Linking Taxation and Social Protection: Evidence on Redistribution and Poverty Reduction in Ethiopia

Poverty reduction, and more recently inequality, are pressing concerns in many low and middle-income countries. This is not in the least due as a result of the Sustainable Development Goals committing countries to significant improvements by 2030. In order to reach these goals, redistribution is very important and is shaped by countries’ tax and welfare systems. Despite redistribution resulting from the simultaneous effect of revenue collection and public expenditures, policies and analyses of their distributional effects have largely been undertaken from narrow and singular perspectives. In this paper, it was aimed to jointly assess the distributional effect of taxes and transfers (through social protection) using Ethiopia as a case study. It was found that currently, Ethiopia’s flagship social protection programme is more effective than income taxation in achieving poverty reduction, while neither policy achieves a sizeable reduction in overall inequality. Overall, the findings provide support for the common belief that social spending is more suitable than taxation to achieve redistribution. It was also assessed whether Ethiopia would have the capacity to achieve the desired level of redistribution by applying higher marginal rates on relatively high incomes. The results suggest that Ethiopia does not currently have the capacity to close the poverty gap, or to fully fund its main safety net programme using domestic income sources alone.