Factors Influencing Tax Revenue in Ethiopia (Co-integration approach)

Abstract

The government capacity to mobilize domestic resources is a crucial factor in the courses of poverty reduction and its overall economic development. Ethiopia's actual tax revenue as a share of GDP is low which has been a problem for the economic development. The main objective of this study is to empirically examine the factors influencing tax revenue in Ethiopia for the period ranging from 1981 to 2016, using Auto Regressive Distributed Lag (ARDL) approach to co-integration. A set of factors that can potentially influence tax revenues such as GDP per capita income, industry value added share of GDP, agricultural value added share of GDP, trade openness, inflation rate; exchange rate and urbanization rate are considered in the econometric analysis. The result revealed that in the long run real GDP per capita income and exchange rate positively and significantly affect tax revenue for the period selected for this study. However, inflation exerted a negative and significant influence on tax revenue. Whereas, in the short run Real GDP per capita income and urbanization rate have negative effect, whereas agricultural value added share of GDP and exchange rate have positive effect on tax revenue in Ethiopia. The sign of real gross domestic product per capita income and agricultural value added share of GDP are contrary to the priori expectation in the short run. Furthermore, the coefficients of the lagged error correction model (ECM (-1)) is significant and negative as expected, which imply the existence of economic or government forces that restore the long run equilibrium from short run shocks. Finally, the study recommends measures such as controlling the informal sector in the industry through effective administration; assessing the tax incentives procedures to large enterprises (industries) along with the degree of tax evasion; effectively regulating the macroeconomic situation of the country; improving the capability of tax authority in terms of competency of man power and infrastructure in tax system; and creating awareness on the importance of tax revenue for the development of a country.