Inequality indices are calculated for each income category to assess the redistributive effect of taxes and transfers. Inequality is measured using the Theil index, since the index provides the advantage of additive decomposability, i.e., aggregate inequality can be decomposed into 1 <u>i i</u> inequality within- and between- sample subgroups. Theil index, = ∑ l , where � � NN QQ QQ is the Theil index of the income _Q_ , is the income of individual QQ _i_ , is the average income ii=1 _Q_ QQ, TT NN QQ<sup>�</sup> QQ<sup>�</sup> TT and _N_ is the sample size. The index varies from 0, perfect equality, to ln( _N_ ), perfect inequality. ii h Total inequality is the sum of within-gender inequality: QQ = ∑ QQ<sup>�</sup> , and between-gender ∑ 2 <u>g</u> = <u>j</u> ww gg=1 gg gg inequality, = ∑ , where NNgg is gender g’s income share of total income, TT SS TT �l �SS ~~�~~ � ∑ j=1 QQjj <u>g</u> is the share of the gender g’s population of the total population (Andrei et al. 2017). TTbb gg=1 SSgg PPgg SSgg NNii=1 QQii NN gg= PP **3.** NN **Data and Assumptions**

# **3. Data and Assumptions**

## **3.1. Data**

The primary source of data for the study is the 2018/19 Ethiopia Socioeconomic Survey (ESS). Basic demographic characteristics, health care utilization, school enrollment status, and labor market outcomes are available at the individual level. Others, such as consumption expenditure, other income, property taxes, business taxes, land use fee and agricultural income tax, were captured for households.

The detailed consumption module allows us to use consumption spending as a proxy for disposable income, from which market income is computed through backward calculation by adding taxes and deducting transfers. Consumption data are also used to estimate indirect (VAT and excise) taxes. To estimate the indirect effects of indirect taxes, we use the 2015/16 social accounting matrix (SAM) input-output table (Mengistu et al. 2019). For this purpose, consumption item data from the ESS is combined with tax schedules from the Ethiopian Revenue and Customs Authority with sectors in the input-output matrix (Annex 4).

In addition to survey data, we use the following administrative information: (1) national public revenue and expenditure data for the 2018/19 fiscal year, and regional education and health spending from the national income and public finance accounts of the Ministry of Finance; (2) enrollment information from the Ministry of Education; and (3) government subsidies for kerosene from the Ethiopian Petroleum Supply Enterprise and wheat from the Ethiopian Trading Businesses Corporation.

## **3.2. Assumptions**

One of the assumptions in this study is about direct taxes. Though direct taxes are borne entirely by the income earner, we assume that these taxes have an effect on the welfare of all household members, who share the burden of these taxes. Employment income tax is computed from the estimated monthly chargeable wage using official tax rates for earnings over birr 600 per month, the threshold for paying taxes (Annex 4). This simulation assumes that all eligible taxpayers do pay taxes. Though firms also pay indirect taxes, we assume that these taxes are borne 100 percent by consumers regardless of the market structure. We also assume that all eligible taxpayers in fact pay the taxes, which may not necessarily be the case.

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