A Taxing Time

Balancing Revenue Goals, Citizen Concerns

The Ethiopian Ministry of Revenue’s aggressive pursuit of tax revenue to address its widening budget deficit and ambitious development goals has sparked significant concerns. The recent introduction of new taxes and tariffs, coupled with the expansion of the Value-Added Tax (VAT) system to previously excluded sectors, has raised questions about their potential impact on the economy and the welfare of citizens.

While the government aims to broaden the tax base and improve tax collection efficiency, critics argue that the rapid pace of reforms and the singular focus on revenue targets could inadvertently harm economic growth and exacerbate inequality. This raises a pressing question: How can Ethiopia balance its fiscal needs with the imperative of fostering a sustainable and equitable economic environment?
The delicate balance between revenue generation and economic well-being is a complex challenge. That’s why the government needs to carefully consider the potential consequences of its tax policies to ensure that they contribute to fiscal sustainability and promote long-term economic growth and social equity. EBR’s Munir Shemesu reports.

Eskinder Yohannes (name changed) has been working as a driver for taxi-hailing companies in Addis Ababa for the past four years. He used to begin his mornings with a trip to the Autobis Tera metro and spend the rest of the day waiting for trip notifications from his phone. Lately, Eskinder has changed his approach to the business, opting to chase prospective customers through callouts and direct solicitations.

“I paid 40,000 birr in taxes last year,” he told EBR with some frustration.

Eskinder was shocked to learn of his tax bill, which was calculated based on the total number of trips in the year rather than a lump sum like in previous years. Like many drivers, he expects to pay less taxes as long as he logs a lot of trips without involving the companies. Taxi companies list the yearly trips on which officials base their taxes.

Eskinder has yet to plan to have prolonged conversations with officials at the Addis Ababa Revenues Bureau over deductibles, expenses, or new mandates. He was further stunned to learn that an additional 2,700 birr was being asked to cover the wages of a civil servant right after he settled his tax bill.

“They demand payment,” Eskinder says.” Very little is explained to you.”

Similar sentiments have been echoed by foreign-owned companies that manage millions of dollars in Ethiopia.

The European Chamber of Commerce in Ethiopia, which lobbies on behalf of nearly 180 companies, released a policy brief six months ago with scathing reviews of the local tax system. The brief identified unmitigated auditors’ powers, sudden changes to tax codes, and inefficient bureaucracies. The Chamber asserted that several foreign companies were forced to shut down operations due to misalignments with tax officials.

An unfortunate trend has contoured Ethiopia’s tax revenue over the past decade, as a flurry of new levies fails to abate the continued dip in the tax-to-GDP ratio.

A tax expert who spoke to EBR attributes part of the plummeting figures to the inefficient collection and an unhealthy fascination with nominal statistics. He pointed out the marked rise in taxed goods and services despite an 8% tax-to-GDP ratio to highlight inconsistencies in principles.

“Everything is tied to gross collection targets on an annual basis,” the tax expert says.

While Ethiopia’s total tax revenue jumped from 85.7 billion birr in 2011/12 to 477.7 billion birr a decade later, it dwindled as a share of GDP from 11.5% to 8.8% over the same period. This coincided with a widening budget deficit, a seven-fold increase in public expenditure and a galloping disenchantment with tax collection practices.

The tax expert underscores the crucial need for increasing tax revenue but also emphasizes the importance of marked improvements in tax collection administration. He fears that the benefits of a broadened tax base could only be recovered with the diligent pursuit of transparency, certainty, and convenience for taxpayers, highlighting the critical factors for successful tax reforms.

“Tax reforms need to inspire confidence not trepidation,” he says

However, as Ethiopia’s federal budget increasingly relies on tax revenue for public expenditure needs in line with attempts to wean off direct borrowing, nominal targets have become more critical by the day. The drive to plug in the shortfall in external financing, as grants fell to 0.3 per cent of GDP in 2022/23, down from an average of one per cent of GDP during the pre-conflict years, has translated to high collection targets across tax bureaus.

