excise tax

Sinister as Sin Tax

Another ‘flawed decision’ just around the corner

Learning from media outlets of new rules, laws or regulations to be enacted the next day without any consultations with the very entities it will govern, is a very common phenomenon in Ethiopia. The new excise tax law is no different. It was after the draft proclamation was approved by the Council of Ministers that businesses affected by the amendment started to voice their concerns. While the government plans to raise tax revenues in congruence with the growth of the economy, businesses are likely to feel the brunt of the bill. Many are complaining that the bill will adversely impact their revenues, while government officials argue the amendment of excise tax rates has shifted the burden of excise tax from producers and importers to end consumers. EBR’s Ashenafi Endale investigates.

Prices of cars, sugar, edible oil, and other items dramatically ballooned since the drafting of the amended excise tax proclamation was tabled to Parliament on December 17, 2019. Particularly the price of vehicles inflated by at least a quarter; other imported items showed a strong growth in price. While the consumer is in confusion, the government, which just introduced the new bill aiming to collect more taxes, is fearing inflation at the horizon, ahead of the ratification of the draft proclamation.

But at different meetings, the silent storm between the private sector and the government broke out to a loose war. The battle is raging and hard-working CEOs, heads of associations, and unofficial lobbyists are trying hard to push the aggressively nimble Ministers of Finance and Revenues to reduce the exaggerated rates, if they don’t manage to push back the document to where it is drafted first. The draft, which took the Ministry of Finance over two years to craft, amends Ethiopia’s excise tax regime, which has not been changed for the last 17 years.

Excise tax is universally conceived as flat-rated taxes imposed on items the government wants to discourage for health and environmental reasons, in addition to luxury items whose demand from the upper-class does not change even when the price is expensive or inflated. Yet, luxury is comparative and bounded by time. Television sets, for instance, were a luxury item 20 years ago. Most of the recommendations for the new excise tax rates that Ethiopia is close to ratifying came from the World Health Organization (WHO), as stated by the government.

The bill imposes varying tax rates on 378 goods and services across 19 categories. This is up from 29 items across 18 categories in the existing excise tax law, in which the rates range from 10Pct on textile products to 300Pct on alcohol and automobiles. The new draft bill imposes an average of 160.5Pct excise tax on all items listed within it.
The bill has also shifted the burden of excise tax from producers and importers to end consumers. This is in contrast to most African countries and the country’s existing practice. Currently, excise tax is calculated from the overall production cost; for imports, it is from the sum of the original price of the goods and freight cost. Depreciation cost used to be deducted before the calculation, until a new directive enacted six months ago reversed it.

The new excise tax bill includes items previously deemed non-damaging and non-luxury, including bottled water, sugar, salt, and used tractors to be under the category of luxury items in the amendment. Even though officials from the Ministry of Finance argue items like salt, from which government plans to collect ETB30 million, are price inelastic, experts argue such items including sugar, bottled water, phone text and many others should not be taxed at all. Though not in real terms, excise tax rates for sugar have fallen from 33pct of manufacturing cost to 20pct sales price. This is due to the change in the calculation method from production-based to selling price.

The government mentioned three driving factors as rationales for the amendment. “The plan is raising more revenue by shifting the tax base from producers and importers to the broader consumer base. Ethiopia’s excise tax to GDP ratio declined from one percent to 0.6Pct over the past few years, despite a growing economy, per capita income, and consumption. This is far from the 1.4pct sub-Saharan average,” said Adanech Abaebae, Minister of Revenues. The Ministry has thus planned to increase excise tax revenue by ETB20 billion to 30 billion, up from the current ETB19 billion.

The second reason has a social and environmental objective: reducing consumption of items like alcohol, cigarettes, and used vehicles. Thirdly, the government introduced the new tax law to encourage local producers and exporters. “In terms of price, Ethiopian products have been less competitive globally. Our prices have been higher, because excise tax has been included in the production cost. Local producers and exporters have been calculating prices with excise tax, and this swells up their final prices,” said Eyob Tekalign (PhD.), State Minister of Finance.

It also protects the emerging local manufacturing industries from dumping, according to the Ministry. “Ethiopia is on the verge of joining the CFTA as well as WTO. Unless we nurture our industries from now, we will have nothing to sell, once we are on an equal level with better exporting countries,” said Mulay Woldu, Director of Tax Policy Department at the Ministry of Finance (MoF). Nevertheless, none of the local producers and importers bought the rationales, despite rush-hour meetings organized daily to persuade the private sector and general public.

The counter argument
Even though excise tax is no longer their burden under the amendment, producers and importers rebelliously complained that the new amendment indirectly affects their business. Domestic breweries, car importers, water bottlers, tobacco companies, and soft drink producers are at the forefront, while the consumer itself is not represented.

