State must look beyond austerity, excessive taxes to boost economy

Taxation is a fundamental component of a functioning society. [iStockphoto]

What exactly is the impact of the recent tax increments on the cost of living and the general well-being of Kenyans? How do these increments influence the social contract that Kenyan citizens have with the government?

Taxation is a fundamental component of a functioning society. It enables governments to provide essential services, maintain social order, promote economic growth, and address various societal challenges.

Taxation is a crucial aspect of the social contract between citizens and the state. It represents citizens' obligation to contribute financially to fund public services and infrastructure, ensuring the collective well-being of society. In return, the state provides essential services, maintains order, and promotes its citizens' overall welfare and development. Citizens also expect that their funds will be managed and disbursed prudently.

Let us recall that the social contract is a theoretical concept used to describe the relationship between individuals and their society or government. As such, the limits to taxation within the social contract framework are often debated and vary based on societal values and economic theories.

The 2010 Constitution of Kenya outlines the social contract between the government and its citizens by establishing the principles of governance, ensuring fundamental rights and freedoms, and defining the roles and responsibilities of different branches of government.

While it doesn't explicitly use the term “social contract,” the Constitution embodies the concept through various provisions, including the Bill of Rights, Chapter Eleven on Devolved Government, Chapter Six on Leadership and Integrity, and the principles of public participation and access to information.

However, several vital considerations can indicate when taxation might breach the limits of the social contract:

First, when taxes become overly burdensome, meaning they significantly reduce citizens' ability to meet their basic needs and pursue reasonable economic opportunities, it can be considered a breach of the social contract.

Use of tax system that citizens perceive as unfair, such as taxing low-income earners at the same rate as high-income earners without providing corresponding benefits, can lead to a sense of injustice and social unrest.

Third, excessive taxation can create disincentives, discouraging investment, innovation, and entrepreneurship. This can hinder economic growth, accelerate divestment by investors, and eventually lead to stagnation.

And finally, when tax revenue is not efficiently used to provide essential public services, maintain infrastructure, or address societal needs, the citizens may feel that their contributions could be better used, leading to a breakdown in the social contract.

The point at which taxation breaches the limits of the social contract is subjective and can vary from one society to another. It often depends on factors such as the overall tax burden, the perceived fairness of the tax system, the quality of public services provided, and the level of citizen participation in governance. When citizens believe that the benefits of taxation are not commensurate with their sacrifices, it can signal a breach of the social contract, leading to social and political tensions.

The recent tax increases on petroleum products will inevitably have a domino effect on the prices of all other goods and services that Kenyans enjoy, given the centrality of petroleum products, particularly in the transportation sector. And this domino effect will affect the lives and livelihoods of Kenyans and, more so, those who are vulnerable.

The COVID-19 pandemic had a deleterious effect on the Kenyan economy, which we have not fully recovered from. The World Bank says the poverty rate in Kenya increased from 43% in 2019 to 46% in 2020. This means that an additional 2.6 million Kenyans fell into poverty in 2020 – the first year of the Covid-19 pandemic. This economic downturn led to job losses, reduced incomes, and higher prices for food and other essential goods, making it difficult for many Kenyans to make ends meet.

The June 2023 Integrated Food Security Phase Classification (IPC) indicated that 4.4 million Kenyans were facing high levels of acute food insecurity, with about 3.6 million people in IPC Phase 3 (crisis) and 779,000 people in IPC Phase 4 (emergency). This is a significant increase from the same period in 2022, when 3.5 million people faced high levels of acute food insecurity. The IPC analysis found that 14.3 million Kenyans face food poverty, up from 12.5 million in 2022, and that 23% of children under the age of five are stunted (a sign of chronic malnutrition).

It is almost inevitable that the food insecurity and food poverty situation in Kenya will worsen in the coming months as the impact of tax increases ripples outward in the economy and combines with the impact of bad weather on harvests (and consequently food prices).

In a country where safety nets are weak and do not offer universal coverage, there is a significant risk that large segments of the population slide back into poverty and that the development gains of the last few years are canceled. The traditional safety net in our context has been and remains the family.

Yet as the costs of living increase, this last line of support also fails, with dramatic consequences for social welfare. As necessities become more expensive, the ability of families to assist their members, particularly beyond the immediate nuclear family, is diminishing, leading to several consequences.

At one level, there is the intergenerational impact: the increase in intra-family inheritance feuds signals that disagreements over resource allocation within families are increasing and that the elderly are increasingly seen as an obstacle or nuisance by their younger family members.

Furthermore, economic pressures from increased cost of living can force family members to migrate for better opportunities. This leads to physical separation within families, making it harder to provide emotional and practical support, further contributing to a vicious cycle in which broken families abound.

Back to the notion of the social contract, it takes on heightened significance during times of hardship. Tax increases and austerity measures during such periods of hardship can undermine social contracts in significant ways.

This is because such taxes often impose additional burdens on citizens when many struggle due to job losses, pay cuts, or higher living expenses. This amounts to a violation of the principle that the government and its policies should support citizens during difficult times.

Even more important is the fact that austerity cuts public services upon which people rely. This reduces the government's ability to uphold its end of the implicit bargain that citizens will contribute when able in exchange for protection and services when needed.

Raising taxes and cutting spending often slow down economic recovery by reducing household spending power, consumer confidence ultimately resulting in weak demand. This can exacerbate unemployment and cause problems for those relying on social programs.

Besides, if the government is perceived as ineffective in addressing the economic crisis, it can erode public trust in government institutions. Citizens might question the government's ability to fulfill its obligations as outlined in the social contract.

Finally, high unemployment, poverty, and inequality can lead to social unrest and increased crime rates. This can further strain the social fabric and challenge the government's ability to maintain law and order.

Given the above, the government must look beyond austerity and tax increases as the only way out of the current economic crisis. Indeed, the conventional wisdom that austerity and tax increases are the only means to economic growth and recovery is ripe for reevaluation.

There are success stories of countries that have taken a different path, investing in critical sectors, safeguarding social welfare, and prioritizing innovation and entrepreneurship, highlighting alternative strategies that lead to prosperity. The key assumption that policymakers made in these countries is that stimulating the economy is the best way to achieve economic growth and recovery.

This assumption is supported by economic theory and evidence from the real world. Flexibility, transparency, and accountability have been crucial to implementing these policies effectively.

But beyond all of this, we need to come to terms with the reality that it is only possible to expand the tax base and tax revenues with a change in the economy's structure. Kenya must focus on shifting from economies of rent to economies of wages.

Essentially, the wage compression implicit in export-led strategies needs to be progressively replaced with a shift to labor-intensive manufacturing for the local economies, where increasing wages necessarily leads to an increase in domestic demand. This allows a non-predatory increase in tax revenues on both personal and corporate income.

Privileging food system transformation - with greater support for farmers and fisher folk that produce for the local economy and increased local manufacturing of food products - is essential to strengthening the domestic economy, ultimately resulting in increased domestic resource mobilization. This is the economic transformation we must seek, not merely tinkering at the edges.

Muliro is Deputy Managing Director at the International Secretariat of the Society for International Development.