The Ministry of Finance & Economic Cooperation (MoFEC) has started a survey aimed at assessing the effectiveness of tax holidays and other exemptions in the country. It is undertaking the study with technical assistance from the World Bank (WB).
This was disclosed three weeks after Abraham Tekeste (PhD), minister at MoFEC, hinted the tax reform of the country while proposing the budget for the next fiscal year to the parliamentarians.
Reducing tax expenditure and aid dependency of the country are the primary objectives of the study. The study is said to be a move to bolster the capacity of the country in mobilising domestic resources, according to an assessment made by the Ministry.
A committee from the Ministry, the World Bank and the Ethiopian Revenues & Customs Authority (ERCA) has been formed to overlook the study.
"We undertook the study to analyse why the tax revenue is not growing in line with the economic growth of the country," said Birhanu Tadesse, coordinator of the tax policy directorate at MoFEC. "Achieving 17pc of tax to Gross Domestic Product (GDP) ratio in the next three years has also necessitated beginning the study."
Although the government has planned to raise the share of tax to GDP annually by one percent, last year it declined to 12.4pc from 13.3pc in 2014/15. Also, the Ministry has proposed a budget bill which increases the share of tax revenue to the budget to 196.4 billion Br in 2017/18 from 170 billion Br during this year.
The new study will assess provisions of tax law, regulations or practices that reduce revenue comparatively for a small population of taxpayers relative to a benchmark tax. This includes special tax incentives that come in the form of exclusions, holiday, deductions and preferential rates.
The new study is undertaken nine months after the government refused to consider the recommendations of the International Monetary Fund (IMF) to review its tax exemptions and holidays given to local as well as foreign investors. At that time, the body stated that a low tax-to-GDP ratio and generous tax exemptions and expenditures are the major challenges for the country's tax administration system.
Annual review of tax expenditures is essential for the nation to bring to an end those expenditures that are no longer cost-effective, according to the recommendation of IMF nine months ago.
"When the government delivers tax preferences to specific groups, it increases the burden on the rest of taxpayers," said Birhanu. "So, the tax expenditures such as the holiday and exemptions must be evaluated for its cost-effectiveness."
With the aim of encouraging investments and inflow of foreign capital, tax exemptions and holiday periods are granted based on the remoteness of the investment from Addis Abeba. Investments in areas with slow economic activities get over 15 years of tax holidays, including 100pc of tax exemption from customs duty.
"Though the aim of tax expenditure is attracting the attention of potential investors, the benefits analysis of these incentives must be checked," said Girma Tafesse, director of the tax directorate at ERCA. "Accordingly, the new study will help us to know whether they are effective or not."
A policy analyst with over two decades of experience welcomes the attempt of the Ministry to assess the effect of the tax expenditure.
"It is good news for a country which is generous in providing tax incentives," said the analyst. "Even though it is late, but it is better than nothing."
Implementation of tax incentives and provisions in developing countries is controversial. Three years ago, the United Nations Conference on Trade & Development (UNCTAD) reported that expanding government revenues and choosing tax structure has become challenging for developing countries in the existing structure of a global economy.
"The country has been losing more than it has gained from foreign investments owing to its excessive tax exemptions and incentive policies," said the policy analyst.
Ethiopia loses seven percent of its GDP every year due to its unnecessary tax expenditures, according to an estimate by an analyst.