has been facing various challenges.”
Finance Minister Ahmed Shide stated that the administration would focus on government expenditure management and ensure that tax rates are affordable, harmonized, and consistent.
Even though taxes have risen in relation to GDP growth, they remain quite low, according to Ahmed. “This is due to the fact that many businesses operate informally. All commercial activity must be legalized and taxed,” he said during the joint house session in response to Desalegn’s queries.
Tax experts say that the government is always tough on taxpayers who are in the tax net, which is why more and more businesses are turning to the underground economy.
Raising tax rates may serve to remove saturated cash from circulation and contribute to inflation management, but as long as the government continues to spend a lot, the money it doesn’t spend goes back into the economy, causing inflation to worsen, a tax expert said.
“In the meantime, the simultaneous influx of tax modifications might cripple businesses and push them towards the informal sector. Raising taxes shouldn’t mean destroying businesses and putting taxpayers’ way of life at risk,” the expert concluded.