Why do we have taxes? The simple answer is that taxation is the only practical
means of raising the revenue to finance government spending on the goods and
services that most of us demand. However, setting up an efficient and fair tax
system is far from simple, particularly for developing country like ours, which
wants to become fully integrated in the international economy. The ideal tax
in Kenya is one which should raise essential tax revenue without discouraging
economic activity and without deviating too much from tax systems in other countries.
This is the task that Honourable Kimunya is faced with, as he prepares to deliver
his second budget in this election year.
Kenya like most other developing countries faces a formidable challenge in
its continuing attempts to establish an efficient and fair tax system. Most
workers in the country are employed in agriculture or in small, informal enterprises.
As a result they are seldom paid a regular, fixed wage. Their earnings fluctuate,
and many are paid in cash, "off the books." It is for this reason
that the base for an income tax is hard to determine in Kenya.
Also a larger part of the economy is informal. This prevents policymakers from
assessing the potential impact major changes to the tax the system may have
on businesses and wananchi. As a result, marginal changes in taxation such as
collecting tax at source are often preferred over major tax structural changes
and reforms, even when the latter are clearly preferable. This perpetuates inefficient
tax structures, and increases the cost of compliance to taxpayers.
What level of public spending should the Minister budget for? This will influence
the amount of tax revenue the Government will need to raise. What is the appropriate
proportion of the total national income for the Government to spend, a third,
a half? Only when this question has been answered can the question of the amount
of tax the Government needs to collect for the next financial year be settled.
This will set the tax level in the budget. Determining the optimal tax level
is conceptually equivalent to determining the optimal level of government spending.
The most recent data show that the tax revenue in Kenya is about 22% of GDP.
This level is higher than the average for Sub Saharan Africa which is about
18%. However it is less than that of the major industrialized countries (members
of the Organization for Economic Cooperation and Development or OECD) whose
average is about 38% of GDP.
By determining the level of Government spending, the Minister will se the amount
of tax he needs to raise to finance the Government’s expenditure. He will
also have to decide in his budget, how the revenue is to be raised. This is
where the tax rates and composition of the tax revenue comes in.
Should the Minister tax income, or tax expenditure, or both? There is no simple
answer to this question, especially given the conflicting theories with respect
to the ideal composition of tax revenue. These theories revolve around the impact
of taxation of income relative to taxation of consumption and, in the case of
consumption, the taxation of imports versus the taxation of domestic consumption.
In deciding on which options to go for, the Minister will have to consider issues
of efficiency and equity of his proposed tax measures. With regards to efficiency,
the Minister will have to consider whether the tax enhances or reduces the overall
welfare of those who are taxed. On the issue of equity, the Minister will have
to consider whether the tax proposals are fair to all wananchi. The Minister
will have to strike a balance with respect to these two, in his budget.
Over the last four budgets, the Government has been gradually increasing the
consumption taxes while at the same time keeping the income tax rates stable,
or in some instances effectively reducing the income tax rates by way of new
investment incentives. Examples of these include the recent widening the VAT
net to include some services provided by insurance companies, increasing the
rate of VAT for the Hotel Industry, as well as collecting taxes at source such
as VAT withholding and payment of fuel duty in advance. I think we should expect
this trend to continue.
Increasing income taxes as a measure of raising revenue is less likely. Especially
in an election year, he will not wish to risk an unpopular change. Another reason
is that increasing income tax rates may have a negative impact on investment.
Likewise the measure is no longer popular with tax authorities because the expected
revenue yield from an increase in income tax is less certain and less timely
than that from consumption tax changes. That is why the phrase “with effect
from midnight tonight” will always continue to feature prominently in
the Minister’s budget speech. This can only be used with respect to adjustments
to consumption taxes.
Finally the, economy is projected to grow by about 6% this year. While economic
development generates additional needs for tax revenue to finance a rise in
public spending, at the same time it should increase the country’s ability
to raise revenue to meet these needs. May be for that reason there may be no
need for new taxes, this year.
If that is the case, then may be main concern should not be the tax measures
to expect, but actually how will the national cake be shared out. Who will get
what funding, what roads will be built, what dispensaries, what schools, and
in what parts of the country? All will be revealed in less than a month’s
time.
The manner in which the Government is to finance public expenditure, especially
with respect to development projects will attract a lot of attention in this
year’s budget as it is an election year. This reminds me of a road in
my home country Uganda which features prominently in every election campaign
as a top priority for tarmacing as soon as the Government is returned to power,
and for three elections in a row now, the loyal voters are still waiting.
