Investor incentives plain loss of revenue

• Capitalists are by nature bold and greedy spirits who will do business with the devil in hell, which is why Western mining corporations are to be found in DRC Congo. So, why would the government of Kenya entice them with tax holidays when research shows that this is the best way for KRA not to meet its targets?

According to a report by Ernst and Young titled African Attractiveness Survey released earlier this month and reported in the Daily Nation, Kenya is leading the pack in attracting foreign direct investments.

It also adds encouragingly that Kenya also leads the pack in the growth of intra-Africa investment. So, we simultaneously attract the greatest number of new foreign investments while the investment portfolios of the various companies domiciled here have grown the fastest.

Last week another report released by Foreign Direct Investment for the year 2011, also published in the Nation, put Kenya third behind South Africa and Morocco in attracting foreign investment. Kenya attracted 55 projects in the just concluded year.

These two reports paint a rosy picture of the levels of foreign investment. Kenya is apparently a very attractive destination for capitalists with sub-Saharan ambitions. More encouraging is that Kenyan companies are venturing out en masse and establishing subsidiaries among our neighbours.

For the next part of the story we need to look at a story in the Nation’s sister newspaper The EastAfrican from last month. It states that East African countries are losing an estimated Sh232 billion ($2.8 billion) in revenues foregone as tax and other incentives to attract foreign investment.

Kenya in particular is estimated to lose Sh100 billion annually in tax exemptions, which is roughly three per cent of our GDP.

It is estimated that it costs us Sh100 billion to woo investors. It makes you wonder how much the 55 projects quoted by FDI earned us in total. Kenya is better off removing the various hindrances that may discourage investors from investing rather than giving them tax exemptions and preferential treatment.

This will enable our government to earn more and help KRA close its tax revenue deficit.

According to the report in The EastAfrican, an increase in the number of incentives offered does not lead to a concomitant increase in the number of investors attracted. Many investors would invest regardless.

Plainly, the tax reductions end up denying the Treasury much needed revenue. East African states are apparently driven by the fear that if they do not dangle enough goodies, the investors will not form orderly queues to set up businesses in them. This fear is unfounded. So we give investors who would be willing to pay a free pass.

Furthermore, in a 2010 study on fiscal incentives offered by export processing zones (EPZs), only one per cent of 137 foreign business respondents said incentives were what they would seek in setting up shop in Kenya.

Incentives are expensive undertakings that are worth more trouble than what they bring in. A study by the IMF in 2006 also found the correlation between incentives and foreign direct investment to be tenuous at best and non-existent in most cases.

The government should, therefore, plug these loopholes and enrich its coffers. The budget faces a deficit and instead of KRA going after beer in the lower end of the market, it should target companies looking to set up breweries in the country. Already the taxman has introduced a charge on loans from multinational corporations to their local subsidiaries.

We should also encourage more companies to cross our borders since the country gains more by local companies branching out than foreign companies setting up shop in our country.

One constraint that is often quoted as a hindrance to foreign investment is regulation. A local analyst claimed on a business show that the eight to 12 weeks it takes to incorporate a company in Kenya was a major hindrance to investment.

It is reasoning like this that is the basis for setting up incentives. They give foreign investors a free pass because they feel that ideally investors will be repulsed by the costs of business or corruption.

I doubt this is the case. Anyone who balks at waiting 12 weeks to set up a business is not a serious investor. In 23 Things They Don’t Tell You about Capitalism, they tell of how in the 1990s one needed 299 permits from 199 agencies to open up a factory in South Korea. It was still outgrowing all its neighbours.

A stringent regulatory regime can co-exist with vibrant economic growth; the two are not mutually exclusive. If there is enough money at the end of the tunnel, people are willing to wait 12 or more weeks to get it.