Post date: Wed, Jul 29, 2020
Category: Public Finance
By: Leo Kipkogei Kemboi,

The Kenyan Constitution requires Authorities to promote the values that underlie an open and democratic society based on human dignity, equality, equity and freedom in the application of Bill of Rights. The design of tax policy must, therefore, promote values that are expressly mentioned in Article 20 of the Constitution. A study makes the argument for the tax law to be founded not only on principles but also on practicality. The research further shows that a country cannot run a democracy well without taxation, and therefore a taxation system cannot be run well without democracy. It must be noted for this analysis that decision on who/what to tax rests solely with Parliament as per the constitution while Kenya Revenue Authority responsibility is tax administration. The National Treasury is responsible for revenue-raising measures which include proposals for taxation which Parliament can either approve or reject.

Overall, the Kenyan taxation system is more a structural issue in two ways: the taxation code is more complex across different types of taxes and policy goals of new taxes don’t conform to the general economic policy of the country. Whereas this may be the case, it’s important to acknowledge efforts/to legal and admin reform to simplify the tax system and codes to increase compliance like the New VAT Act 2013 etc. it may however not have borne much fruit Policymakers should seize the issue of taxation now because its efficiency affects the economy positively.  Given the complexity of the VAT, they are refunds pending to Manufacturers worth almost as Ksh 130 Billion (the US $ 1.23 billion). The Manufacturers complained about the pace of rebates and availability of funds for the same purpose in the submissions for the 2020/21 budgetary process.

The complexity in Kenya’s taxation system and its effects can be seen in the ranking of its tax burden in the Index of Economic freedom. The tax burden is classified into four groups: free, Moderately free, mostly unfree and repressed. Kenya ranks below the globally average at 55.3 points and is classified as primarily unfree in 2020. The average country in the world is moderately free in its tax burden in 2020.  Its only five points above the repressed category. Kenya’s ranking of its tax burden has since early 2000 been below the world average. There have been huge divides between Kenya and the world average since  2010 with the steepest decline in 2010.

Chart 1: Ranking of Kenya’s Tax Burden

Source: Index of Economic Freedom

Now on the newly designed taxes, the Finance Bill 2020, through article 12D and 12E introduces new tax measures that include the Minimum Tax and Digital Service Tax. The Minimum Tax is commonly referred to as Alternative Minimum Tax. The minimum tax is to be levied at 1% of the total gross turnover. Digital companies that generate revenue in Kenya will pay a 1.5% tax on the value of transactions what is now referred to as Digital Service Tax. The Minimum tax measure fails the principles of taxation but also harms overall Kenya’s economic policy. The practicability of the digital tax has been questioned especially with how the tax could be collected. Adam Smith, in his book, the wealth of nations outlined the four maxims of taxation, which include equity, certainty, convenience and economy. These two new tax measures are, and their implication makes it challenging to follow on their practicability based on the four maxims of taxation. The four maxims as tested against the two new tax measures are as follows;

