By JAMES ANYANZWA

The National Treasury faces an arduous task of financing a historic Sh1.64 trillion budget crafted to fund the operations of the county governments and the ambitious promises made by the ruling Jubilee coalition.

It is very clear that the new government appears to be planning to continue the expansionist policy of its predecessor and once again there is a vastly increased spending plan.  Indeed the budget is set at in excess of Sh1.64 trillion against Sh1.4 trillion last year. This is the largest budget Kenya has seen to date. Based on this estimated expenditure and projected revenues of over Sh1.3 trillion, there lies an outstanding deficit of approximately Sh280 billion.

And with revenue collections fading faster than expected, accounting bodies and the Parliamentary Budget Office (PBO) are calling for the re-introduction of Capital Gains Tax to help plug glaring budgetary deficit.

The Sh280 billion represents two times the budget allocated to the Ministry of Education, four times the budget allocated to the Ministry of Defence, and eight times the budget allocated to the Ministry of Health. This comes amid flashing signs that the Kenya Revenue Authority (KRA)’s revenue collections for the current financial year (2012/2013) will fall below target by a whopping Sh120 billion against the original estimates, according to an accounting and business advisors firm PKF.

“There is absolutely no justification why Kenya continues to suspend capital gains tax while tax the poor people through value added tax (VAT) and other indirect taxes,” said Michael Mburugu, Director, PKF Taxation Services.

“To meet the expected financing deficit, the Government should take a bold move and re-introduce capital gains to ensure that every citizen contributes to the national kitty through taxes.”

Capital gains tax

According to PKF, the Government could tap in more than Sh100 billion annually by taxing the rich more. “To broaden the tax bracket, the authority needs to consider levying taxes on income or capital gains from appreciation of properties, stocks and other market assets,” the PBO report says. Capital gains tax is present in Uganda, Tanzania and many African countries. Uganda levies tax on capital gains at 30 per cent and Tanzania at 20 per cent.

Faced with increasing expenditure pressures and slowed growth in revenues, the Kenyan Government has borne the brunt of huge budgetary deficits, which has mainly been financed through borrowing.

And the situation is likely to be worsened by the demands for salary hikes by Members of Parliament (MPs) and by teachers. Teachers want the State to honour agreements made through legal notice 534 of 1997 granting them 50 per cent of basic salary for housing, 20 per cent medical cover and 10 per cent as commuter allowance, amounting to Sh25 billion.

But heavy borrowing particularly from the domestic market carries the danger of crowding out the private sector from credit and throwing the country’s debt to gross domestic product (GDP) ratio out of proportion.

According to the PBO, the Government expenditures have more than quadrupled over the last 10 years with total government spending rising by 350 per cent to Sh1.2 trillion in the 2012/2013 financial from Sh264.1 billion in 2002/2003 financial year. Government spending, which recurrent spending has mainly fuelled has seen public debt more than double over the past decade. “Expansion in public spending is predominantly driven by recurrent expenditure pressures and mainly growth in employees emoluments,” says PBO.

“I think there are much more fundamental problems in our economy. There is no economic wealth being generated by the people in government. These people are making Kenya a very expensive destination to operate,” said Dr Jim Macfie, a Lecturer at Strathmore School of Business.

At the beginning of the financial year (2012/2013), the Government had planned to borrow Sh105.6 billion from the local market. But salary increments for civil servants and in anticipation of high expenditure events of the first quarter of this year saw the Treasury borrow over Sh88 billion by November (five months into the financial year). This increased the country’s debt levels by 9.8 per cent to Sh1.8 trillion.

Experts at PKF propose the implementation of the private public partnership (PPP) to help finance the expanded budget. During the period July-December 2012, the total revenue collection stood at Sh360.3 billion against a target of Sh404.3 billion, representing an under performance of Sh44 billion or a performance rate of 89.1 per cent.  KRA collected Sh380 billion in taxes for the first half of the year ended December 2012, which is less than half of the targeted total of Sh881.2 billion for the current financial year. The matter becomes more complex for the National Treasury, which had projected that KRA would manage Sh1 trillion for the period 2012/13 to meet demands of a bigger devolved government with a huge budget.

