Think tank cautions on tax increases to service debt

External debt levels may discourage investment due to uncertainty on sustainability and future tax policy. [iStockphoto]

A public policy think tank has cautioned the government on the increase of taxes to meet debt obligations amid heavy spending on infrastructure projects.

Such a scenario, the Kenya Institute for Public Policy Research and Analysis (Kippra) has said, may discourage private sector investment.

Kippra has also recommended to the National Treasury to do appraisals of key public infrastructure projects in order to ensure borrowed money yields the best socio-economic outcome.

Kippra, in a discussion paper published August 8, 2023, is of the opinion that while external debt tends to crowd in private investment in the long run, in the meantime, it crowds them out.

This does have an effect on the growth of business and a possible negative outcome on taxes.

According to the paper titled Effects of External Public Debt on Private Investments in Kenya, in the short-run, external debt levels may discourage investment due to uncertainty on sustainability and future tax policy.

But when external debt is sustainable, it says, private investment will increase in the short run.

“However, in the long-run, deterioration on debt sustainability would see private investment reduce,” the paper states.

The paper notes that real gross domestic product (GDP) growth, private sector credit, and real effective exchange rate have a positive effect on investments.

Therefore, to ensure debt is not a constraint to private investment, debt management should be done with a focus on the structure and composition of public debt.

This should be done with the view of improving project management to ensure projects being implemented have a higher multiplier effect and also explore alternative sources of financing public investment, including locally.

Kenya’s public debt stands currently stands at over Sh10 trillion.

The Standard Gauge Railway is one of the huge infrastructure projects the government undertook on debt in the previous administration.

While President William Ruto has been vocal that his administration will not drive the country into more debt, a pronouncement he has not honored, Kenyans have been subjected further into more taxes through the Finance Act 2023 as he seeks to streamline and boost Kenya Revenue Authority (KRA) collections.

Data sources

The paper authored by Josphat Machagua and Martha Naikumi studied data between 1980 and 2020.

Data on gross capital formation in the private sector was sourced from African Development Bank while information on external debt service as a percentage of exports, commercial loans, and advance lending rate, credit to the private sector and real GDP growth was extracted from the Kenya National Bureau of Statistics.

In the discussion paper, Kippra recommends that to ensure that the long-run effects of external debt used to finance infrastructure are secured, the Public Investment Management Unit at the National Treasury, which focuses on projects that are being implemented, could do extensive feasibility and viability studies of public infrastructure.

This is to ensure they are sustainable.

The Unit could also conduct regular appraisals of key public infrastructure projects to enable the optimization of project design and ensure the projects yield the highest social and economic returns in line with national, regional, and international development goals.

“To ensure that payments in external debt servicing do not make it difficult for the private sector to invest, the National government through the Kenya Revenue Authority could ensure that tax rates are not increased to meet debt obligations,” the paper recommends.

Kippra notes in the paper that while external public debt levels tend to crowd in private sector investment in the long run, in the short run, it crowds out private investment.

“This is because external public debt provides key infrastructural development and complementary public goods and services, which creates a conducive environment that boosts private sector investment,” the public policy think tank explains.

It was also determined that external public debt sustainability had a negative effect on private investment in the long run, but a positive effect in the short run.

“This implies that external public debt sustainability crowds out private investments in the long run because of using relatively large amounts of domestic revenue to service external public debt obligations,” it says.

“The net effect of external public debt and external public debt sustainability on private investment was positive in the long run, as the positive magnitude of external public debt superseded the negative magnitude of external public debt sustainability.”

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