1. The first law of Adam Smith’s taxation states that “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.” (Originals in italics).The two taxes target firms and individuals with specific characteristics. Although, the decision to tax is political, there are widespread unintended ramifications if the decision is left to stand. The decision to introduce digital tax might lead to firms in those sectors relocating to other markets. It also disincentivizes decision by firms to invest in specific industries. A very likely scenario for minimum tax is that firms will try and find ways on how to circumvent the regulatory regime by under-declaring their returns. The tax administrator might not have resources to go after every firm making the excise to end in futility.
2. The second Adam Smith law of taxation states that “The tax which each individual or firm is bound to pay ought to be certain, and not arbitrary. It includes on the time of payment of the tax, the manner in which it paid, and the amount to be paid. This ought all to be clear and plain to the contributor, and every other person.”. The minimum tax is a parallel tax system and exempts firms that already have other forms of taxes. The clarity of where the minimum tax begins and different types of income taxes start is not clear. Based on a short assessment, it’s clear that sufficient publication and publicization has not been undertaken even though Article 201 of the Constitution requires enough Public Participation on all financial matters. All the technical information on how the two taxes were designed should be published and publicized. Firms that would be profoundly affected by this move are those that set up requires includes those in the manufacturing sector, utilities and those heavy in research and development. Most of their plans rely on a long-term plan to be able to recoup their initial investment. Although such firms declare losses in their formative years, they end up reporting profits. In most of the cases, their initial capital is enormous sums. The process of collecting digital tax is not transparent and effectiveness—most of the firms that are registered outside Kenya. The move could stifle tech development locally.
3. Adam Smith stated in his third law that “Every tax ought to be levied at the time, or in the manner in which it is most likely to be convenient for the taxpayer to pay it.” Most of the firms that Kenyans rely on services for like the digital taxi firms Uber and Movie streaming sites such as Netflix are out of Kenya. The proposed digital services tax will take time and resource to make it collection more expensive. Collecting tax revenues from digital firms would take time and considerable resources that will necessitate the question of whether it makes economic sense to come up with such tax in the first place.
4. The fourth law in Smith’s maxims of taxation is that “Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state.” The minimum tax proposes to take more capital out of firms irrespective of whether they are making losses or profits. The digital tax, on the other hand, seeks to take more resources from Kenyan firms and citizens even though internet connectivity and strength of firms in this sector remain low.

There are economic and constitutional questions on the two newly designed taxes. The general economic objective of taxation is to take little of out of pockets of the people, provide certainty in how the tax is collected and what is collected, convenience in paying tax and fairness/equity in how it is proposed and administered. The two taxes are proposed in a time that Kenya is undergoing unprecedented socio-economic shock. The timing itself, especially on minimum tax, is shocking. The minimum tax reduces the incentives that are effective in attracting foreign and local investors. It adds more obligations on Investors even before their business has adequately picked up and even when running or when the economy is generally under stress like now.

The Kenyan tax code should be revamped to clarify some of the issues among them the general structure of the economy and profiles of its taxpayers across the bases. This should be easy with the advancement of technology and the amount of data collected by the Kenya Revenue Authority over time.  This action would simplify the code, reducing both taxpayers’ compliance costs and government administrative costs, thereby dealing with the problem on the Demand and Supply Side of the problem. Some distinctions among taxpayers promote fairness, so there are trade-offs among goals, but the tax law could be simplified without compromising equity. This is a decision that Parliament could make easily with empirical evidence existing and so many false starts witnessed.

The National Treasury in its report, “Kenya Comprehensive Public Expenditure Review 2017” points out that contribution from the private investment has contracted and this has affected Kenya’s productivity in a negative perspective. The report further explains what essential role the Private sector investment is essential for the replenishment of capital stock, adoption of frontier technology, boosting firm productivity and ultimately private sector-led growth. The managers of the economy have envisioned a double-digit economic growth. Such robust economic growth can not be attained with the harsh environment or uncertain taxation regime. It must be noted that Low-income countries compete for foreign direct investment with emerging and developed economies who are ahead economically. Local firms, on the other hand, require a friendly and certain taxation regime to be able to compete with other firms on a global value chain. The tax regime is also one of the key factors that affect Foreign Direct Investment attraction amongst other factors that include political stability, governance, and judicial effectiveness etc.

In conclusion, there’s a need for increased vigilance on budget issues by the policy stakeholders and other actors, with a keen eye on revenue-raising measures. At the end of the process, a political decision to tax will be made, but it must be lawful and converges with the country’s economic agenda. The positions put forward by National Treasury to Parliament must be fact-checked by other actors. It is important to use evidence to inform tax policies. This will ensure that both Parliament and National Treasury will play their Constitutional Obligation effectively. Studies around taxation in Kenya must be commissioned to guide the decision making in the long-term.

 

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