Post date: Wed, May 4, 2022
Category: Public Finance
By: Leo Kipkogei Kemboi,

The process of changing the tax code is outlined under sections 40 and 41 of the Public Finance Management Act of 2012. Section 40 outlines the Submission and consideration of budget policy highlights and the Finance Bill in the National Assembly, and section 41 outlines the passing of the Finance Bill. They have been four major complaints about Kenya’s Tax Code;

1. Changes to the tax code are erratic, which means the tax code changes significantly in the short term and the medium making it expensive to comply with. To illustrate the extent to which Kenya’s tax code has changed erratically, I use the example of the income tax act which was assented to on December 21^st 1973 and has been repealed 48 times (as per data published on Kenya law[1])
2. Some of the changes made to the tax code harm the economic and social policy objectives. A good example of this is the excise taxes on sugary drinks in Kenya where there are pervasive cases of child stunting. An additional example includes taxes on financial transactions for a country whose biggest policy is financial inclusion owing to existential barriers to financial inclusion.
3. Some of the Tax Code Compliance requirements have negated the constitutional right to property and further increased the cost of doing business. An excellent illustration of this issue is the introduction of Excise stamps and the Excisable Goods Management System (EGMS)[2].
4. There are no known official evaluations of revenue-raising measures to document the intended and unintended consequences of their impositions. Rather, what is observed is the insights in small chapters of various public expenditure reviews like the National Treasury’s public expenditure review 2017 (Page 43) found that VAT and excise tax increase poverty and have a small, negative effect on inequality. The review noted that the poverty rate increases by more than five percentage points after VAT is accounted for. However, because VAT is mildly progressive, and the burden is high across all income groups, therefore, has a sizable, negative effect on the Gini index (0.6 percentage points). Excise taxes, on the other hand, generate only half of the revenue that VAT generates and therefore have a similar effect on poverty and inequality. The review notes that excise taxes increase poverty, by about one percentage point, and lower the Gini index by 0.3 percentage points[3].

The Mandatory Nature of Submission and Consideration of the Finance

Section 40 of the Public Finance Management Act (PFMA), 2012 requires that each financial year, the Cabinet Secretary shall, with the approval of the Cabinet, make a public pronouncement of the budget policy highlights and revenue-raising measures for the national government. The Cabinet Secretary shall take into account any regional or international agreements that Kenya has ratified, including the East African Community Treaty and where such agreements prescribe the date when the budget policy highlights and revenue-raising measures are to be pronounced, the Cabinet Secretary shall ensure that the measures are pronounced on the appointed date. Section 40 emphasizes the word shall concerning functions of the Cabinet Secretary under section 40 of the PFMA.

On the same date that the budget policy highlights and revenue-raising measures are pronounced, the Cabinet Secretary shall submit to Parliament the Finance Bill, setting out the revenue-raising measures for the national government, together with a policy statement expounding on those measures. Note the word used is shall, making it mandatory for Cabinet Secretary to submit to Parliament the Revenue Raising Measures. Section 41 of the PFMA requires that not later than ninety days after passing the Appropriation Bill, the National Assembly shall consider and approve the Finance Bill with or without amendments. The salient issue that stands out from the reading of Section 40 of the public finance is that the law makes it mandatory for the Cabinet Secretary in charge of the National Treasury to table finance bills for consideration once approved by Cabinet. The keyword used in this case is shall. According to the Merriam Webster Dictionary, the word “shall” is used in laws, regulations, or directives to express what is mandatory[4].

Key Policy Concerns

Making it mandatory for issuance of the Finance Bill annually presumes that only the widening of revenue-raising measures through the introduction of new tax measures will automatically increase the tax collections. That is not always true because of these major reasons.

• Economic growth is a major factor in determining the growth of Revenues- Economic growth especially private sector-led growth is a dominant factor in revenue growth. Part of the major tax policy should be focusing on robust economic growth. There is strong evidence that economic growth contributes to revenue growth. The direction of causality comes from economic growth. Using data for the last 11 years, I note that the economic growth trendline has been on the decline and also the revenue growth has been on a decline. The decline has been much faster in economic growth as shown in the chart below.

 

Even if more revenue-raising measures are proposed in a weaker economy, the results would not boost growth in revenues.

• Tax Buoyancy- Tax buoyancy explains the relationship between the changes in the government’s tax revenue growth and the changes in GDP. It refers to the responsiveness of tax revenue growth to changes in GDP. When a tax is buoyant, its revenue increases without increasing the tax rate. The tax buoyancy argument already reinforces the strong association between the growth of tax revenue and economic growth[5]. A dated study by the Institute of Economic Affairs denotes those changes in tax revenues result from; (a) tax bases growing with the economy or because changes in the tax laws broaden the tax bases, (b) increase in tax rates, (c) better enforcement of an existing tax structure. When all these changes occur, the effect is captured by the buoyancy, which measures the responsiveness of the tax system to changes in economic activity as well as changes in discretionary policy. However, elasticity is a more refined measure than buoyancy as it measures the responsiveness of the tax system to changes in economic activity (GDP) alone[6]. The IEA study found out that Kenya’s Taxation system at that time was not buoyant.

• Laffer Effect- The Laffer Curve is a theory formalized by economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments. The curve is used to illustrate the argument that cutting tax rates can result in increased total tax revenue[7]. The Laffer Curve states that if tax rates are increased above a certain level, then tax revenues can fall because higher tax rates discourage people from working[8].

Conclusion and Policy Recommendations

It is evident that the national tax code variation does not need to happen on an annual basis, but a medium-term review due to economic policy objectives, economic growth, tax buoyancy, and the Laffer effect. This could require amendments to the PFMA to make it conditional for submission of the Finance Bill and consideration by Parliament by changing the wording of the law to reflect the “may” scenario. This will allow the Cabinet Secretary in charge of the National Treasury to only table the Finance Bill where necessary.

 

References

[1] Kenya law. “Cap 470: Income Tax Act,” 2022. http://kenyalaw.org:8181/exist/kenyalex/actview.xql?actid=CAP.%20470.

[2] Public Investments Committee,. The Report on the Inquiry into Procurement and Implementation of the Excisable Goods Management System for Printing, Supply and Delivery of Security Revenue Stamps Complete with Track and Trace System , and an Intergrated Production Accounting System, Nairobi: The National Assembly of Kenya. 2019

[3] The National Treasury and Planning. “2017 Comprehensive Public Expenditure Review: From Evidence to Policy.” Goverment of Kenya- State Department For Planning Monitoring And Evaluation Department, November 2018.

[4] Merriam Webster. “Definition of SHALL.” Merriam-webster.com, 2017. https://www.merriam-webster.com/dictionary/shall.

[5]  Tojo Jose. “What Is Tax Buoyancy, How It Works for the Government? – IndianEconomy.net.” Indian Economy, May 11, 2015. https://www.indianeconomy.net/splclassroom/what-is-tax-buoyancy-how-it-works-for-the-government/.

[6] Moyi, E. & Ronge, E.,. Taxation and Tax Modernization in Kenya: A Diagnosis of Performance and Options for Further Reform, Nairobi: Institute of Economic Affairs. 2006

[7] Hayes, Adams, Michael Boyle, and Patrice Williams. “Laffer Curve Definition.” Investopedia, May 2019. https://www.investopedia.com/terms/l/laffercurve.asp#:~:text=The%20Laffer%20Curve%20is%20a.

[8] Tejvan Pettinger. “The Laffer Curve.” Economicshelp.org, May 18, 2018. https://www.economicshelp.org/blog/140859/economics/the-laffer-curve/.

 

 

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