Fiscal Policy for Promoting Economic Growth in Ethiopia

Introduction

The functions of government are well-known and are vital for the survival and progress of human populations who have historically occupied parts of the world as organized societies in the shape of globally recognized countries. Ethiopia is one such long-recognized country although over the last twenty-eight years its government has been one that is constitutionally working to carve it up into ethnically independent and sovereign countries, to no avail so far, however.

The government is still toying with the failed policy of fiscal decentralization which is supposed to match the constitutionally mandated ethnic territorial decentralization and eventual disintegration. It is a classic case of sheer political obstinacy and stupidity in the face of obvious and disastrous failure in the form of fratricidal internal conflicts, evictions, displacements and massive emigration.

Although the bantustanized ethnic enclaves do have the power to tax their captive populations and collect revenue thereon, the bulk of the tax revenue is collected by the so-called federal government which then allocates it essentially on the basis of population size. Such major budget allocations are strangely termed as fiscal subsidies despite the fact that they actually make up the preponderant part of the regional budgets. The total annual government budget has in recent years exceeded 340 billion birr although implementation rates, a strictly kept state secret, are believed never to have surpassed the 50-60 percent mark.

Ethiopia’s government organization is characterized by weak or weakened and inefficient institutions which are manned by incompetent and largely corrupt officials and personnel. Several superfluous government institutions exist whereas essential ones are absent. Hence, duplication of effort, waste, corruption and red tape are common manifestations of the essentially dysfunctional government organization and personnel in Ethiopia.

The annual federal budget of the country is issued as a public proclamation in the official Negarit Gazette, but budget expenditures are said to have never matched actual expenditures as they are often changed and chopped by the powers that be to suit changing political expediencies. Hence, for example, the expenditure for the military, security services, palace administration, etc. may sometimes be twice as much as or more than the budgeted amounts. Likewise, certain favored regional administrations may receive substantially more than what is formally budgeted for them. Major budgetary expenditures include the so-called regional subsidies, general administration, defense, security services, education, health, agriculture, etc. The budget has two major components, namely recurrent and capital. The capital budget comprises funds mobilized not only from domestic sources (taxes) but also from external sources, mainly from grants and loans.

It is within this overall government budget context that we are herebelow trying to assess the nature of fiscal policy in Ethiopia, if at all it exists in any shape or form.

What is Fiscal Policy

Fiscal policy is a government budget policy which aims to influence positively trends in overall economic growth, employment, investment, inflation, etc. through fiscal policy instruments such as government spending, taxation, tax incentives, etc. Fiscal policy may be expansionary or contractionary, adopting spending increases in the former case and spending decreases in the latter case. Spending increases may be effected though spending existing surpluses, widening fiscal deficits, increasing taxation, selling government securities to raise liquidity, etc. whereas spending decreases may be realized through a reversal of these fiscal operations. Fiscal policy may also be characterized as discretionary and non-discretionary depending on whether the policy measures are conscious ones like tax increases or increased government borrowing or automatic ones such as those which automatically occur from, for example, economic growth such as increased revenue from higher incomes without any changes in tax rates.

Does Ethiopia Have any Fiscal Policy to Speak of?

Let us first try to characterize the nature of the Ethiopian government budget before answering that crucial question. First, it is significantly dependent on foreign grants and loans. Second, internal borrowing to finance fiscal deficits proper and government development projects is massive. Third, progressive taxation is the norm and marginal tax rates do not exceed 35 percent. Fourth, the overall tax rates (tax effort) officially estimated at below 12 percent, is said to be below the African average of over 20 percent. Fifth, official tax assessment (on the basis of what is known as presumptive taxation) is reported to be highly arbitrary. Sixth, the quality of government expenditure is generally believed to be appalling. Seventh, corruption is systemic. Eighth, the relatively recently introduced VAT (Value Added Tax) apart from the rate of 15 percent being high, is applied wrongly on cumulative rather than added value, with an enormous cascading impact. Ninth, revenue collection and budget implementation rates are generally low.

Going back to the question we raised earlier on, there is very little in all this to indicate any kind of conscious fiscal policy. If anything, fiscal policy in Ethiopia, if there is one to speak of, has over the years been a major cause of high domestic inflation, currency depreciation, far less economic growth and employment than the official spin doctors would have believe, generalized waste, value subtraction

 Civil servants are generally incompetent, poorly paid and poorly motivated.

I have personally never heard a minister of finance of any period speak in normal public finance terms, but whether the present one realizes or not, the fiscal policy stance in recent years, as indeed has always been the case, has been expansionary both in terms of the extent of domestic borrowing and in terms of external indebtedness. Domestic bank borrowing of the government from the National Bank of Ethiopia, the country’s central bank, to finance budgetary deficits as well as from mainly government-owned banks, particularly the CBE, have in total ballooned to excessive levels, the CBE alone believed to be carrying a loan portfolio of 500 billion birr extended to government development agencies such as EEPCO and Tele on government loan guarantees. Similarly, direct advances and lending to the government through treasury bills and bonds from the NBE and other banks are reported to be massive without any reliable degree of certainty as to their repayment with interest.

