With the Kenya Revenue Authority coming under increased pressure to boost its revenue collection activities, it essential that the people of Kenya have a clear picture of how tax collection works.
The ability to raise revenues from taxes – called “fiscal capacity” – is a crucial aspect for the functioning of any state. Being able to tax citizens and collect revenues efficiently, is a cornerstone of state formation and survival.
Greater fiscal capacity implies greater access of the state to resources needed to provide public goods and services. Developing countries are only able to raise a small share of taxes. Typically, they collect between 10 percent to 20 percent of GDP. The average in high-income countries is double this, at 40 percent.
These low rates in developing countries like Kenya are the consequence of many problems. First, the large size of the informal economy which encompasses a variety of groups ranging from the jua kali tradesman to the person hawking roasted peanuts in Nairobi traffic. Second, a lack of investment in tax collection – most developing countries rely on sales and trade taxes which are easier to administrate than personal taxes, but entail lower revenues.
Low tax collection rates have devastating consequences on development. They mean that governments aren’t able to invest in public goods such as health, infrastructure and education. This begs the question, why do the developing countries tax so little?
Low income countries typically have a large informal sector and many small-scale firms. The Kenya National Bureau of Statistics estimates that as of 2018, the informal sector represented over 80 percent of employment in Kenya. The low-income countries are also dependent on a few natural resources or commodities (horticulture and tourism in Kenya’s case). This combination of factors often pushes these countries towards a lower level of tax collection, and also a narrow tax base.
The large informal sector in Kenya is also intrinsically hard to tax owing to the lack of proper record keeping and technological integration, which both play a major role in assisting agencies to develop a clearer picture of Kenya’s economic climate.
Economists posit that an increase in formality is a key part of the process by which taxation increases with development. While the relative size of the informal sector tends to shrink as an economy grows, economic growth may not automatically translate into greater formality because government action plays a large part in the process.
Weak institutions, fragmented politics, and a lack of transparency due to weak news media play a significant role in the stifling of an economy’s growth. In addition, sociological and cultural factors — such as a weak sense of national identity and a poor norm for compliance — can stifle the collection of tax revenue.
Holding the executive to account matters for a number of reasons. Firstly, it means that citizens can control and limit the executive’s access to resources. Citizens can also demand greater accountability from the state about what happens to the taxes they pay. Greater constraints on the executive can also make a country’s tax system more transparent.
This effect is sizeable. One country that illustrates this point was Tanzania. An inability to hold the executive to account, plus lack of transparency, seem to be the main drivers behind the country’s budgetary problems. Its tax collection rate is a mere 12.8 percent.
In March 2018 the Controller and Auditor General, Mussa Assad, presented his annual audit report for the 2016/2017 financial year. This showed that state institutions had diverted trillions of shillings into ghost ventures. In particular, there was an unexplained mismatch between the collected revenue of TSh 25.3 trillion (US$10.88 billion/Sh1.1 trillion) and the TSh 23.8 trillion (US$10.24 billion/Sh1 trillion) government expenditure.
The Public Accounts Committee submitted a report in early February 2019 claiming:
“Our verification was limited by lack of supporting documents and adequate explanations from management (of the Ministry of Finance), which were necessary for ascertaining the accuracy and validity of amounts to be verified. For example, the Ministry was unable to provide documents such as the proper cash book for the consolidated funds and bank reconciliation statements that provide crucial underlying information for the figures under verification. The provided information was scattered in numerous sections and were subjected to frequent adjustments in the course of verification.”
This quote highlights two issues. First, Tanzania has a significant mismatch between planned and actual revenue and expenses, and it is unable to keep a record of its transactions. Second, public bodies are unwilling to share information with the public. Nor are they willing to be held accountable.
Building a fiscally capable state won’t bring benefits in the short term. Changing institutions takes time, and changes in the law don’t immediately translate into changes in behavior. But it’s nevertheless key to consolidating working political institutions, providing strong checks and balances on the discretionary power of the executive and building confidence among taxpayers.
The writer, Michael Armstrong (FCA) is the ICAEW Regional Director for the Middle East, Africa and South Asia.
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