“The end price of a bottle of beer will double if the proposed rate in the new excise tax amendment is ratified. We will lose significant portions of our customer base, since they can no longer afford it,” said a manager at Heineken beer, which was awarded platinum level by the PM for paying ETB1.2 billion in taxes in eight months of 2017/8. Frustrated by the new bill, the company is considering laying off some of its employees while disclosing that it has suspended an expansion project in the state of Amhara, which was at the water and soil tasting stage.

The company had already selected Meshenti, near Bahir Dar city, for the USD250 million expansion project, which could have hired 3,000 people. Other breweries also disclosed cancellations of expansion projects following the news of the excise tax amendment. In terms of percentages only, excise tax levied on beer declined by 10 percentage points. Now it is 50Pct, which means distillers had been paying three Birr per liter.

According to the bill, beer excise tax is to be 40Pct, or 35Pct if the brewer uses 100Pct locally produced barley. But in real terms, it is ETB11 or nine Birr per liter, respectively, based on the conversion calculation. If the new rate is approved, consumers are expected to pay at least ETB18 for a bottle of beer (300ml), up from the current average of ETB15. Factories are also unable to deduct depreciation costs under the new law. “As such the law will reduce our earnings, thereby impacting profit; we will be forced to downsize staff and production, which would likely impact farmers as well,” said a senior manager at Heineken.

Meanwhile, despite the concerns and the threats of producers, government has targeted collecting four billion Birr in excise tax from breweries alone in the current fiscal year. This accounts for 30Pct of the total excise taxes planned for collection by the federal government in the existing fiscal year. “We have been studying the profitability and sales volumes of producers, before determining the new rates in the new amendment. We found out that beer consumption will not decline, even if we impose more taxes,” said Eyob. “Cancelling investments is irrational.”

Adanech concurs. “The existing calculation is highly abused by producers and we have been losing significant tax collection as a result. The new rate is equal to what they should have been paying in the old law,” she says. “So, there is no reason for this to affect their market share or investment. But most importantly, it will certainly have a positive impact on government revenues.”

However, a senior manager at Heineken, who wants to remain anonymous, argues that the real intent of the government is not raising revenue. For him, the beer business, which is now facing its worst sin taxes since the liberalization of the brewery industry, is no longer booming after the government introduced a law banning the promotion of beer products on broadcast media last year. “Religious institutions have been pushing for high taxes on, or the outright banning of, beer companies. They are unhappy with the exceptionally booming beer market and the changing consumption trends of the youth. Officials at the Ministries are also trying to earn political loyalty by taxing more,” he complains. “Knowingly or unknowingly, they are trying to enforce an excise tax that will have a devastating impact.”

This is also a concern shared by East Africa Bottling Company (Coca Cola bottlers), which has suspended its USD70 million expansion project after the government introduced the bill. If the government levies the proposed 25Pct excise tax on soft drinks as per the draft proclamation, its annual excise tax payables will increase by ETB797 million, of which ETB86 million is caused by the increment of tax on sugar, according to a study conducted by the bottler. The impact of the new rate will also result in a 15Pct sales volume loss on the company in the first year, meaning ETB123 million, the study says.

Other beverage and water bottlers also gravely protested the impacts of the new excise tax proclamation.
According to the assessments of the Ethiopian Bottled Water, Soft Drinks, and Fruit-juice Manufacturing Industries Association (EBSFMIA), excise tax that will be paid by a sample water bottling company will increase from two million to three million Birr annually under the new calculation. Many overhead costs like depreciation will also not be deducted. Taking such concerns into account EBSFMIA asked the government to levy a maximum of 15Pct for water and soft drinks, ten percentage points lower than stated in the bill. If not, it should be equal to the current rate, which is between seven and ten percent, depending on the item, the Association says.

“Government has no reason to tax a basic item like water. Bottlers are also not affecting the environment because we are attempting to recycle every plastic bottle at a factory we have installed,” argued Ashenafi Merid, Head of the Association. “Even if the government wants to tax us for the plastic bottles, it should not be more than other similar products with waste, like vehicle tires (taxed only to five percent in the amendment).”

Yet, despite such grievances, the new rates levied on local producers are no match for the new excise tax rates imposed on imported cars. Imported two-year-old vehicles are taxed 100Pct, while cars aged seven years and above are faced with a 500Pct tax. On the other hand, the draft reduced excise tax of new vehicles from 35pct to 30pct. Taxes levied vary with concern to different capacities, types, and age. Importing close to 70,000 vehicles annually, Ethiopia has a car population of one million, of which over 75Pct are aged 20 years and above, according to a study by the Ethiopian Customs Commission.

The imposition has matched the price of used cars with that of new ones, and is expected to clean out most car importers from the business, since few people can afford new vehicles. “Practically we banned used cars. Why would people buy used cars, if the price is equal with new cars?” Adanech ponders. Like all businesses affected by the new bill, such measures have brought disappointment to the actors of the car market.

