Value Added Tax and Inflation in Ethiopia: Evidence from Granger Causality Analysis

Abstract

The study investigates the causal relationship between Value added tax and inflation in Ethiopia using quarterly time-series data from 2004 to 2014. Data for this study was sourced from the National bank of Ethiopia (NBE) and the Central Statistical Agency of Ethiopia (CSA). The data is verified for unit root using the Augmented Dickey-Fuller (ADF) test and the Philips-Perron (PP) unit root test, and the result confirms that variables of the study are stationary in their first differences. The Pairwise Granger causality analysis revealed that VAT Granger causes inflation.  The result from the VECM has shown that the speed of adjustment is negative 0.4790.  This result infers that 47.9 percent of disturbances are corrected each quarter in the inflation (LOGCPI) equation. The sign of error correction term when VAT is dependent variable is negative but not significant at 5% level of significance ( -1.67359 and 0.1058, error correction term and t-probability respectively) showing only unidirectional causality running from Value added tax(VAT) to the price level in Ethiopia in long run. The coefficient of VAT from Wald coefficient restriction tests is different from zero indicating the causality from VAT to inflation in Ethiopia in the short run. This also indicates that causality running from lagged variables of Value added tax to the lagged level of price. The study concluded that there is a casual relationship between VAT and inflation in Ethiopia in both the short run and the long run during the period under investigation. The policy implication is that a very comprehensive post VAT cost-benefit analysis needs to be carried out in the process of public revenue generation. It follows that attention should be given to social welfare and communal desire alongside public income generation.

Keywords: VAT, Inflation, Granger Causality Analysis, Ethiopia

DOI: 10.7176/RJFA/11-21-03

Publication date: November 30^th 2020