Africa’s Dwindling Tax-to-GDP: A Wakeup Call For Social Contract Renewal?

In any government, the chief task of a ministry or department of finance is to envision and chart out the nation’s economic development path. The office tasked with raising the money necessary to carry out the development plans is typically the ministry of revenue.

Nonetheless, the prevailing practice across Africa, including Ethiopia, tells a different story. In many cases, both the finance and revenue ministries are primarily involved in mobilizing resources. The glaring reality of mission drift amidst thinning development finance sources was a central topic of discussion for Africans over the past week.

The 11th edition of the African Think Tank Summit opened in Addis Ababa on October 8, bringing together more than 300 think tanks, policymakers, civil society representatives, private sector leaders, and development partners from over 50 countries.

Themed ‘From Taxation to Action: Bridging Policy and Implementation in Public Financial Management (PFM) in Africa,’ the Summit delved into a topic pressing to African economies: dropping tax to GDP ratios and widening deficits in development financing. 

The three-day event was organized at the Sheraton Addis hotel by the African Capacity Building Foundation (ACBF) in partnership with the African Union Commission (AUC) and the African Leadership Excellence Academy (AFLEX). It enjoyed support from the Hewlett Foundation and the World Bank Group, hosted by Ethiopia through the Ministry of Finance, with additional partnership from AUDA-NEPAD and UNECA.

The summit echoed the disparity between tax potential and actual collections across African economies. Experts concluded that Africa is relying more on donors and credit as domestic resource mobilization wanes. The issue is clearly one that is weighing on the continent’s political leaders, as improving domestic resource mobilization has been the theme and top agenda for past AU summits as well.

“Taxation is a sign of civilization. Developed nations like the US and China depend on tax. But Africa has been relying on donors’ money and borrowing for its development financing,” said Zadig Abrha, AFLEX president, as he made his opening remarks. . 

Mamadou Biteye, executive secretary of ACBF, is also worried about Africa’s growing development finance demand and waning resource mobilization.

 “Twenty-two African economies are currently in debt distress. Debt constitutes 66.8 percent of African GDP. Africa is losing two to five percent of its GDP to climate impact. Modernizing tax systems, reforming and enforcing laws, is crucial for Africa to improve domestic resource mobilization. Investing in sustainable capacity, leveraging technology and building resilient institutions are also key,” said Biteye.

He observed that Africa’s tax system is mired in various challenges arising both from governments and the taxpayers. 

“Structural bottlenecks in Africa’s tax system also persist. The large informal sector, institutional weaknesses, narrow tax base, limited accountability, corruption and low compliance are among the outstanding factors for Africa’s low tax-to-GDP. The deficit between potential tax and actual tax collection is wide in African economies. Governments also must improve public service deliveries to improve tax. Tax is not just a necessity but also sovereignty, freedom. Tax should not be a burden, but a covenant between citizens and governments,” said Biteye.

Fikadu Tsega is a former state minister of Justice who was recently appointed to lead the Ethiopian Policy Studies Institute (PSI), a think tank that undertakes research and forwards policy inputs to government decision makers. He is also concerned about the issue.

“The success of Agenda2063 hinges on our ability and success in domestic resource mobilization. Africa is home to 30 percent of global minerals and 60 percent of arable land, among others. But Africa has the lowest tax to GDP ratio,” he said.

Fikadu notes there are a myriad of factors stemming from both the government and taxpayers that are contributing to low revenue mobilization.

“Weak administration, evasion, diversion, informal economy, mismanagement in procurement, opaque resource utilization, and political economy challenges are contributing. Public trust in governments remains limited, especially when resources are mismanaged. A robust, equitable, fair and transparent tax system is critical,” said Fikadu.

Holy Ranaivozanany, deputy executive director of the Africa-Europe Foundation (AEF), warned that African economies can no longer count on external sources of finance given the ongoing upheavals in the global order.

“A paradigm shift is a must at this uncertain time, from a donor mindset to co-investment and self-sufficiency,” said Ranaivozanany.

Aynalem Nigussie, minister of Revenue, shares the concerns.

“Policy on its own is insufficient. Institutional capacity and political commitment matters. Robust and sustainable public finance management [PFM] matters. Tax must reflect in public service delivery, public development, and poverty reduction. Broadening the tax base and strengthening the social contract between citizens and government is critical. Robust PFM is key for Africa’s sovereignty. In the past six years, Ethiopia has registered significant tax revenue by introducing tax reforms under the overarching HGER. Debt management also improved. More tax revisions are underway,” said Aynalem.

While most speakers at the event, especially those representing governments, pushed for increased taxation, other experts have their reservations, warning that a blind push towards more tax revenue can have dire consequences.

Prof. Njuguna Ndung’u, senior advisor at the Trade and Development Bank Group, is one of the latter. Hailed as the architect of Kenya’s economy, Ndung’u is also  involved with major organizations like UNECA and AfDB, among others.

“The big question in Africa’s development is how to finance infrastructure. For the private sector, financing infrastructure is unfeasible because of its low profit. So, taxation must improve so that governments finance infrastructure. To do this, tax optimization is crucial. The problem is, when taxation distorts markets. When taxation increases, it distorts markets and goods start flowing to the informal market. Domestic debt is also not an option for African governments. It only crowds out the private sector. Instead, African governments should devise ways to involve financial institutions in domestic resource mobilization. This creates crowding-in, which is good. More taxation will also lead citizens to suffer,” he said.

Ndung’u sees public-private partnership (PPP) as the ideal solution.

“The private sector has capital, and technology. But the private sector is very cautious when it comes to time and returns. African economies also need to eye taxing the digital era economy. Digital ID is just the first step,” said the expert.

However, people with experience in tax administration say the work is easier said than done.

