@article {10.34196/ijm.00310,
article_type = {journal},
title = {Economy-Wide Effect of Fiscal Drag in Ethiopia},
author = {Shahir, Adnan Abdulaziz and Figari, Francesco and Feleke, Solomon Tsehay},
volume = 18,
number = 1,
year = 2025,
month = {feb},
pub_date = {2025-02-14},
pages = {33-55},
citation = {IJM 2025;18(1):33-55},
doi = {10.34196/ijm.00310},
url = {https://doi.org/10.34196/ijm.00310},
abstract = {This study evaluates the economy-wide effect of fiscal drag in Ethiopia, focusing on household consumption expenditure and income. Drawing on a prior study that used the ETMOD tax-benefit micro-simulation model and assessed the effect of fiscal drag on income distribution and work incentives, this study uses a static CGE model. The simulation introduces a 9.1 percent increase in the average income tax rate due to the failure of the tax system to update the monetary tax parameters for inflation. The study allows for unemployment in agricultural labor, and four critical conclusions are drawn from the empirical investigation. First, fiscal drag reduces consumption expenditure by urban non-poor households but fosters consumption outlays by the urban poor, rural poor, and rural non-poor households due to a fall in saving that outweighs the negative impact due to the increase in the income tax rate for the three household categories. Second, an inflation-driven increase in income tax rates decreases disposable income for urban households while increasing the disposable income of rural counterparts who face higher prices of their factors of production. Third, fiscal drag slightly increases economic growth, household consumption, and export but reduces imports. Fourth, the upsurge in revenue from direct tax due to fiscal drag more than offsets the fall in government revenue from indirect taxes mainly due to the reduction of consumption of the urban non-poor households.},
keywords = {Fiscal drag, Income tax, Macroeconomy, Ethiopia},
journal = {IJM},
issn = {1747-5864},
publisher = {International Journal of Microsimulation},
}