Yet, the last few years have only been a taste of what will come as the executive imposes a wave of new levies. Agriculture, bank services, real estate, VAT on insurance claims, and even removing exemptions on nonprescription drugs are on the docket.

During a high-profile award ceremony last month for loyal taxpayers, Ethiopia’s ambitious Prime Minister revealed a lofty revenue target of one trillion birr.

“You have to work diligently, “the commander-in-chief noted. “We have to rid ourselves of thievery.”

Prime Minister Abiy Ahmed (PhD) pointed to increased tax collection capabilities emanating from comprehensive digitization across the Revenues ministry. He assured the attendees of reforms that would see the country’s tax receipts rise to the potential signalled by the size of the economy.

While the PM’s revenue targets might appear high-minded, reviewing recent agreements between the government and international lenders provides some insight.

A day before the Council of Ministers approved the National Medium-Term Revenue Strategy in October, finance minister Ahmed Shide signed off a World Bank loan which targets increasing the tax-to-GDP ratio by up to 30%. In addition to civil service reforms through digitization, the 70-million-dollar four-year project supports a 26.1% annual increase target in domestic revenue for the next seven years.

The government seeks to attain a tax-to-GDP ratio of 18% by overhauling value-added tax (VAT) and excise laws, expanding the tax base, and inculcating voluntary compliance.

The project financing included automated audit case selection, digitized excise tax administration, and a data centre to be built at the Revenues Ministry’s headquarters.

While authorities expect the FX reforms adopted in July to ease the erosion of the tax base amid recent import surtaxes and excise levies on telecom, the revenue targets require a broader tax base.

Nonetheless, inefficiencies in enforcement have often led to comical depictions of ineptitude. In October, dozens of heavy-duty trucks hauling wheat from Djibouti ports to Ethiopia were stranded at dry ports over the unclear implementation of VAT exemptions. Eyob Tekalegn (PhD), the State Minister for Finance, had to pen a letter to the Ethiopian Customs Commission to clarify confusion over a relatively straightforward legislation.

With constrained financing over the past few years, the authorities have implemented an expenditure-driven consolidation at constant nominal value despite double-digit inflation rates. This has contributed to a widening budget deficit, which ballooned to nearly 4% of the GDP in 2022.

Economists like Arega Shumete (PhD) concur with policies that limit public expenditures to productive sectors while broadening the tax base. He acknowledges the need to increase domestic revenue but cautions against potential inflationary pressures in specific economic segments.

“The morality behind some of the recent levies raises eyebrows,” the economist told EBR.

Arega particularly questioned the siphoning of percentages from taxed income earned by public service employees. He advises balancing collection targets, inflationary concerns, and investment incentivization.

“Few would argue against broadening the tax base.” Arega noted.” Suppose they are aware of broader economic realities.

The economist highlighted how Ethiopia’s economy has been experiencing double-digit inflation rates, which he feels justified the contractionary fiscal policy of the past year. Still, he underscores the importance of bolstering taxpayers’ average earnings through targeted investments.

“Taxable income has to rise in tandem with expanded revenue targets,” the economist noted.

However, increased household income could soon be out of reach for most Ethiopians. The latest multidimensional poverty index by the United Nations Development Program (UNDP) and the Oxford Poverty &Human Development Initiative indicates staggering figures. Nearly 72% of Ethiopians, or around 86 million people, live in poverty, accounting for the highest percentage among countries on the African continent.

Furthermore, nearly half of the adult population falls into this category of Ethiopians who earn less than 2.15 dollars a day. The most challenging income hurdle has yet to fully materialize as the full effects of the recent adoption of market-based exchange regime policy take hold.

Following Ethiopia’s macroeconomic overhaul prescribed by the International Monetary Fund(IMF) three months back, the value of the local currency(Birr) against the US dollar has plummeted by over 100%. Fixed-income households, pensioners, and civil servants have been hit the hardest as a slew of primarily state-owned enterprises quickly increased fees. Everything from telecom services to passport charges, electricity tariffs, and school fees has risen in costs over the past three months. The removal of fuel subsidies has pushed transport costs, nudging prices further along.

