States across the world are experiencing a drastic fall in government revenue and unmatched growth of expenditure due to COVID-19. Ethiopia is no different. So far, the government has approved over ETB50 billion as a response to the COVID-19 crisis. USD1.6 billion is also required to further boost the country’s potential to overcome the crisis. Meanwhile, businesses are struggling to pay their taxes, a situation which is likely to result in a fall in government revenues from taxes. This is expected to widen the budget deficit, presenting yet another macroeconomic woe for the government that is already challenged by inflationary pressure and unemployment. EBR’s Kiya Ali explores.
Last fiscal year, the exclusive importer of Toyota cars in Ethiopia, the Motor and Engineering Company (MOENCO) was recognized by the Ministry of Revenues for fulfilling its tax duties. MOENCO was the second highest taxpayer, just next to the state giant Commercial Bank of Ethiopia. The two companies sat at the forefront of 160 companies awarded by Prime Minister Abiy Ahmed (PhD) for being loyal taxpayers.
Encouraged by the award it received, the car importer with 1,500 staff was planning to repeat its success this financial year. Attaining its plan, however, has not been possible for MOENCO due to the adverse impacts of COVID-19 on business activities. Based on information EBR received from the company’s marketing department, “the virus killed its business.” MOENCO’s earnings first plummeted, now they are almost getting no income while incurring expenses every day as vehicles are considered a luxury item during the outbreak. The information further indicates that the company is not going to meet the targets it set to achieve this year.
Such stories spell bad news for the government that plans to collect ETB270 billion during the current financial year, 68.75Pct higher than that of last year. The Coronavirus recession is upon everyone. Unemployment is ballooning alarmingly, incomes are plummeting and spending on non-essential products is dwindling faster.
Many people are sick and many more are facing hardships, including hunger. Governments are also feeling the pinch across the world. It is no different in Ethiopia. The unexpected bulge of costs to respond to the pandemic have put a huge strain on the finances of both the federal and regional governments. Funds allocated to different projects have been diverted to fight the outbreak and mitigate the impacts of the economic slowdown it has brought. As the economic recession worsens, it strangle holds the main source of government revenue – taxes. That would complicate the tasks of policymakers for years to come.
Several financial augmentations were made by the government even before the country reported its first case of the virus, with the first being the ETB300 million financial package allotted to bolster the capacity of health facilities during early March, 2020. Two weeks later, additional five billion Birr was allocated for the same reason. On top of this, ETB15 billion was injected to the private banking industry, while an aggregate of ETB33 billion was injected to boost the liquidity of Commercial Bank of Ethiopia.
Even more, ETB48 billion supplementary budget was approved by the end of last month. The ETB28 billion additional budget during mid-2020 increased the total amount of budget approved this year to ETB463 billion. This has also put policymakers between a rock and a hard place as the already fragile situation worsened by a fall in tax revenues since last month.
So far, the government has focused on alleviating problems faced by the private sector. For instance, in an effort to stimulate the economy, the government introduced tax waivers that are expected to benefit 80Pct of the businesses severely affected by the virus. “The stimulus package aims at easing the burden businesses shoulder and it is like a cost sharing measure,” said Eyob Tekalign (PhD), State Minister of Finance.
Another measure taken by the government is the cancellation of overdue tax that was unpaid between 2005 and 2015. Taxes that have been audited but unpaid between 2016 and 2019 are also exempted from interest and penalties, though 25pct of the overdue principal should be paid over a month while the remaining 75Pct could be settled within a year. Lake Ayalew, the Minister of Revenue, stated that businesses will get a 10Pct reduction of payment as an incentive, if they settle 100Pct of their overdue tax within a month.
The decision made by the Council of Ministers also includes a 50Pct waiver on income tax. “If the private sector doesn’t survive this trying time, the government will lose its backbone. Hence, the tax reduction will help the private sector mitigate the detrimental impact of the pandemic and assist their effort for recovery. So this is the right decision and it is the obligation of the government to do so,” said Wasihun Belay, an Economist. Despite optimism over the action of the government, this specific measure would cost the government at least ETB78 billion collectable taxes, further widening budget deficit due to ballooning government expenditure.
There are two types of government revenues: tax and non-tax. While the former includes direct and indirect taxes, the latter comprises dividends from state-owned enterprises, earnings made from provision of different services and others. In Ethiopia, income and profit taxes account for 97.4Pct of direct taxes, which account for 43Pct of the total tax revenue. The remaining direct tax is collected from lease of rural and urban land.
Revenue from indirect taxes, on the other hand, accounts for 57Pct of tax revenues. About half of the indirect tax revenues come from import duties, whereas the rest is domestic taxes. Non-tax receipts account for 13.7Pct of government revenues. Of the total non-tax revenues, 37Pct is government investment income while the rest is collected from sales of goods and services, charges and fees, among others.
