The underground economy and tax Evasion in Ethiopia: Implications for tax policy

The underground economy and tax Evasion in Ethiopia: Implications for tax policy

While knowing the size and evolution of the underground economy is important for policy making, its very nature makes anyone very skeptical of any attempt to measure its magnitude. With booming literature on methodological issues and measurement attempts for the last three decades, the skepticism is becoming less daunting. However, research on the underground economy in Ethiopia is still scanty. Hence, this paper intends to estimate the size of the informal or underground economy in Ethiopia thereby bridging the literature gap and assisting policy makers in designing appropriate public policy by revealing the magnitude of the sector. To this end, a monetary approach was adopted. The finding of the study suggests that there is a significant amount of economic activity (  36% of the recorded economy) that is not reported and captured by the official statistics. The amount of tax evasion reached 10% of the economy. The result has important implication for tax policy (increasing the tax rate versus the tax base) and incentive structure towards the small and medium scale enterprises if these sectors are to be the deriving engines of Ethiopia’s transformation.