Understanding the interaction between tax revenue performance, the shadow economy, and economic growth is critical for sustainable development in Ethiopia. This study investigates the nexus among tax revenue performance, the shadow economy, and economic growth in Ethiopia over the period 1983 2024 using Vector Error Correction Models (VECM), Dynamic ARDL bounds testing, and Partial Least Squares Structural Equation Modeling (PLS SEM). The analysis focuses on four interrelated ob jectives: (i) identifying the determinants of tax revenue performance, (ii) examining the growth effects of the shadow economy, (iii) analyzing the drivers behind the relative size of the shadow economy , and ( evaluating the conditional role of
taxation in shaping economic growth outcomes. The findings on the determinants of tax revenue performance reveal that GDP per capita exerts a positive but statistically insignificant effect in the short run, consistent with the concept of tax buoyancy, whereby inc reases in income do not immediately translate into higher tax revenue. In the long run, however, GDP per capita positively and significantly affects tax revenue performance (approximately +0.25%), supporting Wagner’s Law, which posits that economic develop ment expands the fiscal capacity of the state. Tax burden reduces compliance and revenue performance in the short run, but its long run positive effect (+0.29%) suggests the presence of a fiscal adjustment mechanism consistent with Laffer Curve intuition. Foreign direct investment (FDI) shows no immediate contribution to tax revenue, yet generates significant long run gains (+0.72%), reflecting the predictions of Endogenous Growth Theory regarding capital accumulation and productivity spillovers. Sectoral c omposition also critically shapes fiscal outcomes. Agricultural value added negatively and significantly affects tax revenue in both the short and long run, reflecting the hard to tax nature of agriculture and the gradual process of structural transformati on toward more taxable sectors. Industrial value added exhibits weak short run effects but a strong negative long run effect (−1.10%), which may indicate excessive tax incentives, profit shifting, tax avoidance practices, or weak industrial tax administrat ion. The shadow economy has no significant direct short run effect on tax performance, although indirect channels, particularly through FDI, appear relevant.
- Quote paper
- Cherinet Bariso (Author), 2026, Tax Revenue Performance, Shadow Economy and Growth of Ethiopia, Munich, GRIN Verlag, https://www.grin.com/document/1737318
