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To drive growth, we cannot afford ‘to sock the rich’

By Charles Kanjama | Updated Sun, January 5th 2014 at 00:00 GMT +3

By Charles Kanjama
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Sometime in the 19th Century, somewhere in Europe, a busy town was separated from a poorer residential quarter by a river crossed by a footbridge built by the town authorities. Any person crossing the footbridge had to pay some money, say ten shillings, to cross one way or the other. Then a benevolent town council decided to ease the situation of the poor labourers by abolishing the bridge levy. After several months, it was noticed that the rents in the poorer quarter had generally increased by about five hundred shillings, thus absorbing the labourers’ monthly savings gained from the abolition of the bridge levy.

In 1879, American writer Henry George wrote his groundbreaking work, “Progress and Poverty” to explain this phenomenon. His main economic idea was that growing population as well as infrastructure investment raises the value of adjacent land regardless of the economic activity carried out on the land itself. Henry George was a brilliant writer and an incisive thinker, and he inspired fervent disciples, though mainstream economics treated him largely with contempt. He was derisively called ‘a single-taxer’ due to his proposal to abolish all forms of taxation save for land value taxation.

What George really supported was an intelligent approach to capturing the resulting value from public investments for the whole society. For example, in the European town above, the footbridge had been a form of economic value creation. Once the levy was abolished, the value was captured, not by the labourers as planned, but by their thriving landlords. This was a perverse form of value capture.

A century later, the impressive economist and Nobel Prize laureate Joseph Stiglitz supported George’s insight, now called the Henry George Theorem. Stiglitz demonstrated that spending by government on infrastructure often increases aggregate land values by a proportionate amount. So for example, land values along Thika Road increased substantially due to the construction of the modern super-highway. These increases in value were captured mainly by the adjacent land owners and by transporters.

Likewise, a substantial injection of value from the Mombasa-Nairobi-Malaba standard gauge railway project, as well as from the proposed Lamu-Garissa-Isiolo-Moyale/Lodwar LAPSSET Corridor Project, will be captured by landowners within a certain radius of the service points or railway stations to be established along the line. Of course, the improved efficiency in transportation will create value in other areas, including job creation, and relative reduction in the cost of both industrial and consumer goods.

If government was clever, it would include a value-capture approach in project financing. The economic speculation in the land adjacent to the proposed Lamu port, to the planned Isiolo Resort city and to the Mlolongo railway exchange is a pointer of the anticipated value creation from these public investments. Value capture uses multiple approaches to allow government to recoup a portion, say half, of the returns from its investments.

One acceptable approach is land value taxation, or alternatively government land-purchase-and-resale schemes. The former is more legally apt, but under Kenya’s Constitution can only be levied by county government (art.209(2,3)). Another acceptable approach, which is now overdue considering the state of our economic development, is the reintroduction of capital gains tax. This tax was suspended in 1985, the idea at the time being that Kenyans should be encouraged to save and invest, including in the securities market.

However, from the perspective of tax equity today, it is scandalous that capital gains tax, which mainly affects the wealthy, still remains suspended. Of course Kenya must avoid going down the path of European socialist nations like France, which has recently introduced a top-bracket 75 percent income tax for the ultra wealthy. We cannot afford ‘to sock the rich’, as it will discourage investment and trigger capital flight, as well as entrench greater tax evasion. This does not mean that a well-designed capital gains tax cannot work for both property and equity investments.

Still, there is a need to avoid an obsession with traditional but costly approaches for funding Kenya’s mega infrastructure projects. Importantly, the electromagnetic spectrum that is now the focus of government-media disputes over digital migration is a potentially large source of public funds. Also the issuance of oil and other mineral exploration and extraction licences, which should be backed by a credible mining royalties and taxation regime that allows government to recover a substantial portion of mineral value.

My New Year wish is that both national and county governments can progress useful infrastructure projects through creative financing that does not unduly stretch our debt leverage ratio but which directly contributes to our economic and social welfare.