Tax reforms: Writing is on the wall, buckle up for a recession

American award-winning economist Milton Friedman said that “one of the greatest mistakes is to judge policies and programmes by their intentions rather than by their results”. By design, economic policies can look attractive but with devastating effects.

Take for instance the much-hyped structural adjustment programmes of the 80s and the 90s. African governments were pressured to open up borders for cheaper imports, privatise government corporations, liberalise the economy and free up the foreign exchange markets, among other reforms. The results were mixed.

Local industries died while others stagnated. In Kenya, the textile industry was killed by the influx of second-hand clothes from Europe and America while the sugar industry is on its death bed. The Kenyan balance of trade has deteriorated over the years as the country relies more on imports.

In March 2013 when the Jubilee government took over, the consumer price index (CPI) stood at 137.96. In March this year, the CPI stood at 190.62, an increase of 52.66 points, or 38 per cent. In other words, if President Kenyatta were to hand over the reins of power this year, he would have left the Kenyan household 38 per cent worse off than he found it. Good intentions got us here.

After rebasing, the Kenyan economy was classified as lower middle income. With this, the Bretton Woods institutions believed we could raise more revenue through tax and even borrow more. What they never mentioned to Kenyans is that these lower-middle-income economies in Africa and Latin America are overly sensitive to small shocks.

Treasury decided to charge capital gains tax and with it sent the stock market on a lull. To date, the Nairobi Securities Exchange, which was one of the best performing in the continent, has not picked pace. A seemingly small decision by the Government to put interest rate caps on borrowing equally stalled the growth of the banking sector. Borrowing was reduced and with it the growth of small and medium enterprises.

The biggest contributor to the increased CPI is the value added tax (VAT) reforms of 2013 that saw it stretched to cover basic food items, petroleum products and imported vehicles. The implementation of VAT on petroleum products was pushed to 2016 initially, then 2018.

With the same amount of money, when one goes shopping today, he will get 38 per cent less than he did in 2013. With these results, one would expect that the second term of this administration would focus on a turnaround programme to alleviate the situation and make wanjiku better off. Not so.

The Government is once again experimenting on neo-colonialist fiscal policy. In principle, economic growth would be spurred by cash injection. This can be done through massive spending like the one deployed in Kibaki’s tenure, dubbed the economic stimulus programme (ESP). These programmes would take cash to citizens, which would translate to savings, investment and growth. At a micro level, this can be done by encouraging foreign direct investment.

Depending on the magnitude of the change required, the Government can also reduce taxes and interest rates at this time to ensure people’s disposable income is substantive while enabling businesses to access credit at lower rates. In the short run this might bring inflationary pressures on the economy but these autocorrect after producers realise there is a supply shortfall and increase production.

On Uhuru’s memo regarding the Finance Bill, I concur with Milton Friedman. He would say in his most characteristic tone: “I am in favour of cutting taxes, under any circumstances and for any excuse, for any reason, whenever it’s possible”. Tax increases stifle growth and often fail to yield the desired revenue levels.

In 2009 Greece announced it would have a 12.9 per cent deficit in its budget, four times the recommended three per cent by the European Union. This led to a downgrade of its credit rating by several agencies. This led to widespread panic across board that resulted in a debt crisis. The following year, the Greek government announced it could default on its loans.

After numerous diplomatic engagements, Greece agreed to embark on austerity measures and fiscal reforms. They increased taxes across board and reduced spending, especially pension payouts to the aged population that made up 20 per cent of the population. The reforms stopped the panic and the spiraling crisis. However, given the government was taking more money from the economy in form of taxes and spending less, the reforms led to a recession that stretched out to 2017.

The Greek economy shrank by 25 per cent; the much-needed revenues for recovery reduced instead; youth unemployment rose to 50 per cent and debt to GDP ratio stood at 182 per cent by 2017.

With high debt repayment amounts and tight austerity measures, the government’s spending will significantly reduce in the next few years. On the flipside, the increased taxes will take away money from the economy. The double axe on revenue and expenditure will without fail lead to an economic recession within a year or two.

Listening to the Members of Parliament supporting the President’s proposals, one got the impression that the Government has good intentions. From the full implementation of the Constitution, the Big Four Agenda and attractive development plans, a stranger to this country’s economics would wonder how bright our future looks.

Learning from the VAT reforms, capital gains tax and the interest rate capping policies however, I’d say the results will be awfully different from the intentions. The writing is on the wall, buckle up for a recession.

The writer is managing consultant at Elim Consulting.