30 December 2012

Ethiopia: Timely Tax Overhaul


In recent years, we can hardly find an agenda, in the Ethiopian economic policy circles, as important as increasing tax revenues. To this end, new tax laws are being enacted, regulations issued and improved tax administration implemented.

Tax collections, over the past 10 years, have increased in a way never before seen. Tax to gross domestic product (GDP) ratio has gone up to 11.7pc, in 2011/12, from 8.1pc, in 2006/07. The efforts surrounding tax administration have mainly centred on ushering the untaxed into the tax system and receiving a fair share of tax from the under taxed.

It has not been an easy journey, however. Disputes and grievances have been common place. They partly arise from a misunderstanding of the tax laws and regulations, and the general lack of a taxpaying culture. The focus on achieving targets, mistrust of the business community, lack of well-trained staff and some vague regulations have all caused aggravations to the tax authorities.

Yet, there has been no turning back. The government understood well thatEthiopiawas far behind other Sub-Saharan countries, with regards to tax collection. Leaving aside high tax collectors, statistics inEthiopia's close neighbours show higher tax to GDP ratio. The ratio forDjiboutiis 20pc, whilstKenya's is 18.4pc.

Ethiopiacannot afford to be highly dependent on foreign aid, loans and privatisation proceeds, which account for more than 35pc of government revenues. Increasing the tax revenue is unquestionable. The big question, however, should not be whether there should be an increase in tax payment, but rather, which section of the population should carry the lion's share of the burden.

Looking at the debate, in the policy circles, on how the budget is to be allocated, which sector is to be prioritised and which regional state should get extra support, would make anyone wonder why there is a lack of such rigorous debates. There needs to be discussions on how tax revenues should be levied across different income groups.

At a time when the economy is showing considerable growth, followed by soaring inflation and wealth disparity, the lack of any sign of income tax review proclamation is disappointing.

It is even more disappointing considering the impact of inflation on income. Wage-earners' income is bloated, and as a result, a considerable number of people have been pushed into higher tax brackets. Now we seem to have reached a point where, even those at the bottom of the income ladder, are subject to taxation. In reality, they should not be.

The existing proclamation was issued more than a decade ago, when the economic condition was completely different. The tax base, the rates, and the exemption thresholds were determined by the economic conditions at that time.

Taxation should be dynamic, in line with changes in the economy. Moreover, taxation as a wealth distribution tool should be periodically reviewed to create a fairer society. It is unreasonable, however, to ignore the costs and the time associated with enacting and implementing new tax laws.

In a number of countries, a finance bill is enacted every year. How revenue should be raised is given the same attention as the allocation of expenditures. In determining the various revenue items, the bill takes into account the changes in the economy. The various taxable items, tax rates, tax bands, and exemption thresholds are all reviewed.

We need to set a time span for reviewing taxation; a suitable time period would be between three to five years. Reviews for the current income tax proclamations are long overdue.

In principle, those with broader shoulders should carry the burden of taxation; high wage-earners, medium and large-sized businesses, dividend earners, rental income earners, and capital gain earners. To pull those at the bottom of the salary ladder out of poverty, the tax exempted threshold should be raised to a reasonable level, and the 10pc tax bracket should also be broadened.

In order to compensate the loss in tax revenues from the poor; corporation, dividend, and capital gains tax rates could all be raised. The increased tax rates could even be introduced specifically into the most lucrative business sectors, such as; financial services and real estate.

It is very important not to discourage small businesses, formed as companies, through excessive taxation. By setting up a small company threshold, it is possible to make them exempt from higher tax rates too.

Merging incomes and levying marginal tax rates could also increase the tax revenue.

The selection of income items to be taxed at marginal rate, however, needs to be thoroughly studied, as some income items, such as interest income, can have a huge economic impact.

It has to be stressed that a fair distribution of the tax burden is as important as the commitment to increased tax revenues.

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