Since at the end of 2016, employment income tax (PIT), rental income tax and corporate income tax has been undergone a policy reform in Ethiopia. With the tax policy reforms in 2016, the rates of direct tax bracket on average reduced by 40%. In this study, we aim to analyze the effects of direct tax reductions on macroeconomic variables, income and expenditures of the government and income distribution and welfare of households. Since a major tax policy change can have considerable impacts on the economic agents, the economic impacts of these changes should be evaluated by taking economy-wide effects into account. For this study, the researcher employed a recursive dynamic computable general equilibrium model developed by IFPRI. The impact of the direct tax reform is different among households and factors. For households, a decrease in the direct tax causes to a higher disposable incomes, especially for urban non-poor households that involve in the labor market. Benefits to rural poor households were lower; because their income is depend on subsistence farming. Due to a reduction in the import and GDP reduction relative to the baseline, households affected by the rise in consumption prices, but for rural and urban non-poor households the disposable income increment out ways the price increment and thus experiencing improvements in their consumption patterns, as a result, their welfare is improved. The reduction in the direct tax creates income variation among factors of production. The sectoral analysis shows that the manufacturing sector tended to benefit more from the reforms than other sectors. Therefore, for countries like Ethiopia, which collects tax revenue below their capacity and unable to cover all the expenditures by their own capacity; increasing the tax base is a good policy measure.