The VAT Standoff: Political Reality vs Fiscal Necessity in Ethiopia

In the battle between Ethiopia’s urgent fiscal needs and the political appetite for reform, tax policy has once again taken center stage. A recent study by the Ministry of Finance, working with the International Finance Studies (IFS), laid out a sobering picture: Ethiopia’s tax-to-GDP ratio, once hovering above 12% in the mid-2010s, has now sunk to a meager 7.5% as of 2022. That number is not just a statistic; it is a stark reminder of how fragile the country’s public finances have become at a time when demands for reconstruction, debt servicing, and social spending are pressing harder than ever.

The report benchmarked Ethiopia against comparator economies, showing just how far the country has drifted below the African average of around 15pc. To close that gap, it was recommended that bold moves were required, including an increase in VAT from the current 15% to 18%, alongside tightening loopholes and expanding the tax base. Yet, days after the findings made their way into the public debate, the Ministry of Finance announced that the VAT rate will remain at 15%. The decision reflected more than just a reluctance to tinker with the rate of a single tax. It highlighted the enduring tension between economic necessity and political reality in Ethiopia’s tax reform journey.

The VAT issue is emblematic of the larger struggle. Technocrats can model the gains from raising the rate; a move to 18% might have brought in as much as 1pc of GDP in additional revenue. But policymakers are acutely aware that VAT is regressive, hitting consumers at a time when inflation has already eroded purchasing power. Official inflation may be moderating, but in the markets of Addis Ababa and beyond, households complain of relentless price increases. To push VAT upward in this environment would risk a political backlash that the government can scarcely afford.

Still, the government’s refusal to budge on VAT leaves an uncomfortable question hanging in the air: if not through VAT, then how will Ethiopia reverse its alarming fiscal decline? The study makes clear that there is no single lever. Excise duties, corporate income tax, and better enforcement of property and land taxation all have roles to play. But these are notoriously difficult areas, plagued by resistance from vested interests and capacity constraints within the tax administration system.

The deeper issue, however, is that Ethiopia’s tax-to-GDP ratio is not just low; it has been on a steady decline for years. This erosion reflects a combination of structural weaknesses. Exemptions have proliferated, eroding the base. The informal economy, vast and resilient, continues to evade the tax net. Tax administration itself struggles with outdated systems, inconsistent enforcement, and a shortage of skilled professionals. To put it bluntly, while Ethiopia’s economy has grown in size, the state’s ability to claim its fair share has shrunk.

The 7.5% figure cited in the study is particularly telling. Although it is based on 2022 data and more recent numbers may show slight improvement, it still captures the essence of Ethiopia’s predicament: the state is attempting to finance 21st-century ambitions on a revenue system that barely measures up to the standards of the 20th. The comparison with peers is stark. Countries at similar levels of development, from Kenya to Senegal, have managed to consistently keep their tax ratios well above 12%. Ethiopia, once celebrated for its fiscal discipline and rapid infrastructure-led growth, has now slipped dangerously below even the African average.

The risks of such a weak revenue base are not abstract. With debt service obligations mounting and concessional finance tightening, Ethiopia has little room to maneuver. The government faces the unenviable choice of cutting essential spending or accumulating more debt. Neither option is sustainable in the long run. Domestic resource mobilization is, therefore, not a matter of choice but of survival.

Yet, in this context, the Ministry’s decision to hold VAT steady at 15% signals an important political calculation. It suggests that the government is not ready to absorb the social costs of a headline tax increase, especially when trust in state institutions remains fragile. Tax reform, after all, is not just about numbers. It is about legitimacy. Citizens are far more willing to pay taxes if they believe the revenues are used effectively and transparently. Ethiopia’s recent history, marked by conflict, economic dislocation, and questions of governance, has left taxpayers skeptical. Raising rates without addressing this trust deficit may only encourage more evasion and deepen the cycle of underperformance.

This is where the IFS-MoF study provides a crucial insight. It argues that Ethiopia cannot fix its revenue problem through rate hikes alone. What is needed is a more comprehensive strategy that tackles both the administrative and political barriers. On the administrative side, digitalization of tax collection, closing exemptions, and strengthening enforcement can expand the base without raising rates. On the political side, there needs to be a renewed social contract where taxpayers can see and feel the value of their contributions. Without this, any attempt at reform risks collapsing under public resistance.

There is also the question of sequencing. Ethiopia may not have the luxury of waiting years to build capacity before acting, but neither can it afford the blunt instrument of raising rates overnight. A phased approach that combines modest rate adjustments with aggressive administrative reforms could strike the right balance. For instance, tackling widespread VAT evasion and broadening the registration of small businesses might bring in nearly as much revenue as a rate hike, but with far less political fallout.

Ultimately, the government’s stance on VAT reveals a paradox. By refusing to raise the rate, it may have avoided immediate public discontent. But in doing so, it has postponed a reckoning with the revenue crisis that looms ever larger. Ethiopia’s tax puzzle, therefore, remains unsolved. The challenge is not just to collect more, but to do so in a way that strengthens state-society relations and supports inclusive growth.

The coming years will be decisive. Ethiopia has little choice but to lift its tax-to-GDP ratio closer to the African average if it wants to maintain fiscal stability. That will require creativity, political will, and a willingness to confront entrenched interests. The Ministry’s recent decision to hold VAT at 15% shows just how difficult that path will be. But it also underscores the urgency of looking beyond rate hikes toward deeper reforms that can put the country’s revenue system on a sustainable footing.

Ethiopia’s fiscal future will not be secured by headline tax rates alone. It will depend on whether the government can build a fairer, more effective system that commands both compliance and legitimacy. The research by IFS and the Ministry of Finance has laid out the scale of the challenge. Now, the real test lies in whether Ethiopia can translate analysis into action before the tax puzzle becomes an outright crisis.