The government external debt situation has shown a similar trend, the outstanding current amount having been estimated to be anywhere between 25-30 billion USD, a record level by historical standards. Repayment of government debt both domestic and external (of course, with interest) has been a perennial problem indicating the poor and deteriorating quality of government expenditure. Public expenditure judged by the measure of “value of money” has been an unmitigated failure! The NBE is typically tight-lipped and economical with its words when it comes to disclosing the government’s outstanding domestic debt and its annual fiscal deficit financing operations. Be that as it may, independent analysts are now broadly in agreement that the major source of domestic inflationary pressures is domestic monetary expansion via NBE and CBE direct and indirect lending to the government.

Just a Penny!

CNN’s versatile anchor Richard Quest in a financial ad says “Just a penny! It all begins with a humble penny, and it is not how many you have but what you do with them!” Richard says this in response to a lady who has just dropped a penny and refuses to stoop to pick it up. Ethiopia’s annual government budget of about 340 billion birr or roughly about 11 billion USD is a penny compared to the US Federal Government’s annual budget of nearly 5 trillion USD (a mere 0.00002 percent)! But it is not the small amount that has mattered but the relatively little we have been able to do with it.

As hinted above, the quality of government expenditure as measured by the “value for money” yardstick has been appalling. A lot of it has been frittered away on development projects of highly dubious feasibility, profitability and benefit. A lot more has been gobbled up by sheer waste, value subtraction and outright corruption. Personnel incompetence and institutional weaknesses have also vitiated against the quality of government expenditure. The final outcomes have obviously been disappointing to say the least. Excessive government domestic borrowing has resulted in income–eroding inflation (especially as regards fixed income earners) and unstoppable currency depreciation and foreign exchange reserve depletion. On the other hand, external indebtedness, which is ultimately supposed to enhance the foreign exchange earning capacity of the country, seems to have had the opposite outcome causing the country to teeter on the brink of external debt default.

The Way Forward

Taxation with representation

 is a recently and important component of the social contract between the electorate and the government, but it is also important for the government to strictly adhere to the time-honored canons of taxation including the ability to pay, certainty of payment, economy of tax collection, convenience, simplicity, etc. Any polity is ready and willing to pay taxes the revenue from which is spent in such a way as to yield tangible benefits for the society in question. Hence, tax revenue well spent on building a strong and efficient national defense structure is usually fully embraced by the electorate. Government infrastructure projects of concrete benefit to the public at large are also a welcome expenditure category. Specific education and health taxes help to materially subsidize public education and health expenses are also greatly favored.

Hence, it is necessary in Ethiopia to formulate a formal and transparent fiscal policy that will demonstrably promote rapid economic growth, investment (particularly private investment), employment, export growth and generally foreign exchange earnings, equitable income distribution on a merit basis. Arbitrary tax assessment should be avoided. Reasonable taxes should not be evaded nor even be avoided. Superfluous government institutions should be closed down or merged with already existing institutions which provide similar functions. Patently incompetent employees should be phased out into retirement. Government officials should be recruited and appointed purely on the basis of qualifications, special individual merit, proven track-record or work experience, integrity, etc., but they should be adequately remunerated.

To this end, the following major recommendations may be forwarded:

• Effect further organizational reform particularly in the Ministry of Finance and Economic Cooperation
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• (MoFEC) and Customs and Inland Revenue Authorities;
• • Appoint a highly qualified minister of finance and his deputies who are well-versed in public finance and fiscal policy formulation and implementation;
• • Establish a fiscal policy department within the Ministry of Finance and Economic Cooperation responsible for the collection, tabulation, serialization, analysis, etc. of public finance figures and statistics and making projections based on them in order to formulate a national fiscal policy consistent with the country’s macroeconomic policy, particularly with monetary policy;
• • Systematize and streamline the country’s tax code on the basis of the time-honored canons of taxation;
• • Set up within MoFEC a “value for money” watchdog department to control the overall quality of productivity and efficiency of government expenditure, both on the recurrent and capital accounts;
• • Lift VAT on food and other basic items and services and reduce the VAT from the current 15 percent to 7 percent;
• • Introduce special education and health taxes of 2 percent each specifically for the improvement of the quality of education and health services;
• • Lift and forgive the annual 50 birr TV tax and arrears; and
• • Set up external and internal public debt sustainability assessment units within the MoFEC;
• Fiscal policy in competent hands is a fascinating and rewarding instrument for promoting overall economic growth, employment and financial stability and sustainability. We should do away with the backward practice of operating the fisc by whim and start handling it with the modern and ingenious techniques and mechanics of fiscal policy!

The Ethiopian Herald June 9, 2019

 BY TEKLEBIRHAN GEBREMICAHEL