Does the Tax Incentives Benefit Ethiopia?

Emerging economies have introduced tax incentives for various reasons. In some countries in transition, such instruments may be seen as a counterweight to the investment disincentives inherent in the general tax system. In other countries, the incentives are intended to offset other disadvantages that investors may face, such as a lack of infrastructure, complicated and antiquated laws, bureaucratic complexities and weak administration.

Currently, most developing countries introduce massive tax incentives program in order to attract capital and support economic growth. But developing economies are suffering greatly from tax incentives they offer to foreign companies to attract investment in their respective countries.

A 2014 report by United Nations Conference on Trade & Development (UNCTAD) stated that the current structure of the global economy is making it difficult for developing countries to expand government revenues and to choose their tax structure. In line with this, a study which was conducted by Tax Justice Network-Africa and Action Aid International five years ago in four East African countries (Kenya, Rwanda, Uganda and Tanzania) also confirms that tax incentives are resulting in large losses of government revenue, up to 2.8 billion dollars annually. There are estimates that Ethiopia losses seven percent of revenues from the total Gross Domestic Product (GDP). The GDP currently reaches 1.2 trillion Br.

The government has been giving massive tax incentives to attract Foreign Directed Investment (FDI) to boost investment. But there is no single study or document which assesses the benefits earned and what costs were incurred as a result.

Implementation of tax incentives, tax holidays, and tax sparing provisions in developing countries is debatable. There is no model, developing countries do not have the guidance to implement an established system to achieve the economic goals these kinds of policies are intended for, usually the tax policies implemented are based on trial and error.

International institutions quote that tax incentives are probably harmful to development as they often cause the race to the bottom. Tax incentives would not stimulate the development but rather develop tax competition. The lack of information about the real costs and benefits of implementing tax incentives into the tax systems due to problems with data availability is also an issue. In countries with weak political systems, it is difficult to check if tax incentives work. No cost/benefits initiatives because developing countries do not really control their tax incentive policies.

In fact, it seems they are being drawn to use them by the developed world – to develop themselves they have to create incentives not to be uncompetitive towards other territories. Problems connected with such measures is the fact that for real developing countries tax incentives are a very heavy burden, additionally strengthened by the exploitive competition between neighbouring countries.

Attracting foreign capital does not always mean bringing the newest technology and ensuring economic growth. Multinational enterprises (MNEs) with their FDI’s indeed invest money and bring some technology into developing countries, but very often as the next step they choose squeezing the market, elimination of local entrepreneurs and tightening local competition. As a consequence, the importance of tax incentives proposed to MNEs seems to be overestimated. Tax incentives introduce complexity into the tax system, as tax authorities add the special rules to the regular ones.

Additionally – as a natural reaction to the tax planning practices that inevitably result from the introduction of tax incentives – tax authorities also implement other anti-avoidance measures aimed at protecting the national tax bases. This complexity imposes additional costs – both on administrators and taxpayers. It also increases the uncertainty of tax results. In most extreme cases such phenomenon can deter the investment which incentives were intended to attract.

Developing countries have to be conscious that the changing policy has to reflect their true priorities. There is a necessity to put more emphasis on developing tax administration, restructuring and training, and better pay to people hired employees.

There is a strong need for developing countries to bear in mind the necessary conditions when giving tax incentives: making sure that the incentive is transparent and the cost of its implementation is known; identifying taxpayers who benefit from the incentive; analyzing how effective the benefit is and making sure it is not harmful to the entire system.

These are the biggest challenges in a situation of weak administration, corruption, undertrained and underpaid tax personnel. All those constraints have to be overcome, as they are a large ballast to emerging economies.

Tax incentives have for a long time been identified as a significant factor influencing FDI and strengthening economic growth. However, investors often point out that transparency, simplicity, stability and certainty in the application of tax law and in tax administration mean more for them than special tax incentives.

This shows that tax incentives cannot overcome the other, more fundamental problems that inhibit investment. As a consequence, the implementation of tax instruments attracting foreign capital has to go hand in hand with the modernization of tax codes and regulations to keep up with new business processes and transactions, tax avoidance techniques and international agreements.

For over two decades FDI’s in Ethiopia has opened many economic sectors for foreigners. The inflow of FDI has increased to 4.5 billion dollars last year from seven million dollars in 1992.

The government seems to recognize the role of the private sector in the economy. It has revised the investment law over nine times for the last 22 years to make it more transparent, attractive and competitive.

Currently, it is giving massive tax incentives including 100pc exemption from customs duty on the importation of capital goods and income tax exemption (tax holiday) ranging from one to 15 years depending on type and location of the investment for FDI.

Can we measure the cost and benefits of these tax incentives that has been given by the government for FDI as well as domestic investors?

The answer is No!

This is because based on the current poor data availability and clarity regarding tax incentives in government offices such as the Investment Commission, Revenue & Customs Authority, and Ministry of Finance & Economic Cooperation it is impossible to analyze. Some of these tax incentives data have not been appropriately recorded or not recorded at all.

Theoretically, there are two extreme models to measure the cost and benefit of tax incentives. One extreme is a primitive model that counts only the direct cost and benefit of a given tax incentive program. This extremely primitive model can be derived solely with conventional accounting, or use of “head count” approach. And the other extreme is an ultra-comprehensive model that is the Computable General Equilibrium (CGE) model built upon input-output accounts with both overall and sectoral economic multipliers being readily available for simulating the impact of various specified tax and non-tax parameters and behavioural reactions.

With the current data availability let alone using (CGE) model we cannot measure the cost and benefits of these tax incentives using the primitive model.

The government must seriously take this poor data availability and organize a task force which can collect, analyses, verified and organized these important data that are very obliging for a government decision, for policy and research input.Many research findings indicated that tax incentive is not a priority for international investors. What matters most are factors such as consistent and stable macroeconomic, fiscal policy, political stability, adequate physical, financial, legal and institutional infrastructure, skilled labour force, availability of adequate dispute resolution mechanisms; foreign exchange rules and the ability to repatriate profits, language, cultural conditions and product markets.

Under the current circumstance, without the tangible analysis of the cost/benefits tax incentive, the government does not really control its tax incentive policies.

It is time for the government take a step back and re-think and evaluate tax incentives for FDI as well as domestic investment. They should temporarily suspend tax incentives for FDI until mechanisms are in place to efficiently control the implementation of these policies. It is impossible for any government to control its tax incentive policies without continuous measurement and appraisal of the cost and benefits.

By Dawit Tadesse
He is an assistant professor who specializes in economics. He can be reached at

Published on Apr 08,2017 [ Vol 17 ,No 883]



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