“We are already in a deep problem,” said a car importer in the business for the past ten years. “We usually order the cars and start processing bank and freight issues three months ahead. But I just heard about the excise tax amendment after I ordered,” he complains. “How can I reconcile the documentation of the cars on their way with the new law? Government should have consulted and discussed with us instead of pulling out such a deadly law by surprise.” The new excise tax is forecasted to significantly reduce the importation rate of cars to Ethiopia. Car importers used to import a number of used cars with a few thousand dollars approved by the National Bank of Ethiopia (NBE). They fill the balance from the parallel black market, due to the foreign currency shortage. But under the new law, they cannot access enough foreign exchange to import a single new car, which can be as expensive as USD 25,000 for mid-size automobiles excluding shipping and documentation costs. Under present conditions, this amount of money can be used to import at least five Vitz automobiles.

Although such a measure, according to the government, would encourage local investors, the reality is different. Domestic assemblers are also not happy with the amendment, since the bill imposes an excise tax of 30Pct for completely knocked down (CKD), semi knocked down (SKD), and brand new cars imported directly by the assembler/importer.

“CKD and SKD cars are capital and labor-intensive investments that could help in technology transfer. Why should I not import new cars? Assembling locally has no difference in incentive,” remarks a sales engineer at a vehicle assembling company EBR spoke to. Further, agricultural tractors and trailers aged two years are imposed with 100Pct tax, while that of over seven years are slapped with 400Pct tax. Experts have criticized the government for the taxes on tractors, citing its importance in modernizing the agricultural sector.

However, Eyob argues this will propel Ethiopia to a new automotive era. “Many leading international car manufacturers like Volkswagen, Toyota, and others are ready to install their factories in Ethiopia. They have been asking to invest in Ethiopia, should we cut out the import of used cars. They have been standing aside and watching the booming car market in Ethiopia, because they could not invest under the circumstances.” Similarly, the 40Pct excise tax levied up on saturated health risk edible oil is expected to encourage local oil producers. The reduction in excise taxes levied on transport buses is also expected to positively contribute to mass transport.

What’s more, the conversion rate of the bill is also criticized for being flawed. “It has a problem since it does not maintain equal price transformation when the calculation swaps from factory cost to sales,” said Tadesse Lencho (PhD.), Associate Professor, specialized in tax issues at Addis Ababa University. “The proclamation also lacks clarity of policy, besides creating economic distortion. It is perplexing how such an arbitrary document passed the council of Ministers in the first place.”

Mulay begs to differ. “The conversion cannot be equal. The amount of excise tax producers had been paying under the existing production cost-based calculation is considerably underestimated. Producers had been hiding the exact amount of input used—minimizing their over-head cost to minimize excise tax,” said Mulay. “In fact, only experts at the Ministry of Finance know the calculations used for the conversion. So maintaining the former method and amount is wrong.”

Yet, Tadesse believes the government selected many items in the amendment smartly, just to collect taxes without much effort. “Excise taxes are the lowest hanging fruit. So it is not really about imposing excise tax on a bulging consumer segment because there is no such thing as luxury in Ethiopia,” he says. “They are just trying to single out easily collectible taxes, at sales points. Most of the items do not meet the criteria of excise tax imposition.”

He argues excise tax is imposed on items in three categories. The first is health damaging items like alcohol and cigarette. The second is items that are a threat to the environment. The third is a road tax collected from drivers so as to fund road maintenance. He argues the new items should be introduced under three different proclamations. “Government is playing hide and seek but trying to stay politically correct. That is why they hastily took the document to parliament before discussing with relevant stakeholders,” Tadesse says. “The Minister of revenues also thinks taxing is the solution for every problem. The amendment cannot meet its objective, unless it is backed with extension works in every sector, hand in hand with tax.” For instance, banning old cars creates an efficiency problem unless new cars are produced locally, according to him.

Ethiopia’s tax base structure
Ethiopia’s tax regime over the past two decades has been a reflection of the government’s developmental state ideology. Government’s need for money has been exponentially increasing, in order to finance its infrastructure and mega project investments and the provisioning of services that do not generate revenue in return. As a result, widening budget deficits and external debt have become common features of the economy, further exacerbated by the low performance in domestic resource mobilization.

Tax revenue contributes only 58Pct of the government’s ETB387 billion budget for 2019/20, down from an historic 84.2Pct in 2013/14, according to the Ministry of Finance. Tax to GDP ratio stood at 10Pct, down from 12.7Pct three years ago, as data obtained from NBE shows. This is despite the government’s target to raise the figure to 17Pct by 2019/20, equal to the sub-Saharan average. The decline in tax revenues demonstrates the deteriorating tax compliance in Ethiopia. For instance, Addis Ababa, which has over 347,000 registered businesses, collects ETB32 billion taxes annually on average, while the potential is between ETB50 billion to ETB80 billion, according to official estimates.

