Tax Revenue Potential and Effort in Ethiopia: Evidence from Stochastic Frontier Analysis

Abstract

This study aims to estimate the actual tax effort and tax revenue potential of the country, measuring the gap between realized performance and the stochastic tax frontier, as well as between income and consumption using utility maximization function. The results from the stochastic tax frontier model have been compared with the utility maximization function as a robustness check. Very close values for tax effort, tax potential, and tax gap are recorded under each model. The estimated tax potential, effort, and gap from the two methods are found to be 22.89 percent, 23.69 percent, 36 percent, 34 percent 14.37 percent, and 15.58 percent, respectively. The empirical results revealed that Ethiopia is characterized by a huge tax gap and low tax effort, mainly resulting from the country’s policy choice and enforcement mechanisms.