Replace 'old' turnover tax with windfall tax on financial sector

One of the anomalies of developing countries is the extent to which they blindly copy legislation from developed countries. Often with little regard as to whether the legislation works or is appropriate for them.

For example, European financial regulation such as Basel, seen as best practice, was eagerly adopted in Kenya, yet the West's financial sector faced a financial crisis in 2008 and recently major Western banks, such as Credit Suisse and Silicon Valley Bank, collapsed.

Massive taxpayer bailouts of Western banks considered too big to fail were needed to stave off systemic collapse of this sector where a few huge state assisted banks replaced what was once a diversity of banks, further consolidating sector risk in a few large entities. So how good is Western financial regulation?

Truth is, there are substantial issues with Western models, these issues are papered over by tools such as vast quantitative easing post the 2008 financial crisis (where Central Banks print money to buy financial assets, increasing money circulating in the economy).

Therefore, care needs be taken before implementing foreign legislation, even where required by treaty, or for market access, amendments tailored to Kenya should be included.

The 2023 Finance Act introduces a three per cent turnover tax. Turnover tax is unpopular because it's unfair. While tax on profits or net receipts can be seen as fair, tax on gross receipts is seen as unfair, as even if you make a loss you must pay it.

In developed countries turnover tax has been replaced by value added tax (VAT). However, the Kenyan government seeks both turnover tax and VAT, a double bite of the cherry.

Turnover tax is a European tax from the middle-ages. Founded in ancient Athens, it was applied at a brutal 10% rate on Egypt under Greek rule. The Romans then used a one per cent Turnover tax on goods, followed by Spain which implemented a cascading turnover tax that is blamed for its economic downfall - to the extent that economist Adam Smith said it was the reason the Spanish Empire failed where the British Empire succeeded.

After WWI, turnover tax was widely used in Europe to gain revenue before being replaced by VAT. It has faced massive resistance in many countries due to its disparate impact on producers, favouring of vertical integration and it increases non-compliance by taxpayers desperate to avoid the nefarious tax.

Economist Edwin Seligman stated that turnover taxes, "constitute a rough and ready system, suitable only for the more primitive stages of economic life." The tax is widely considered unwise in the extreme. Yet in some developing countries, governments see the tax, paid in instalments, collected by business, as good for revenue and responsive to high inflation and dire economic conditions.

"Those who don't know history are doomed to repeat it." It is submitted that the government should consider replacing Turnover tax with a Windfall tax on the financial sector.

Dr Andrew Lilico's article on "Controlling Spending and Government Deficits: lessons from history and international experience", offers an approach the Treasury may wish to consider. Lilico recommends that cutting debt should be based on a ratio of an 80 per cent expenditure cut and 20 per cent tax increase. Further that income tax should increase, not turnover tax or VAT.

If interest rates are increased this will give the financial sector, banks, bigger profits, it is therefore fair for the Government to tax those increased profits with a Windfall tax. This tax can be partly used to protect those hit hardest by increased interest rates. Increasing interest rates will help manage the dollar exchange rate, boost savings and grow certain sectors of the economy.

Therefore, rather than Turnover tax, a mix of interest rate increases, combined with large expenditure cuts, limited tax increases, tax cuts, pro-business tax incentives, conservative borrowing and a Windfall tax would likely strengthen the Kenya shilling and help grow the economy.

While expenditure cuts are often unpopular, if a recovery plan is properly and simply explained to people by the Government - think one page in a newspaper - the public and business are more likely to grit their teeth for a few years in the hope that if the plan is successful economic conditions will improve.

A Turnover tax on the other hand is seen as anti-business, unfair and a sign of an economy in serious trouble.

There can be no tangible economic recovery without private sector confidence. Turnover tax with its failed history, certainly should not exist alongside its replacement VAT. With its track-record of economic failure, social unrest, non-compliance and decline, turnover tax should be left firmly in medieval Europe.

The writer is a legal and finance expert