Uhuru just threw us from the pan right into the fire

President Uhuru Kenyatta while addressing the nation from State House, Nairobi.

Pressured to increase tax for the reconstruction of the country after the second world war, UK Prime Minister Winston Churchill said, “I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.”

He went on to say: “Nor can we borrow and bomb our way to prosperity.”

In 2005, after 15 years of an active value added tax (VAT) regime that exempted petroleum products, the Philippines introduced VAT on fuel items.

It was anticipated to hurt poor households, increase inflation and slow down growth. To mitigate these negative effects, the government decided implement a raft of measures.

First, it removed excise taxes on fuel products to manage anticipated inflation. Additionally, the government increased expenditure on social services such as education and health to protect the poor.

Targeted transfer payments were also expanded and deepened to help the elderly and disabled mitigate the changes in their economic basket.

These measures were very successful.

David Newhouse and Daria Zakharova in their paper ‘Distributional Implications of the VAT Reform in the Philippines’ wrote, “The mitigating measures increasing social spending are substantially better targeted to poor households than those that reduced energy taxes, depending on their exact composition.”

No consideration

Conversely, when the Kenya Government decides to introduce VAT on fuel, we see no consideration for the resultant shocks on a struggling economy. President Uhuru Kenyatta has proposed, among others, an 8 per cent VAT on petroleum products, doubled excise duty on banks and financial services to 20 per cent, increased duty on telephone and data services to 15 per cent, and doubled excise on mobile money services to 20 per cent.

This means that fuel costs will remain high and by extension create a fuel-driven inflation across the board.

Transport costs will affect food products moving across the country. Additionally, most manufacturing machines are diesel driven. This means basic items such as cooking oil, bread, maize flour, milk and soap will equally be affected by the VAT on fuel.

Sadly, the charge will not be 8 per cent, as the President desires. There shall be a compounding effect that will force producers and traders alike to raise prices beyond the 8 per cent.

The change in general inflation might go as high as 15 per cent in the short run. Additionally, the onslaught on the financial services sector is expected to collect for the Government the benefits of expanded borrowing after the removal of the interest capping law.

Bank charges might, therefore, not affect borrowing given the change in policy. However, the taxes on mobile money transfer and data services will significantly increase inflation and drive up cost of production. Many poor households that rely on M-Pesa will be affected.

Until two years ago, VAT was the highest income earner for the Government at 25 per cent of all revenue collected. However, income tax has since taken over as the biggest revenue earner.

Perhaps this is why the 1.5 per cent statutory deduction to raise funds for affordable housing is being introduced to the taxpayer. If well implemented, construction has a way of creating a placebo effect on the economy by generating short-term unsustainable growth figures.

Burning question

The burning question is, does Kenya need these tough fiscal policies to lift itself from poverty?

In the 1970s, the International Monetary Fund (IMF) and the World Bank imposed a reform agenda for countries as a precondition to access financing. Among other conditions included opening up of borders, liberalising economies, introduction of VAT and establishment of autonomous revenue collection agencies.

These policies came to be known as the ‘Washington Consensus Reforms’. The fiscal reforms by Uhuru’s administration smirk of these policies, which pushed many countries in Africa, Latin America and the Caribbean into poverty.

Conversely, many Asian countries, celebrated today for growth, did not implement the Washington Consensus Reforms. In particular, South Korea continued with its domestic tax regime that heavily taxed anything foreign, locked its borders and desisted from borrowing.

This conservative fiscal policy paid off well. Lower targeted taxes meant more savings. Closed borders meant that local nascent industries could develop unperturbed. Less borrowing strengthened the local currency and spurred creative management of resources.

If the President’s motive is a legacy, there are better ways of getting it done. A combination of business-sensitive legislation, fiscal and diplomatic measures would motivate companies to establish bases in Kenya and bring the much-needed foreign direct investment.

The writer is a managing consultant at Elim Consulting