Kenya needs to change taxation system for growth

Stephen Barasa, petrol station supervisor at Total in Kibuye, Kisumu reviews the prices of fuel on May 5, 2019 a day after the change in pricing was effected by the government. [Denish Ochieng/ Standard]

Finance Cabinet Secretary Henry Rotich’s Sh3.1 trillion budget is clearly overambitious. This might just be the year that the country’s bottomless capacity for funding, and Kenyans’ capacity to pay up will diverge beyond tolerable levels.

Any kind of spending control was clearly abandoned by policy makers some time ago and Central Bank appears to see no link between rising fiscal deficits and debt and the blunting of effective monetary policy.

So, as a new Kenya Revenue Authority commissioner-general takes over, one hopes that high on his task list is finding a way to help close the budget deficit by raising revenue.

The time is now for reshaping Kenya’s entire taxation system to create a low-tax, high-incentive and robust taxation paradigm. Such a taxation system will be far better set up to serve the needs of an economy that creates jobs, provides healthcare and housing and educates the populace.

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In the current environment, we have a supposedly progressive personal taxation system, a web of consumption taxes under various guises (VAT, levies, duties, excise and so on), and a system of corporate taxes set off by subsidies.

Unfortunately, the complexity of this system is one akin to that of a much bigger economy, where the costs of compliance, regulation, monitoring and enforcement can be borne. In countries where the government’s budget equals about half of gross domestic product (GDP), you can have a complicated system. In a country gathering about 17 per cent of GDP under taxation, one has to start looking at how the current model is not fit for purpose any more.

Let us also remember that the Pay As You Earn system generates 33 per cent of Government revenues from about 10 per cent of the population, and remarkably manages to tax housemaids and shamba workers at higher rates than owners of the land they work on and the slumlords they pay rent to. Broadening the tax net has to be a priority - the current system is not generating enough to sustain Government’s role in economic growth.

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What would a new system look like?

First, scrap the entire current system of personal taxation and revamp it to release the lowest earners from taxation altogether. Everyone earning less than Sh600,000 per year (Band 1) pays no taxes, no NSSF, no NHIF, nothing. For families earning Sh600,000 to Sh1.5 million (Band 2) there is a 10 per cent rate, and above Sh1.5 million (Band 3) make it 20 per cent. No deductibles, no exemptions and no subsidies.

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Income would be defined as all salaries, allowances and bank or debt instrument interest. Dividends would be exempt, thus boosting the attractiveness of equity investments. Inheritance and capital gains taxes would be scrapped, encouraging wealthier Kenyans to make long-term investment decisions within Kenya for the country’s benefit in jobs and future growth – instead of engaging in avoidance and evasion. 

Single rate

Second, in return for this slashing of income taxes, Kenyans would all pay higher consumption taxes. All duties, excise, levies and VAT would be consolidated into a single VAT rate applied on everything at a high 30 per cent. Unprocessed food, prescription medical services and pharmaceuticals, school books and materials, contraceptives and menstrual products, and monthly rent on housing below Sh50,000 would be the only exemptions by law.

Adding items under these categories would only be done on a three-year basis, removing the incentives to corruption and mis-governance for short-term exemptions.

Each Band 1 family would receive a Sh75,000 annual subsidies to offset the effect of the high VAT. Band 2 families would get Sh50,000, and Band 3 families nothing. The payment of the annual subsidy for low earners could be easily done through the growing digital financing system, encouraging use of the technology.

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Finally, tax rules and laws would only be changed on a three-year basis, and then only after ratification of the underlying assumptions and calculations by statistics, revenue allocation, audit and budget planning agencies. This would remove uncertainty and any lobbying or corrupt incentives, and make the process predictable and transparent.

- Deepak Dave, founder of Riverside Capital.

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Henry RotichSh3.1 trillion budgetKenya Revenue AuthorityTaxation SystemPAYE