Tax Rebate Too Little Too Late to Impress

From the days of the Egyptian Pharaohs to the modern era’s sophisticated global economic interactions, the business of taxation remains one of the few instruments where state sovereignty is powerfully imposed. Taxes are not only tools used in mobilising resources for economic ends, but they are also instruments through which a governing party expresses its political will – with allocations revealing its priorities.

States legitimise their rights to tax citizens, claiming to fulfil the nine elements that the World Health Organisation (WHO) determined, in 1986, were essential for a healthy community. Meeting in the Canadian town of Ottawa, the WHO declared that healthy communities require peace, shelter, education, food, income, stable ecosystem, sustainable resources, social justice and equity. National governments the world over pledge to fulfil these public goods, paying for them through taxes they collect in varying forms and to differing degrees.

Where they actually differ is in their tax policy decisions, in as much as the capability, or lack thereof, of their tax administration. The most conventional way of calculating this is to measure up their domestic mobilisation capacity with the country’s economic size. Those in the business describe it as ‘tax-to-GDP ratio’.

Seen from this light, Ethiopia is one of the few countries where the amount of tax collected from direct and non-direct sources is way down compared to the total size of its economy. At 12pc of the GDP last year, it is the lowest performer, even by the measure of Ethiopia’s league in the East Africa Community, which, bar Uganda, has an average tax to GDP ratio of 22pc. The star in the bloc is Kenya, which recorded a ratio of 20pc last year.

It shouldn’t be surprising to see that the Revolutionary Democrats, since their ascent to power 25 years ago, have developed the knack of tinkering the tax policy. Indeed, they have restructured the tax administration more than four times. Each time, the key driver behind the change is their determination to see their ambitious plans being paid for by resources mobilised from internal sources. Yet, it remains an uphill battle for them to unshackle the country from foreign handouts and largesse. In the latest budget bill tabled for MPs’ discussion, the administration of Hailemariam Desalegn hopes to get 15pc of the revenues from the nation’s development partners through loans and grants.

Informed by these figures, enhancing the domestic mobilisation of resources, inching to 100 billion Br for the next fiscal year, has remained a major preoccupation. Ethiopia’s tax gap compared to the potential the economy offers is one of the highest, at 37pc. Studies reveal that an additional 35 billion Br can be collected across the country compared to the current level. Put differently, the tax gap represents four per cent of the total GDP, according to the IMF.

Indeed, the devil is in the details. Addis Abeba, Afar and Tigray are areas in the country where there is a lower tax gap, compared to the other regions. This is especially true of the Somali Regional State, where the gap may reach as high as 80pc.

Regrettably, squeezing taxpayers already in the tax net appears to be a much more convenient solution to the administration`s operatives than broadening the tax base. Those easily preyed upon include businesses in Addis Abeba, where the informality of the economy is less pervasive than the 34.3pc of GDP national average seen across the regional states. At the same time, the tax authorities ability to enforce the law in the capital is much more evident.

It is interesting to note that perhaps the only place where there is a negative tax gap is also in Addis Abeba, if judged by the taxes collected from the income of its citizens. This is a form of tax left untouched for over a decade, despite so much change in the volume and type of the national economy.

If there can be an area the Revolutionary Democrats should feel a sense of pride in, it is their accomplishments over the past two decades – the changes in the macro-economy are more profound. From the abyss, they have enhanced the national economy to have 55 billion dollars in nominal GDP, while per capita GDP grew five-fold to reach 547 dollars. The size of collected tax too grew exponentially, enabling the country to cover no less than 80pc of its federal budget by itself.

But these outcomes were registered in the shadow of the inaction of policymakers and a reluctance to reform the aspect of tax that would have rewarded individual taxpayers in a way that reflects the current reality. Ethiopia follows a progressive tax regime, with regards to the tax on gains made from employment. While 150Br is a tax-free threshold on monthly employment income, those earning over 5,000 Br are taxed a blanket rate of 35pc. This is clearly an outdated ratio, if not too high to stimulate consumption at a household level.

But, there were reasonable assumptions made in the early 1960s, when these figures first appeared. The purchasing power of the Birr against a basket of major foreign currencies was much higher, the inflationary pressure was lower and the number of people being paid over 5,000 Br was marginal. The historical record in inflation shows a significant upward trend, of double digit, since 2005 – two years after the income tax regime was amended. The 5,000Br salary threshold in the early 2000s had a purchasing power of close to 14,000Br in today’s market – or more than 52,000Br, if compared to the same income in 1961 (the year the tax rate was first introduced).

Keeping this rate for such a long time does no justice to taxpayers earning a living from employment. Indeed, the very concept of using tax as an instrument to introduce equity in society is simply assaulted. While individuals eating income from other activities in the economy are taxed less in relative terms, those employed have been on the receiving end of administrative inaction for far too long now.

This may change soon, however, following a bill finalised by a working committee under the Minister of Finance & Economic Cooperation, amending the tax regimes on incomes from employment and rents. For many, however, this has come too late, as what is on the offer is too small to impress. It is unfortunate to see an administration pouring water on a highly anticipated reform, simply because it is determined not to lose revenues through a tax rebate.

The authors of the proposed amendment appear to be satisfied that increasing the tax-free threshold to 585Br is enough. They have also advised that the monthly income to be taxed at a flat rate should be set at 10,833Br and above. This would be inconsequential should policymakers buy this proposal and endorse it for implementation.

It should be in the interests of the Revolutionary Democrats to see the economy continue the growth trajectory witnessed over the past decade. Yet, the uncertainties posed by the ongoing drought cast a shadow over the growth prospects in the current fiscal year. In an economy where a 45pc contribution in GDP comes from agriculture, the loss of productivity will no doubt have an impact – as was the case back in 2003, when agricultural production dropped by 16pc.

A country going through such shocks, while too being choked by the scarcity of foreign exchange provisions, can hardly afford to have an economy with sluggish consumption. What would rather help to keep the economy alive is a policy decision to cut red tape, encourage both domestic and foreign investment, and continue with the EPRDFites enthusiasm of public infrastructural development. Putting money back into the pockets of consumers by increasing the tax-free threshold to 1,500 Br and the flat tax amount to over 50,000 Br, would be a generous incentive that could make huge waves in rejuvenating the economic slowdown in the offing.

Indeed, this is only one part of the equation. The Administration should also have the courage to take successive moves in reforming corporate tax rates, introducing various categories, with capital, revenue and the company’s size all taken into consideration.

Published on Jun 14,2016 [ Vol 17 ,No 841]



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