Value Added Tax and Fiscal Federalism in Ethiopia
| Date | 01 May 2020 |
| Pages | 147-170 |
| Published date | 01 May 2020 |
| DOI | 10.3366/ajicl.2020.0308 |
Modern nation states, particularly in Africa, often include a variety of cultural, ethnic or tribal groups, with differences commonly accommodated by a federal structure which provides a national government to represent all groups and subordinate jurisdictions that roughly align with the locations of the various groups found in the federation. Whether residual powers lie with the central government or subordinate governments under the constitution, in the modern political state the
In Ethiopia, as in many developing countries, the most important source of government revenue is a value added tax (VAT). In Ethiopia's case, the constitutional power to enact a VAT sits solely with the central government, an assignment that aligns with the traditional public finance consensus that it is highly undesirable to have separate VATs enacted by subnational governments or have central and subordinate governments share responsibility for collecting VAT. A somewhat more nuanced view in the case of advanced economies has emerged following the adoption of a VAT in Canada with what are in effect provincial surcharges built on the national VAT and, in the case of one province, a separate locally administered VAT, though the underlying consensus in favour of a single national VAT remains intact, particularly in the case of developing and transitional jurisdictions.
While a single VAT levied by a federal government with some portion of revenue collected by the central government distributed to subnational regional governments is not uncommon, there are many variations in the basis for distribution of the portion flowing to subordinate governments. All of the goods and services tax (GST, as VAT is called in many Anglo jurisdictions outside the UK) collected by the central government in Australia is distributed to subnational states on the basis of a fiscal equalisation formula. A different equalisation formula is used by the federal government in Germany to distribute a portion of its VAT revenues to subnational states. China levies a single national VAT but distributes half of the tax to provinces on the basis of the locations from which supplies are made. The member states of the European Union (EU) levy separate VATs, subject to conformity with an EU law (the VAT Directive), with VAT revenues for cross-border sales redistributed to the final place of consumption. Many Canadian provinces impose a surcharge on the federal GST that is collected by the federal government and distributed on the basis of place of consumption.
The Ethiopian VAT is unique in three respects. The first is the division of VAT administration responsibilities between the federal government and regional governments on the basis of the legal form of a business. The administration of VAT in respect of unincorporated businesses, usually referred to as individual traders in Ethiopia, is assigned to regional governments while the federal government retains responsibility for administering the VAT payable by private companies. The second unique feature is the allocation of VAT revenues on the basis of the legal form of a business, with VAT paid by individual traders assigned to regional governments and VAT paid by private companies divided between the federal and regional governments. The third feature is the allocation to state governments of all VAT collected from individual traders and a share of VAT paid by private companies on the basis of the place at which businesses are registered for tax purposes.
The arrangements raise questions ranging from their constitutional validity through to the administration and compliance costs of the system and, most significantly, the impact the rules have on fiscal federalism, particularly the implicit subsidy of wealthier states by poorer states on cross-border business-to-business sales. While there has been recognition in several quarters that the current system is problematic, there has been little consideration of reform options that can address these issues within the current legal, political and economic frameworks. These issues are considered below.
The Ethiopian Constitution, adopted in 1994 with effect from 1995, establishes the country as a federation of nine regional states established on ethnic lines
The federal government collects the lion's share – three-quarters – of all tax revenue, with almost half the remaining tax revenue collected by the federally chartered capital city Addis Ababa.
The emergence of VAT as the important revenue source in Ethiopia is a phenomenon replicated in many developing and transitional countries. The VAT was first mooted in theoretical terms in the early part of the twentieth century, proposed independently by a leading American economist
While the design was conceptually attractive to public finance scholars, neither proposal gained immediate traction, with theoretical models largely ignored during the depression and world war that followed. The idea was revived in Europe in the postwar period as the continent struggled with postwar reconstruction. The principal business tax in Europe was a turnover tax, imposed on all sales by businesses. Because business customers were unable to recover the tax included in the cost of their inputs, the turnover tax became a compounding tax, encouraging vertical integration of enterprises to avoid tax along the supply chain. The vertical integration discouraged economically efficient specialisation. Cross-border transactions were particularly problematic, with tax imposed in the seller's country and again in the customer's jurisdiction.
The French were the first to consider VAT as a solution to address the turnover tax problems of compounding along the supply chain and double taxation on cross-border sales, experimenting with a limited VAT in the mid-1950s.
Since that time, the tax has become the predominant indirect tax on sales of goods and services, with its adoption in less developed nations largely a consequence of the influence of international organisations, particularly the World Bank and International Monetary Fund.
Evidence to date suggests the shift from a sales tax to VAT has had only a small effect in terms of the weighting of the taxes relative to the total of all taxes and as a percentage of the country's GDP.
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