Strategies for Increasing Ethiopia’s Tax-To-Gdp Ratio Equitably

Brook Leulseged

Strategies for Increasing Ethiopia’s Tax-To-Gdp Ratio Equitably

Date

2025-06-26

Authors

Brook Leulseged

Publisher

A.A.U

Abstract

Despite sustained economic growth, Ethiopia’s tax-to-GDP ratio fell sharply from 12.7% in 2013 to 6.2% in 2024, exposing critical fiscal vulnerabilities. This study explores the disconnect between GDP growth and tax performance, with a focus on sectoral composition. The study aims to assess how growth in the industry and service sectors has influenced Ethiopia’s tax-to-GDP ratio, while identifying key tax instruments behind the decline and proposing reform strategies. Using 24 years of national accounts data, the study applies Isometric Log-Ratio (ILR) transformation to manage GDP’s compositional constraints. It also analyzes tax instruments—VAT, trade taxes, and business income tax—vis a vis GDP growth. Industry growth, particularly in construction, shows a negative association with tax performance (–1.49; p = 0.090), likely due to informality and tax-exempt public projects. Service sector expansion shows a modest positive effect (+4.94; p = 0.064), reflecting greater formalization. VAT contributed the largest revenue loss (–2.43 points), followed by trade taxes (–1.05) and business income tax (–0.72). Inflation above 30% has distorted compliance and expanded the VAT base artificially, creating a threshold inflation trap. The study recommends reducing exemptions, expanding e-invoicing, and tightening customs audits as quick wins, alongside equity-focused measures like simplifying presumptive taxes and enabling mobile SME registration. It also urges restructuring the Medium-Term Revenue Strategy around VAT reform, trade enforcement, and informal sector inclusion. Future research should double down on the subcomponents of the industrial sector vis-a-vis GDP growth rate.