Until the end of the third quarter of the existing fiscal year, tax revenues exhibited a positive growth. Record-breaking collection rates were evident in the first nine months of the fiscal year. Tax receipts reached ETB183 billion in the nine months of this fiscal year, which came to an end in March 2020, 29Pct up compared to the same period last year. Taxes on domestic activity portrayed a modest rise of just 13Pct, while trade taxes showed a 45Pct rise. Despite the increase, however, Ceipheus Capital predicts keeping up the momentum would be difficult in the last quarter of the fiscal year. “The budget deficit was expected to be ETB85bn pre-corona, but is now projected to reach ETB134 billion (2.6Pct of GDP) because of extra corona related spending and foregone/lower revenue,” a Quarterly Macroeconomic Review of Ceipheus published last month read.
Experts also argue that the possible shrinking of the economy will have a negative impact on both tax and non-tax revenues. An assessment by Alemayehu Geda (PhD), Professor of Economics at Addis Ababa University, entitled Macroeconomic Impacts of COVID-19 on Ethiopia’s economy indicates this will reduce the total government revenue, including grants by 16 percent (this is assuming grants will remain at their historical level). According to the Professor’s assessment, the rise in public expenditure, along with a fall in revenues, would result in the widening of government deficit by at least ETB117.1 billion.
Keeping the share of each government receipt into account, Alemayehu says taxes and non-tax revenues would decline by 18.8Pct and 7.7Pct, respectively. IMF, on the other hand, projected that tax revenues would drop by nearly one percent of GDP relative to 2018/19 due to the severity of the shock. The international institution predicted that the drop would offset the revenue over performance in the first half of the fiscal year and concluded that higher spending and lower tax revenues are projected to result in a fiscal financing gap of 1.4 percent of GDP.
Iain Steel and David Phillips, in an analysis published in April 2020 under the title ‘How Tax Officials in Lower-Income Countries Can Respond to the Coronavirus Pandemic’, suggested that understanding and quantifying impacts now can help lower-income countries to prioritize fiscal policy responses to Coronavirus and manage their cash and debt operations. They warned that broad-based tax cuts could risk losing valuable revenue and would be less effective than usual given that social distancing measures prevent people from working and spending normally, and businesses are likely to be particularly risk-averse.
Tax stimulus could even be counter-productive if it reduces the effectiveness of efforts to control the spread of Coronavirus, according to the two scholars who said some lower-income countries will face tighter constraints on their options, such as more limited fiscal space, larger informal sectors outside of the tax net and lower administrative capacity. These constraints will make it even more important to design well-targeted policies to maximize impacts and minimize costs, while policy support outside the tax system might be more effective, Steel and Philips argued.
On the other hand, although external finance from international institutions and development partners can help plug financing gaps, it is difficult to access enough finance as many countries are facing the same problem simultaneously. In addition, access to capital markets to fund deficits may become limited.
As the government is likely to face the problem and its derivatives for the next two or three years, therefore, it must review the projects it has planned to implement in the years ahead. “The government must reprioritize its project plans,” Gutu Tesso (Phd), an Economist with more than 15 years of experience, argues. “Currently, 31 million Ethiopians live below the poverty line and are being supported under safety net programs. Yet, the government is pursuing projects like ‘Beautifying Sheger’, instead of prioritizing initiatives that will reduce unemployment. Unemployment and inflation are the two main problems affecting the majority of Ethiopians,” Gutu suggests. He went on to state: “So, the government should give priory to labor intensive projects to reduce the level of unemployment. Furthermore, projects with over 70Pct implementation rate that would contribute a lot to GDP must get priority.”
Tadesse Lencho, an Assistant Professor of tax law at Addis Ababa University, recommends emphasis on the agricultural sector. “The effect of COVID-19 on the economy is expected to continue for the next three to five years. If the country extensively works on its comparative advantages like agriculture, in the long run, it will boost its export earnings and stimulate the economy. Then when the economy recovers and gets stimulated, the government could generate more revenue,” he said.
Wasihun agrees. He remarked: “Equal attention should be given to urban agriculture; those engaged in urban farming must receive incentives.” Gutu, for his part, argues measures should be taken to alter consumer spending behavior. “Households are experiencing a fall in disposable income due to business slowdown and rise in permanent or temporary layoffs. This, together with restrictive measures taken by the government, substantially reduces consumer spending, making buying behaviors more erratic especially on non-essential products and services,” Gutu explains. “Such an outcome is discouraging producers and reducing production. To avert this, boosting consumer spending by increasing their disposable income and reducing income tax in the coming years are very important,” Gutu remarks.
But for Yonas Birmeta, Assistant Professor at Addis Ababa University, in order to motivate tax payers and facilitate the process of tax collection, the Ministry of Revenue should give additional focus on ease of doing business. He pointed out that businesses with surging sales should be given more incentive and others should also be encouraged to change their lines of business by taking current demand into consideration. “Encouraging small and medium enterprises with innovative ideas is also equally important to save the economy and increase government revenues,” remarked Yonas.
Meanwhile, the government approved ETB470 billion annual budget for the next financial year, hoping to collect ETB270 billion in taxes. Whether the government would be successful to make its plan a reality is yet to be seen, although experts fear that achieving this is no different from sucking blood from a stone. EBR
9th Year • Jun.16 – July.15 2020 • No. 87