The government has taken various measures to improve the tax to GDP ratio. The trend is gradually improving particularly after the diplomatic, yet firm, Adanech came to the top last year. The Ministry collected ETB19.2 billion in November 2019, 104Pct of the plan for the month. This is worth noting compared to the underperformances of the past. What makes this more outstanding, however, is the shift to domestic revenue mobilization from customs taxes.

The share of direct taxes to total revenue increased from 22.8Pct in 2010/11 to 30.1Pct in 2017/18. On the contrary, the share of customs tax declined from 27.7Pct to 24.5Pct during the same period, while the share of excise tax stood steady at eight percent. Nonetheless, despite the fact that government’s domestic revenue is increasing, it is not on stable footing. Although the fundamental shift from customs tax to domestic taxes is a good step, the difficulty in effectively utilizing cash register machines and inability in tracing tax evasion has contributed to the poor performance of domestic taxes. Many economic sectors and businesses are still out of the tax net due to the failure to transform the tax system, despite efforts escorted by foreign institutions and states, including the UK.

Experts say changes in a tax system are the product of tax-to-base and base-to-income elasticity. Tax-to-base, which is the relation between taxes collected and the base, is manipulated by tax administration factors. On the other hand, base-to-income elasticity is influenced by changes in the structure and growth of the economy, which is out of the control of the tax policy. Low elasticity in the base-to-income relationship indicates the inability of the tax base to capture a wide enough tax revenue, attributed to the presence of a significant underground economy, and results in the excess burden being placed on few tax payers in the tax net.

Keeping this in mind, revenue from excise tax and VAT is inelastic with respect to the economic growth. This reflects the low tax-to-base elasticity, resulting from administrative constraints, low levels of compliance mainly in relation to VAT, numerous tax exemptions, and massive avoidance practices. Excise, value added, and income taxes increase by only 0.44Pct for every one percent growth in the GDP, according to an NBE study. This is why the government says there is room to increase excise taxes through the expansion of the tax base along with GDP growth, according to tax experts. The government strongly concludes that the tax revenue growth rate is way below the real potential of the economy, according to Eyob.

However, some experts argue this is an overestimation. Ethiopia’s 10.2Pct average GDP growth over the past fifteen years is mainly driven by government expenditure, and is not consumer driven growth. Since most of the returns on infrastructure and other mega projects are not integrated into production and income, forecasting the tax loss is missing the point, according to experts. Nonetheless, Eyob argues that “if the government invests in a construction project, there is money going to the employees’ pocket, increasing their per capita, as well as consumption. The GDP expansion thus has a real impact on consumption expenditure.”

But for Mamo Mihretu, Economic Advisor to the PM, what should be prioritized is modernizing the tax system and increasing voluntary compliance rather than overwhelming the few tax payers in the net. “This is the effective way to reduce tax administration costs,” he argues. For him, the Ministry of Revenues needs to first cut out the hectic services that discourage tax payers to come and pay voluntarily. Secondly, the tax system needs modernization like online filing and payment, just like the single electronic window service launched last month. Thirdly, the government needs to rationalize the incentives that are serving no objective. “Such mechanisms can solve the deficit problem and create a predictable tax system. Otherwise, we will always struggle with budget deficits, debt and inflation,” Mamo says. “We also cannot attract investment in such an unstable macroeconomic environment. So, modernizing the tax system is critical for good fiscal policy and a stable economy.”

Unlike Eyob and Adanech, Mamo is not pushing hard for the new excise tax amendment. “The excise tax document has many blurs, and requires more consultations,” said Mamo, who also admits there is a communication gap between the government and the private sector. “But I still believe the current chaos on the new excise tax is due to the lack of communication. The people and stakeholders must be exhaustively consulted before ratifying the final draft. Every case should be seen based on merit. They should elaborate the government’s expectations from the amendment.”

Bearing such concerns in mind, parliament has turned back the excise tax document to the Ministry of Finance for reevaluation after deliberating on the draft on January 1st, 2019. “Most probably the rates on bottled water, sugar, salt and tractors will be reduced, if not eliminated. The rates on alcohol and cigarette will see no change. Rates of some items like mobile and internet services might be increased. But the proclamation will surely be ratified within a few months’ time,” said an official at the Ministry of Finance.

But Tadesse still argues that government cannot generate significant increases in excise tax through this amendment because it will discourage consumption, and it will thus be very difficult to finance the already ballooning budget deficit. “The government could collect higher revenues by imposing an additional 2Pct on VAT on all items, instead of imposing huge excise tax on arbitrarily selected items,” he concludes.

9th Year • Jan.16 – Feb.15 2020 • No. 82


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