Ethiopia Bets on VAT Expansion to Bolster Fragile Finance

Ethiopia’s federal government has moved to widen its tax net, issuing a new directive that compels more businesses and professionals to register for value-added tax, a step officials describe as essential to keeping the country’s reform agenda alive amid a sharp decline in foreign capital flows to Africa.

The directive, signed on September 2 by Finance Minister Ahmed Shide, requires not only large enterprises but also professionals and medium-sized firms with annual turnovers above two million Birr, double the prior figure, to register for VAT. Even service providers earning less than that threshold must comply unless they qualify as small “Category B” taxpayers under the recently ratified income tax law. Taxpayers have 30 days to register and will be required to collect VAT on taxable goods and services thereafter.

The measure comes as Ethiopia faces mounting fiscal pressures. According to United Nations and OECD data, external financing to Africa fell by nearly 7% between 2020 and 2022 and has continued to decline, with projections of a 16 to 28% drop in 2025. For Ethiopia, that translates into fewer options abroad and heightened urgency to mobilize resources at home.

Debt-service payments on past loans also remain high, while domestic revenue contributes a little over 6% of GDP, a fraction of regional peers. 

In recent months, the government has embarked on an ambitious overhaul of its tax system. A long-stagnant income-tax law has been rewritten to reflect today’s economy, introducing progressive presumptive taxes for microenterprises, eliminating turnover taxes, easing compliance burdens, and redefining reinvestment incentives to spur corporate savings and growth. The changes also broaden coverage of the digital economy, a sector largely untaxed under the old regime.

The reforms are part of a national medium-term revenue strategy running through 2028, designed to balance relief for low-income earners with the urgent need to stabilize public finances. Minimum salary exemptions have been raised more than threefold, offering relief to households, but enforcement remains the Achilles’ heel: fewer than 40% of registered businesses pay any income tax, and a handful of state-owned enterprises contribute almost half of large-taxpayer revenue.

The latest VAT directive represents strategic step: bringing professionals and mid-tier firms into the fold not only broadens the tax base but also signals to international lenders that Ethiopia is serious about mobilizing domestic resources in an increasingly multipolar international economic landscape.