Managing Ethiopian Cities II: Informality in Ethiopia: Taxing the Hard to Tax

Large informal (hard to tax) sectors are an integral part of the economies of developing countries (Ethiopia included). In much of Africa, the informal, or gray economy that escapes tax collectors and government regulators, is the hidden dynamic driving economic growth. The informal economy is an important contributor to employment and production in Ethiopia but also to fiscal and regulatory evasion and, as such, is an intensely debated issue. Informality has a direct impact on public revenues and expenditure. If it is large and growing over time, policy must attempt to bring it more fully into the tax-base and/or attempt to contain its growth. Possible policy-measures will depend on the causes of its growth. If it is growing because of restrictions on entry into formal activity, then policy must address these restrictions. If, on the other hand, it is growing because of too many taxes, then policy must address the structure of taxation. Addressing these causes may transform informal into formal activity. Important questions to answer in terms of policy are: to what extent the informal sector should be taxed, and what instruments can be used to efficiently and effectively accomplish the task. All over the world several governments (including Ethiopia) have relied in the recent past, and still even rely today, on various forms of presumptive taxation, to respond to the high levels of informality. Existing presumptive tax regimes have seldom been examined thoroughly. This paper looks at the issue of presumptive taxation in the Ethiopian context and reflects on how efficient and effective the use of presumptive taxation has been. This paper argues that it is difficult to evaluate the success of special tax regimes (presumptive taxation in this case) to achieve their goals, whether those goals are increased participation in the formal tax system, obtaining some basic level of revenue from all economic agents, educating new taxpayers, or reducing compliance costs for at-risk taxpayers.