Economic growth and industrial development are high priorities for the Government of Ethiopia. The recent growth record is good, but manufacturing has progressed slowly. It is correspondingly important to know whether the tax burden is a significant constraint on enterprise and investment. Does the tax system bear down unfairly and inefficiently on some firms rather than others? 

 

Not a squeeze in the middle: Small firms bear the highest tax burden

Until recently, we did not know the answers to these questions. Indeed, one view – that middle-sized firms suffer the biggest squeeze – turns out to be wrong. Reliable and robust answers require good access to the information held by the Ethiopian Revenue and Customs Authority (ERCA). ERCA itself has very limited analytical capacity.

 

Working collaboratively with ERCA and the Ethiopian Development Research Institute (EDRI), ICTD researchers have done pioneering new research on these issues, made the results publicly accessible, and stimulated debate within the Ethiopian government on the practical policy implications.

 

Using ERCA data on corporate tax returns, the researchers calculated “effective tax rates” – the proportion of corporate income collected in taxes – for different sizes and types of firm.

 

Contrary to one widespread view, it turns out that small firms face the highest effective tax rates, and middle-sized firms the lowest. Why? Large firms are very visible, and government depends heavily on them for revenue. The largest 10% of firms contribute 90% of total corporate taxes. They cannot escape the attention of the tax collector. At the other end of the scale, small firms find it a challenge to comply with ERCA’s procedural requirements. They have neither the technical capacity nor the personnel resources to grapple effectively with these procedures. Many pay more tax than is formally required. 

 

An excerpt from an Addis Ababa newspaper on ICTD research findings, February 2016 

 

Ethiopia

 

 

The problems faced by small firms are worsened by the fact that tax thresholds have been unchanged in Ethiopia for 13 years. Because of inflation, many small firms and individual taxpayers have entered the tax net over this time. They are required to file complex tax returns and pay higher rates. In a separate recent study for the Ministry of Finance, Giulia Mascagni of the ICTD has calculated the consequences – for government revenues and for fairness – of revising tax thresholds to take account of inflation. Her proposals are currently being discussed at Ministerial level. One other research finding that has attracted attention locally is that the sector facing the highest tax burden is manufacturing. This is at odds with the government’s intention, as expressed in the new Growth and Transformation Plan, to promote manufacturing.

 

Evidence based policy

ERCA has not in the past put much emphasis on research. However, working closely with EDRI and ICTD researchers, it has come to appreciate how it can analyse the information it collects to inform policy in a very practical way. ICTD is responding positively to recent requests from ERCA for further research collaboration and research capacity building for its staff.