The Impact of Fiscal Policy on Poverty in Ethiopia: A Computable General Equilibrium Microsimulation Analysis

Abstract

Ethiopia has implemented various fiscal policy reforms in the past decade. Most of these reforms center on indirect taxes and pro-poor expenditure patterns. This study investigates the economy-wide impacts of these fiscal policy changes on poverty. To this effect, the study used a static computable general equilibrium (CGE) model linked to a microsimulation (MS) model. The CGE model used the 2005/06 social accounting matrix (SAM) and the MS model used the 2004/05 Household Income, Consumption and Expenditure (HICE) survey to investigate household poverty by way of the consumption expenditure changes from the CGE model. The fiscal policies simulated are domestic indirect taxes, government consumption expenditures, and government transfers to households. The findings of the study suggest that the increase in revenue from indirect taxes has worsened the poverty state of households. The results from the CGE model have all shown decline in real GDP, sectoral output, employment and welfare. In contrast, the study found improvements in the poverty state of households as a result of the introduction of various short-run expenditure measures. However, examination of the net effect revealed worsening poverty at the national level in general and for rural households in particular. On the other hand, poverty tended to decline among urban households. The major conclusion is that the tax policy has dominant adverse effect on poverty in the short-run. Thus, policy makers need to take into account these adverse effects and come up with pro-poor spending policies that would protect households from the negative strains while the financing policies go along.

Keywords: Fiscal policy, poverty, indirect taxes, government consumption expenditure, government transfers, social accounting matrix, computable general equilibrium, household income, consumption and expenditure survey, microsimulation

JEL Classification: H30, H53, I32