National tax policy step welcome

It is clear that realising tax yields from the hard-to-tax sectors will require a lot of work that will entail the use of big data to establish tax potential, and reducing the cost of formalisation. FILE PHOTO | SHUTTERSTOCK

With the Finance Bill 2023 having been signed into law, it is now imperative to address some of the structural weaknesses in Kenya’s tax system. There was so much tiki-taka around the Bill during public participation as well as debating stages.

First, a finance bill is basically a taxation plan on how to fund a budget. Because it often entails amending tax laws and administration to achieve desired revenue target(s), it has to be (dis)approved by Parliament (where the power to tax domiciles).

That said, it is noteworthy that tax performance has greatly improved. In absolute terms, ordinary revenues have risen from Sh682 billion in 2010/11 to Sh1.56 trillion in 2020/21.

Despite the growth in absolute terms, the annual growth rate has been declining. Therefore, low tax yields have been cited as one of the factors behind the upward recalibration of tax rates in the Finance Bill 2023.

Specifically, ordinary revenue as a percentage of GDP has generally been declining over the last 10 years from a high of 18.2 percent in 2013/14 to 13.8 percent in 2020/21.

This can also be seen through lack of tax buoyancy, implying that revenue growth has not been consistently responsive to growth in nominal GDP.

However, there is a need for caution when using the GDP-yield measurement, because Kenya’s GDP has been swollen twice through rebasements (ostensibly to create more room for borrowings).

There are still a number of underlying issues affecting the tax system which have negatively impacted yields. The proposed national tax policy is a step in the right direction towards addressing some of the issues.

It provides a policy straight line and introduces an element of certainty in the tax environment. Every year, the Treasury Cabinet Secretary amends the Income Tax Act, VAT Act and the Excise Duty Act as well as import duty and customs-related taxes.

These annual amendments make it difficult for businesses to plan for taxation, especially manufacturing entities. Consequently, the national tax policy proposes a comprehensive review of tax laws every five years, which provides a reasonable degree of predictability on tax rates.

The policy paper also talks about monitoring and evaluation framework for tax incentives as well as a sunset for some of the incentives.

This is crucial as tax incentives amount to three percent of GDP and yet the Government still lacks a monitoring and evaluation framework.

Specifically, it would be interesting to see the impacts of export processing zones (EPZs) or special economic zones (SEZs) on the domestic economy viz-a-viz policy objectives.

Further, tax incentives cannot be issued in perpetuity. At some point, they have to be withdrawn especially in cases where objectives have been met or there is no elasticity.

Another crucial point is how to tax the harder-to-tax sectors such as the agricultural and informal sectors.

In 2022, total employment outside small-scale agriculture and pastoral activities was 19.1 million, out of which employment in the informal sector stood at 16.0 million jobs.

Wage employment in the private sector recorded a growth of 4.8 percent from 1,983 thousand jobs while wage employment in the public sector stood at 938 thousand jobs.

It is estimated that 60 percent of the informal employment is mainly in wholesale, retail trade, hotel & restaurants while 20 percent is manufacturing activities.

With this in mind, the paper does not provide a clear strategy on how to onboard informal activities onto the tax system, other than mention the use of presumptive tax.

It is clear that realising tax yields from the hard-to-tax sectors will require a lot of work that will entail the use of big data to establish tax potential, and reducing the cost of formalisation.

The overreliance on the formal sector for tax revenue is not sustainable.

The writer is a thought leader.