The Impact of Tax Incentives on Sectoral Economic Growth in Ethiopia

Abstract

In order to stimulate economic growth, tax concessions have been used as the main strategy for
attracting both domestic and foreign investment resources in Ethiopia. On the other hand, tax
incentives offered by governments reflected negative results or a loss of government revenue and
were persistently criticized as economically inefficient and leading to the misallocation of public
funds. This study, therefore, examines the impact of tax incentives on economic growth
performance in Ethiopia. The study employs a robust panel data model for 10 subsectors over the
period 2004–2015. To control cross-sectional dependence, heteroskedasticity, and
autocorrelation, the study also adopts a cross-sectional time-series Feasible General Least Square
estimator and the cross-sectional dependence-consistent Driscoll-Kraay estimator. The main
findings of the study indicate that an increase in tax incentives is a statistically significant variable
and fosters the growth performance of the country. The study, therefore, suggests that the
government of Ethiopia has to strengthen the provision of tax incentives for economic activities.
But they must be carefully designed and well administered so as to avoid side effects that diminish
productivity by distorting resource allocation, sustaining inefficient or unsustainable activities,
and losing revenue needed for other components of the productivity packages. The study also
suggests that the government of Ethiopia has to devise a mechanism for enhancing the
effectiveness and efficiency of foreign resources, otherwise it will aggravate capital outflow and
increase the cost of the domestic economy.