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.