Ethiopia is navigating a moment of profound change, driven by the urgent need to address challenges that have slowed growth for years. One of the boldest steps in this journey is a sweeping economic reform aimed at revitalizing the country’s financial system. These efforts, launched after the political shift in 2018, are intended to bring stability and lay the groundwork for a more prosperous future.
A defining moment came on July 29, 2024, when Ethiopia made the daring choice to float its currency, the birr, letting the market determine its value. It was a necessary step to align with global financial norms, but it wasn’t without pain. Within a day, the birr’s value against the U.S. dollar plummeted by 30%, dropping from 57.48 to 74.73 per dollar. For many Ethiopians, this abrupt shift felt like stepping into unknown territory, uncertain and daunting, but it also reflected the country’s determination to chart a new economic course.
The impact was immediate. As an import-dependent nation, Ethiopia saw the cost of living surge almost overnight. Prices for imported essentials like food, fuel, and medicine skyrocketed, straining household budgets and putting businesses under pressure. Families struggled to stretch their incomes, and the reality of economic reform hit home in a very personal way.
In response, the government took action. On July 8, the Ethiopian House of Peoples’ Representatives approved a historic budget of 971.2 billion birr for the 2024/2025 fiscal year. But as the effects of the reform rippled through the economy, the Ministry of Finance had to ask for an additional 582 billion birr ,pushing the budget to 1.5 trillion birr. This extra funding is aimed at stabilizing the economy and offering much-needed support to low-paid government workers and vulnerable families relying on social safety nets.
To meet the demands of this record-breaking budget, the government is preparing to broaden its tax base. The approved budget includes ambitious revenue targets, with 281 billion birr expected to come from taxes. The country seeks to collect 1.5 trillion birr ($12.5 billion) in the fiscal year to July 7. That compares to 613 billion birr the finance ministry set in its 2024-25 budget presented in June. However, for many Ethiopians, this will likely mean changes in tax policy and enforcement, another layer of adjustment in a period already marked by significant economic transformation.
With ambition to expand its tax base and enhance revenue collection, Ethiopia’s Proclamation No. 1341/2024, approved in July 2024 after 20 years, introduces a clearer and more equitable VAT framework. The law applies VAT to goods and services while exempting capital goods used in production to encourage investment in machinery and equipment. Additionally, it includes provisions for tax fairness and digital integration, aiming to boost economic growth and support the private sector.
Ethiopia has faced persistent macroeconomic challenges and a budget deficit, primarily funded through loans and subsidies. “The budget falls short of the country’s needs, as indicated by key macroeconomic indicators,” said Natae Eba, Seasoned Tax Lawyer. To address these issues, the government has introduced tax reforms, including a three percent social welfare levy on imports, with some exceptions. Previously exempt services such as electricity, water, transportation, and e-commerce are now taxed. This move, pressured by lending countries, aims to increase tax revenue to meet societal demands.
However, he acknowledged there are limitations, expressing concern that the creation of new businesses and registration of new TIN numbers must be prioritized to avoid overburdening already strained businesses. He also noted that higher tax rates on even small services are discouraging businesses, including foreign direct investment (FDI), and affecting business predictability. “As costs rise, uncertainty grows, potentially deterring investors, particularly from China, who had once seen Ethiopia as a promising destination,” he added.
“‘Don’t kill the goose that lays the golden eggs’ is a fundamental tax principle which warns against overburdening or overtaxing sources of wealth or income, as doing so can stifle growth and long-term productivity,” said Natae.
He cautioned that investors are now regretting their decisions. He added, “This was one way of diplomacy to attract foreigners, but it is the business environment, not just appealing corridor development, that will draw them in.”
While tax enforcement has improved, businesses that were once overlooked due to weak enforcement are now required to comply with the law. However, Natae pointed out that challenges persist in the tax collection system. He emphasized that a one-size-fits-all approach to audits doesn’t work, as businesses in sectors like manufacturing and retail operate differently. Tax authorities need to recognize these differences and avoid imposing their own limitations on businesses. Additionally, customs regulations should allow importers to declare goods at market prices, without applying international pricing standards, which has led to unnecessary disputes.
An anonymous economist expressed concerns that the government’s tax ambitions might be difficult to achieve, particularly given the ongoing demolition of small and micro-sized businesses due to development. These businesses, which could significantly contribute to government revenue, are being displaced, which could undermine the tax collection goals.
The economist expressed concern about the transition of informal businesses to the formal sector, stressing that, given their large number, the shift should not be rushed. The recommendation is to create a supportive and encouraging business environment to facilitate the process.
The government’s tax revenue is on the rise, with ETB 312 billion collected this quarter, a figure that once represented an entire year’s target. However, experts argue that true revenue growth will depend on the creation of new businesses and the registration of new TIN numbers. They stress that when setting revenue targets, it’s crucial to consider the potential number of transactions and provide clear projections for revenue growth. This approach will help prevent overburdening existing businesses.