Dwindling disposable incomes, the rapid removal of subsidies, and a slew of pending taxes have created anxiety.

Surafel Meles, a newlywed bank teller who earns between 16-17,000 birr, has panicked after hearing reports of a pending tax on his employee benefits. He expects taxes on the interest spread between central bank policy rates and employee loans to chip away the attractiveness of work as a banker.

“Everyone knows the salary is average,” Surafel says.” It is the benefits that keep you around”.

Still, this is only one part of the broad tax levies envisioned in the long term. Over the next four years, real estate taxes, agricultural taxes, reforms to personal income taxes, and even motor vehicle circulation taxes are being considered.

An economist who spoke to EBR on conditions of anonymity expressed no surprise at the proposed tax reforms. He pointed out that most IMF programs worldwide require an overhaul of domestic revenue mobilization strategies.

“Does one size fit all is the real question?” the economist pointed out.

He explains that fiscal consolidation towards debt reduction by the IMF typically translates to lower public expenditure and increased domestic revenues.  The economist expects the 3.4 billion dollar extended credit facility to serve as little more than a temporary palliative to the government’s exchange needs. He fears that the rapid implementation of the “usual” IMF reforms could exacerbate economic vulnerabilities without remedies to pervasive political problems.

“Conflict remains a problem in several parts of the country,” the veteran academic notes.

He perceives a rapid broadening of the tax base as potentially counterproductive to the targets of an economic program which could usher comprehensive benefits with the right touch.

The economist questions whether adequate consideration has been given to a rapid broadening of the tax base alongside a rolling removal of subsidies amid a precarious political situation.

Nevertheless, the authorities have not signalled any slowdown in the pace of the reforms. Instead, self-congratulatory pronouncements have characterized speeches by Ethiopia’s economic chieftains over the past three months.

During his coronation speech, newly crowned President Taye Asqeselassie set even higher tax revenue targets than the PM. He laid out the government’s goal of collecting 1.5 trillion birrs in the year and reiterated plans to raise the tax-to-GDP ratio to 8.3% in the current fiscal year, with an economic growth rate of two per cent less.

Abiy’s administration has increasingly seized domestic financial resources over the past four years, regardless of prevailing economic conditions.

Without a successful debt restructuring agreement under the G-20 Common Framework, external debt servicing costs will weigh heavily on public finances. Even as institutions like the European Union, the World Bank and other multilateral creditors have begun unfurling credit towards Ethiopia after adopting the IMF program, higher domestic revenue remains atop the government’s agenda.

However, a cursory look into how increased taxes, decreased subsidies and social security have played out under similar IMF programs provides critical insights.  In September of last year, the Human Rights Watch(HRW) organization published a report that looked into 39 IMF loan programs since March 2020. Twenty-three reviewed programs include measures to increase VAT rates, remove exemptions, or increase VAT revenues. In nearly every country, the pursuit of increased revenues from VAT has made several items out of reach for low-income households. Countries like Ecuador withdrew from the IMF program following massive protests against the government’s decision to remove fuel subsidies while reducing VAT exemptions.

The conclusions of the report mirror many of the fears expressed by Ethiopian economists, political parties and perhaps most importantly, everyday citizens.  It highlights a pattern of alteration in the social contract between a government and its citizenry during adopting an IMF program. The most vulnerable segments of society end up bearing the brunt of the impact arising from higher taxes, spending floors and subsidy removals, according to the HRW report.

International human rights law sets out strict parameters for when and how states may pursue austerity measures defined as increased regressive taxes and cutting public spending.  IMF programs fail to justify why policies included in specific programs are most likely to fulfil rights, such as by reducing poverty and inequality and enabling adequate spending on essential sectors.

Adopting another standard policy tool from the IMF arsenal, the Ethiopian government has revealed an adjustment to civil service wages. Several public servants have questioned the adequacy of wage adjustments, and petitioners received quick backlash from security forces.

Ethiopian households are set for a roller coaster year in managing their budgets. With death and taxes being the two certainties of life, a calibrated adoption of the policy packet under the four-year economic program might be a prudent pill to swallow.EBR

13th Year • November 2024 • No. 135