“Macro-stability and economic transformation are the two most difficult challenges of African economies. There are many challenges to tax reform. Structural adjustment is difficult. Most ministries of finance in Africa are busy with mobilizing resources. They are hardly working on economic development, and solving development challenges. They are not crafting strategic visions. Formalizing the informal sectors is also a challenge. In general, things are improving in Africa, but not sufficient,” says Hakim Ben Hammouda, former Tunisian minister of Finance and president of Global Institute 4 Transitions (GI4T).

Ndung’u says that high tax rates are unlikely to generate high tax revenue.

“Optimizing all tax instruments is crucial. African economies are struggling with a tax-to-GDP ratio stagnating at around 17 percent on average. Structural issues matter. Economies must be vibrant to increase tax collections. Otherwise, recession also bites. Can taxation incentivize tax collection? Yes, but if tax instruments are optimized. Digitization, open up, expanding tax base, reform, and levying reasonable tax rates are crucial to optimize tax tools,” said the expert.

Dr. Christiane Abou-Lehaf, head of international cooperation at Afrexim Bank, has a different opinion. During the summit this week, she argued that the government’s tax ambitions cannot succeed without fairly involving the private sector and improving the service side for the taxpayer.

“For instance in this summit, private sector representatives and also local financial institutions should have been participating,” she observed.

Other experts also argue that the public, particularly those in the tax net, are being overtaxed and warn of deepening poverty and discouraging businesses for the sake of collecting more taxes. Scholars also argue that there is no ‘huge uncollected tax potential in the economy’ as governments and policy makers claim. They note that the more the public and businesses lose trust in governments, the less tax comes to government coffers, calling for fundamental renewals of social contract terms.

Where Does Ethiopia Fit?

Ethiopia is home to one of the lowest tax-to-GDP ratios in the world, lower than the 17 percent and 22 percent average for Africa and globally, respectively. However, this is at odds with the country’s fast growing tax collection.

In terms of data, Ethiopia’s tax-to-GDP ratio went up to 12.4 percent in 2015, before nosediving to 7.5 percent in 2023, according to a detailed document released by the Ministry of Finance last August. The document is dubbed ‘Ethiopia’s tax-to-GDP ratio: Benchmark estimation and performance analysis.’

“This means that 7.5 Birr out of every 100 Birr earned in Ethiopia were collected by the government in the form of tax. This was less than other sub-Saharan African (SSA) countries. In the same year, Uganda’s tax-to-GDP ratio was 13.1 percent, Kenya’s was 15.2 percent, and Rwanda’s was 15.7 percent. The median of all other SSA countries was 13.2 percent (in 2021). Ethiopia collects substantially less than other SSA countries in direct taxes, VAT and excise duties,” states the document.

But in real terms, Ethiopia’s actual tax collection has grown substantially. In the 2024/25 fiscal year, the government collected 700 billion Birr in tax revenue. Under Aynalem, the Ministry of Revenue targets the one trillion Birr milestone in the current fiscal year.

Despite the growth, tax revenue is far from enough to cover the ballooning federal budget, which this year is nearly two trillion Birr (USD 14.6 billion). The government is largely relying on domestic debts, treasury bills (T-bills), government bonds, and non-concessional loans to fill the budget deficit. Approximately two-thirds of the budget deficit (416.8 billion Birr) is expected to be financed through domestic sources, primarily via T-bills.

The Finance Ministry’s analysis attributes the dwindling tax-to-GDP ratio to low GDP per capita, high share of agriculture in GDP, low share of urbanization, low urbanization rate, uncollected excises and VAT on fuel, absence of excises on airtime data on financial transactions, and low VAT rate, among others.

The low revenues have led the government to introduce a barrage of new tax instruments and also raise rates on existing tax lines over the past year.

The northern war also had a substantial effect on tax collection, according to the Ministry. In 2019/20, tax collection by the Tigray regional administration accounted for 0.16 percent of Ethiopia’s GDP. This figure fell by more than half during the first year of conflict, and then again to 0.04 percent in 2021/22, according to the Ministry.

Tax revenues in neighboring regions, which were also affected by the war, also fell. In Afar, collection fell from 0.04 percent of GDP in 2020/21 to 0.01 percent by 2023. In Amhara, it dropped from 0.4 percent of GDP to 0.36.

The analysis also notes that large taxpaying entities in Tigray, such as EFFORT, had all but stopped paying taxes by 2022.

“As there are likely many other companies outside the EFFORT portfolio that were exposed to the Tigrayan conflict, looking at the EFFORT group gives us a lower-bound estimate of the true impact of the conflict on companies based outside Tigray that have operations in Tigray,” it reads.

The Ministry also proposes that Ethiopia’s low tax-to-GDP ratio could stem from inflated GDP figures.

“A final possible reason for a low tax-to-GDP ratio is that GDP – the denominator – is overstated. For instance, if GDP was in fact 10 percent lower than officially measured, the true tax-to-GDP ratio in 2022/23 would be 8.3 percent rather than the official 7.5 percent. If GDP had become increasingly overstated in recent years – in other words, if GDP growth had been overstated – this could also explain (part of) the decline in the tax-to-GDP ratio,” it reads.

There are many reasons why GDP or GDP growth may have been overstated, reads MoF document.

The process of GDP measurement is difficult in a country with a large agricultural sector and a large informal sector, so GDP growth may simply have been inaccurately measured, according to the analysis.

More problematically, there may have been political pressure to make statistical choices that boosted measured GDP, or outright data manipulation, it notes.

Tax officials collected 165 billion Birr in 2014/15. This jumped to 636 billion Birr in 2022/23. During this period, GDP surged from 1.3 trillion Birr to 8.7 trillion Birr.