A Bold Tax Reform for A Better System

A Bold Tax Reform for A Better System

Aug 9 , 2025. By Mulay W. Asegahegn ( Mulay W. Asegahegn is an economist by training and conducted his postgraduate studies in applied economic modelling and forecasting, with a specialisation in fiscal policy analysis, at Addis Abeba University. )

The federal government has recently implemented a key reform to keep the economic reform program alive at a time when the world’s supply of foreign capital is drying up, while demand for resources to finance the increasing economic and social development is higher.

In the three years beginning in 2020, external financial flows to Latin America and the Caribbean fell by 14.5pc and to Africa by 6.8pc, according to data from the United Nations Conference on Trade & Development and the OECD. For sub-Saharan Africa, the slide continued last year with another two percent drop, and forecasts point to a 16pc to 28pc fall in 2025.

The 2.3 billion dollars less for Latin America and 5.3 billion dollars less for Africa could be part of the reason that jolted Ethiopian leaders into pushing domestic resource mobilisation to the top of their to-do list. The room for manoeuvre, however, is limited.

Debt-service costs on older loans remain substantial. Domestic revenue accounts for only 6.3pc of GDP, less than half the yield of peers and far below the economy's potential. Policymakers concluded that tinkering would not do the job.

A decade-old income-tax law, unchanged in any meaningful way for nearly a decade, has now been amended to address present-day macroeconomic priorities, digital transformation, the emerging capital market, and other structural shifts.

The effort began two years ago with a stack of studies. A comprehensive audit of tax administration weaknesses from both tax authorities’ and taxpayers’ perspectives was conducted, including a review of double-tax treaties, a detailed examination of personal income tax design and its associated costs, and a policy-costing exercise for every proposed solution.

All these feed into the “national medium-term revenue strategy” blueprint for broadening the tax base while keeping investment attractive and improving economic conditions for the fiscal period of 2024 to 2028.

The government implemented this reform with the aim of addressing the key structural and policy bottlenecks, as outlined in the Strategy. Small businesses feel the changes first, with the old presumptive-tax system leaves taxpayers with high compliance costs and baffles tax authorities. Turnover tax was levied at two percent on goods and 10pc on services, based on gross sales on top of the presumptive income tax, which complicated the administration of the tax for these small & microenterprises.

In its place is a simplified progressive presumptive income tax, with the turnover tax scrapped altogether. Officials believe this simplification will ease the cost of paying tax and the burden of tax on micro-enterprises and enhance the country’s image as a place to start a business.

The previous tax regime, with 99 business categories, 199 income brackets, and nearly 2,000 scenarios, was too complex, nudging Ethiopians toward consumption and the grey economy. Moreover, the amendment redefines reinvestment to include profits ploughed back into a firm, exempts dividends that stay within the corporate family, and wipes out tax on dividends used to pay for subscribed shares that lift a company’s capital, encouraging ndividuals to invest.

By relieving intra-business dividend transfers of tax, officials hope to coax more savers into formal equities.

Taxpayer categories, previously split into three, are consolidated into two, with thresholds adjusted to reflect inflation and business realities. For sole proprietors and property owners, the annual exemption jumps to 24,000 Br, a 333pc leap that the ministry calls a pro-savings nudge, despite tight fiscal space.

Macroeconomic changes over the years have pushed up wages and prices, while income tax brackets have remained unchanged. The minimum portion of a salary exempted from tax rises to 2,000 Br a month from 600 Br, again a 333pc increase, while brackets shift upward to limit bracket creep and keep the system progressive.

The government reminds critics that the lower public salary went up 320pc last year, cushioning households before the new thresholds kicked in.

Still, enforcement remains the central headache.

Only 37pc of registered businesses pay any income tax, and state-owned enterprises, claiming roughly 10pc of GDP, supply over 45pc of federal large-taxpayer revenue. To capture chronic non-filers and inaccurate filers, the latest law introduces a minimum alternative tax of 2.5pc of turnover, equivalent to a 30pc profit-based tax on businesses, assuming a less than 10pc profit margin. It aims to address the growing issue of tax evasion among certain businesses, echoing global minimum-tax drives aimed at curbing profit-shifting and base-erosion manoeuvres.

The digital economy, almost impossible to police with the old toolkit, falls under the same umbrella. Rather than invent a new income tax, the amendment closes loopholes that allow online platforms to escape taxation. Passive-income rates on interest, dividends, royalties, and capital gains adjust to match international norms and protect the government’s taxing rights under its network of double-tax treaties.

Public debate, however, has centred on the employment-income exemption. Some advocates urge lifting the monthly cutoff above 2,000 Br, arguing the rising cost of living warrants more relief. The exemption is not a minimum wage, but rather a slice of income exempted from tax, and increasing it without offsetting revenue would erode regional budgets.

Employment income tax contributes around 35pc to 45pc of regional tax overall tax revenue, peaking at 70pc in some jurisdictions and government levels below the regional states, such as woredas, kebeles, etc. Absent new revenue sources, raising the threshold again could force payroll cuts or money printing, options likely to stoke inflation and erode purchasing power further and exacerbates poverty.

The ministry estimates show that today’s changes alone cost at least 0.21pc of GDP in revenue. The Ministry of Finance, addressing Parliament’s Plan, Budget & Finance Standing Committee, said the federal government “is fully committed to make further reforms” but has to act in phases, “without compromising public finance.” Federal transfers to cover local shortfalls are off the table until economic growth restores fiscal capacity.

The overhauls balance relief with realism. Replacing blanket exemptions with targeted salary adjustments for the lowest-paid public workers offers more help to vulnerable households than broad cuts that benefit top earners, too.

The reform agenda, which incorporates market-friendly regulation, capital-market development, and digital-service rollout, depends on reliable domestic financing now that foreign inflows are dwindling. By modernising the income-tax code, the government hope to boost revenue, encourage investment, and maintain its debt sustainability without stifling enterprise.

The government believes that the new framework sets the stage for better compliance tools, including e-filing, real-time sales data, and tighter links to the nascent capital markets.

They invoke an Amharic proverb, “YalewunYeseteNifug Ayibalim,” (roughly translated to “no one scolds the giver who shares what little he has.”

The line, they say, captures a government offering relief even while revenue needs soar.

Whether the gesture wins broader trust, and with it better compliance, remains the test. For now, the overhaul provides the economy with a modern tax code tailored to today’s economy and a fairer distribution of the burden across sectors, incomes, and technologies.

The amendment is in fact the bedrock for the competitive, inclusive, and resilient economy the government pledged to build.

PUBLISHED ON Aug 09,2025 [ VOL 26 , NO 1319]