Determinants of Tax Revenue in Ethiopia

Abstract

Background: Tax revenue is essential for economic and social development, providing resources for public services and infrastructure. In Ethiopia, understanding the determinants of tax revenue is critical for policymakers, especially given the country's low tax-to-GDP ratio despite recent economic growth and poverty reduction. This challenge limits investments in crucial sectors such as education and healthcare. This study investigates the determinants of tax revenue in Ethiopia from 1994 to 2023, focusing on the impact of GDP per capita, the agricultural sector's contribution to GDP, inflation, foreign direct investment (FDI), trade openness, and political stability.

Methods: An explanatory research design was used to analyze the determinants of tax revenue collection in Ethiopia over the past 30 years using descriptive statistics and a line graph. The dependent variable is tax revenue, which is a continuous variable. The study uses an Ordinary Least Squares (OLS) model and multiple linear regression to represent the relationship between tax revenue and independent variables. The World Bank database was chosen as the sole source of valid secondary data, providing high-quality economic indicators.

Results: Findings reveal a strong positive correlation between GDP per capita and tax revenue, indicating that higher economic performance enhances tax collection. Conversely, the agricultural sector's contribution negatively affects tax revenue, reflecting difficulties in taxing informal agricultural income. Inflation was found to have no significant impact on tax revenue. FDI showed a weak, statistically insignificant relationship due to tax incentives, while trade openness emerged as a significant predictor of tax revenue. Political stability did not significantly influence tax collection. The variables of the study explained 85.6% of the variability in the dependent variable, indicating strength.

Conclusion: The study concludes that enhancing tax revenue in Ethiopia requires targeted fiscal policies and effective tax administration, emphasizing the importance of GDP per capita and trade openness as key determinants. Policymakers should prioritize strategies that boost GDP per capita and promote trade openness. Additionally, improving tax coverage in the agricultural sector and reviewing the effectiveness of tax incentives for FDI can strengthen revenue mobilization. These insights are valuable for policymakers seeking to improve fiscal capacity in developing countries.