The shortfall was a result of a decline in revenues in all the major tax divisions, including Value Added Tax, domestic excise duty, trade taxes and petroleum taxes. And the delayed enactment of the VAT Bill denied the taxman an estimated Sh11 billion, while domestic excise duty underperformed, owing to shifting consumption patterns as more people preferred the cheaper non-taxable keg to the more expensive taxable beers.

During the period, the taxman realised Sh250 million against an estimate of Sh2 billion from land rates and rents paid by landlords after an aggressive campaign last year to ensure compliance in the real estate sector.

The Government, however, expects a rebound in the level of economic activities based on an increased investor and business confidence following a peaceful political dispensation, and stable macroeconomic environment.

Kenya is currently hard pressed for funds to support key programmes pledged under the ruling coalition’s Jubilee manifesto.

According to the PBO, the stock of public debt has increased substantially over time and is tipped to grow even further as the government borrows extensively to make up for the persistent revenue short falls.

Domestic DEBT

“A review of our current public debt indicates that the Government has in the recent times financed its deficit with an increasing proportion of domestic debt,” said PBO. “This presents the risk that the country may find it difficult to service the debt in future under modest economic growth rates, underperformance of revenue, large contingent liabilities and increasing fiscal pressures.”

But tax experts warn that heavy borrowing from the domestic market will crowd out the private sector from credit. “The more the government borrows the less funds are available for the private sector. This is something that could be of concern because it will crowd out the private sector from credit,” said Nikhil Hira, head of tax practice at Deloitte and Touche East Africa.

“We have a debt to gross domestic product (GDP) ratio that is higher than the internationally accepted standard of 45 per cent simply because our tax collections don’t meet the targets. If this debt continues climbing then that is worrying because taxpayers are to pay for it.”  According to the PBO, the Government expects to finance the expanded budget through taxes, borrowing (domestic and external) and grants. The National Treasury also plans to issue a sovereign bond during the 2013/14 fiscal year to profile and benchmark Kenya in international capital markets and to fund priority infrastructure projects. At the current debt levels, Kenya is reeling from high cost of servicing domestic debt, a situation that is slowly pushing borrowing to unsustainable levels and is likely to stoke interest rates.

According to Central Bank, cumulative interest and other charges on domestic debt for the period July 1, 2012 to May 24, 2013 in the 2012/13 fiscal year amounted to Sh94.5 billion compared with Sh69.9 billion during a similar period of the previous fiscal year.  This was Sh24.6 billion more compared to similar period last year.

This is as domestic debt jumped by Sh213.6 billion, from Sh858.8 billion at the end of June 2012 to Sh1.1 trillion on May 24, 2013.  CBK said this followed increases of Sh132.4 billion, Sh50.8 billion, Sh26.9 billion and Sh3.5 billion in the stocks of Treasury bills, Treasury bonds, Government overdraft at the Central Bank and other domestic debt, respectively. In early April, the debt stood at Sh1 trillion, meaning that it has gone up by a massive 100 billion in less than two months. This is even pressure for higher salaries by public servants continue to put a tight squeeze on the government coffers.

The increase has surpassed the borrowing limit for the current fiscal year 2012/13 by more than Sh75 billion. Treasury had set the limit at Sh138 billion but so far it has seen the domestic debt increase to Sh213.3 billion this financial year.  This jump is majorly driven by rising financial obligations, especially higher pay for public servants and implementation of the devolved government.  PBO says the Government needs to adopt a borrowing strategy that will maintain public debt at a sustainable level.

Fiscal discipline

“The current debt level of about 50 per cent of GDP is unsustainable going forward,” said PBO. The deficit in the current account is projected to stand at Sh304.6 billion, Sh341.2 billion and Sh382.6 billion in the fiscal years 2013/14,2014/15 and 2015/16 respectively, according to PBO. And 2013 will be a defining moment for Kenya since the pace at which the country shall adhere to fiscal discipline amid high expenditure incurred following the just concluded general elections remains a crucial factor in determining the pace of future growth of the country.

The growth trajectory will largely depend on how fast the country returns to normalcy as well as how quickly people and industries get back to full capacity. In addition, the huge recurrent related expenses will continue to be a major challenge as the implementation of devolved system of governance sets in.