In Taxing Aggressively, Fed's Fiscal Reckoning Arrives

Jul 19 , 2025.

Parliament is no stranger to frantic bursts of productivity. Even so, the vote last week on a new income tax law was dizzyingly swift. Only five legislators dissented before the bill was rubber-stamped. Authors of the bill, whose undeterred position was thundered in the legislative chamber by Eyob Tekalegn (PhD), state minister for Finance, hailed the passing of the bill that revised the income tax law after 17 years.

No less, it is an instrument to scrape “every penny” from taxpayers and plug an ever-widening deficit.

The federal fiscal gap, including grants, reached two percent of GDP in the fiscal year that ended in July 2024 and shows scant signs of narrowing. Revenue has slumped from 8.1pc of GDP in 2021/22 to 7.3pc in the subsequent year, barely half the sub-Saharan African average. Officials promise a bounce to 10.2pc by 2025/26 and 11pc two years later. Such ambition belies years of frustration. Despite growth averaging roughly seven per cent annually for two decades, the tax take has stayed stubbornly low.

Direct taxes on personal and corporate income have flagged since 2019. Consumption levies, notably VAT and excise duties, also underperform, seen as a sign of pervasive informality and rampant evasion. Trade taxes have withered from six percent of GDP to a meagre 1.5pc, largely because import volumes have shrunk. Customs duties and import VAT, though, remain a modest bright spot, a result of recent administrative tightening.

Geographic disparities compound the malaise. Addis Abeba, home to barely four percent of the population, provides more than a quarter of federal revenue. Peripheral regional states collect less than five percent of what they spend, relying on block grants that have already slipped from 65pc of general expenditure to 45pc.

Spending pressures, by contrast, are relentless. Recurrent costs balloon as the public payroll swells, while capital budgets often go unspent, crimping future productivity, and, thus, future tax capacity. Loss-making state-owned enterprises add to the burden, drawing on government guarantees to cover debts. Confronted by a narrow tax base, administrative frailties and shrinking foreign finance, federal officials have opted for a bolder hunt for cash.

The new law widens the base, trims exemptions and ratchets up rates for high earners. Its centrepiece is a minimum tax regime. Businesses should now pay at least two percent of their turnover, regardless of whether they are profitable or not. The Finance Ministry attributes this to 67pc of businesses routinely declaring losses; hence the floor. Taxpayers whose annual income tops one million Birr face a jump in their top marginal rate from 35pc to 40pc. Multinationals and well-heeled individuals suspected of shifting profits abroad are promised sterner scrutiny.

Whether these measures will work is another matter. Inflation, running at 14.1pc in May 2025, coupled with Birr's loss of ground against a basket of major currencies, erodes real incomes and trust. Credit to the private sector has shrunk by nearly 12pc after the IMF barred direct central bank financing of the budget. Liquidity is tight, making it harder for firms to pay higher bills on time. In an economy where about 80pc of workers toil informally, the temptation to duck into the shadows is strong.

Further tax hikes, critics warn, may drive even compliant businesses underground, widening rather than narrowing the gap.

External buffers remain brittle. Net foreign direct investment has petered out, falling to 3.2pc of GDP, down from five percent in 2017. The current account deficit, stuck near 2.9pc of GDP, keeps pressure on the Birr. The Central Bank’s hard-won reserves, projected at 1.7 months of imports by June 2025, are still perilously thin. High public debt, 34.8pc of GDP, even before hoped-for relief, is eating into the federal government’s room for manoeuvre.

Officials tout the benefits of “aggressive” taxation, yet investors fret that a heavier burden on the formal private sector could hobble the very engine of growth and job creation. Small and medium-sized enterprises, which account for half of formal employment, are bracing for a blizzard of paperwork now that the Ethiopian Revenues & Customs Authority enjoys beefed-up audit powers.

Relying heavily on income and consumption taxes carries other risks. Levies on spending can sap demand in an inflationary climate; steeper rates may also deter formalisation, especially when public services are patchy. The federal government forgoes tens of billions of Birr a year in exemptions, according to the Finance Ministry. Evidence, say critics, of a system simultaneously too lax and too heavy-handed. Real reform, they argue, requires more than squeezing the same lemons harder.

Technocrats inside and outside government offer a fuller menu.

Digital filing and risk-based audits, modelled on Rwanda’s electronic-billing triumph, could enhance compliance without requiring inspectors to visit every shopfront. Mandatory e-invoicing and a consolidated business registry would make it more difficult to remain invisible. Presumptive taxes and simplified regimes for micro-enterprises, paired with access to credit and social protection, could encourage informal operators to come out of the shadows. Targeted excise duties on luxury or environmentally harmful imports could raise cash without throttling productive investment. Natural resource royalties, particularly from mining and geothermal projects, remain largely untapped.

For now, policymakers' strategy leans on compulsion. Officials will chase paperwork, cross-check invoices, and threaten audits. Over time, they will be compelled to court consent. Streamlining business registration, offering tax credits tied to formal employment, and digitising services could sweeten compliance. Better public accounting, timely audits of spending ministries and transparent procurement would reassure sceptical taxpayers that money is not vanishing into black holes. A credible medium-term fiscal framework, spelling out how today’s pain translates into tomorrow’s roads, clinics, and jobs, would be helpful.

The political economy of tax is as important as the economics. In a country where state legitimacy is contested and security concerns persist, taxation serves as a barometer of trust. Citizens part with cash more readily when they perceive value in return. Yet, many see threadbare schools, infrequent water supplies and erratic electricity. Without tangible improvements in public services, higher taxes may deepen resentment.

Policymakers also tread a fine line with donors. The IMF urges discipline, but knows all too well that excessive austerity risks suffocating growth. Development partners want domestic resource mobilisation but fear social backlash if the burden falls on the poor. Balancing these demands will test the finesse of Prime Minister Abiy Ahmed’s (PhD) administration.

Under-collection breeds underinvestment, which depresses productivity and keeps revenues low, creating a vicious circle that it can ill afford. An assertive tax law is only a first step. The next should be a modern administration, calibrated incentives, and above all, a social compact that links taxes to visible benefits. This will determine whether the administration escapes its fiscal bind or simply rearranges the numbers.

PUBLISHED ON Jul 19,2025 [ VOL 26 , NO 1316]