Improved tax systems can spur growth

The McKinsey report for 2016, Lions on the Move: The Progress and Potential of African Economies, interrogates Africa’s immediate economic challenges and prospects.

It observes that even though African economies are growing, they are performing below potential and that huge business-building opportunities remain unexploited.

One of the key priorities governments must deliver is mobilising domestic resources.

Pooling domestic resources is a viable way of mobilisation, given weakening currencies in emerging markets, rising interest rate spreads on sovereign debt, low commodity prices, and high volatility in capital inflows.

Statistics show that Africa’s financial depth — total financial assets as a percentage of GDP — has declined from 108 per cent in 2009 to 97 per cent in 2015.

The savings rates have dropped from 27 per cent of GDP in 2005 to 16 per cent in 2015.

To unlock funding for economic growth, governments must adopt efficient and fairer tax collection methods by modernising national tax systems.

This can double Africa’s tax revenue, which currently stands at between $295 billion and $320 billion.

In Kenya, tax collection levels stand at a paltry 19 per cent of GDP.

Many factors lead to low tax collection. One, revenue authorities have limited data on the number of potential taxpayers.

In Kenya, a citizen not registered for PIN can easily avoid paying direct taxes. Second, the tax collection processes are often complex and burdensome.

Modernising tax systems will significantly reduce non-compliance resulting from fraud, neglect, error, and non-payment.

Revenue authorities must, therefore, overcame structural challenges, the key one being high levels of informality in doing business.

DIVERSIFY SYSTEM
The second challenge is revamping the tax system.

The time it takes to prepare and pay taxes and other related payments needs to be addressed.

The third challenge is tax administration, which relates to the level of e-filing for corporations and qualitative assessment of tax administration modernisation.

If the revenue authorities were able to tackle the informality in doing business, revamp the tax system, and make tax administration efficient, there would be an increase in the collection of taxes — direct, indirect taxes, trade, resource such as extraction royalties.

To measure tax modernisation efforts, McKinsey formulates a modernisation index classifying countries into three tiers: kick-starters, transitioners, and modernisers.

Each tier measures the effort made to strengthen tax administration, build capability, and boost revenue.

Kick-starters, being smaller countries, have a lax tax system, collecting a relatively small proportion of the GDP.

These need to standardise and simplify internal processes, close tax loopholes, and improve collection procedures.

The transitioners — Kenya falls here — are the countries with more established tax systems and on the path to modernisation.

They have the potential to advance to higher quality systems through tax reform.

They need to diversify the tax system, upgrading IT infrastructure, increase the use of pre-filing and e-filing, and introduce sophisticated compliance programmes.

The third tier consists of the “modernisers”. In Africa, only Morocco and South Africa make the cut.

These are countries with well-functioning tax systems.

WHAT TO PRIORITISE

They have the opportunity to build state-of-the-art tax administrations, roll out targeted modernisation initiatives to improve customer experience, and use advanced risk analytical engines to improve compliance.
Kenya needs to move from being a transitioner to become a moderniser.

To achieve this, the country must improve its tax system.

This could be done by expanding the tax base and balancing tax incentives and exemptions to attract foreign direct investment without overly eroding tax revenue.

The administration of tax systems could be made more efficient by improving data collection, using data to drive risk-based compliance, and ensuring better enforcement.

Informality in doing business should be addressed.

When businesses do not pay tax, they create unfair competition for the formal sector. Informality could be curtailed by digitisation the economy.

Tax regulations need to be revamped to strengthen financial and regional market integration leading to increased cross-border capital flows and investment.

Robust law reform and tax treaties to deter double taxation should be prioritised.

The author is an advocate of the High Court of Kenya. [email protected]