Doing away with exemptions and zero-rating will simplify taxation

Tuesday November 8 2011


By JAINDI KISERO ([email protected])

Ask me what the acronym VAT stands for and I will not hesitate in telling you that it means “Very Annoying Tax”.

I was a young business reporter in 1990 when the government abolished sales tax and replaced it with the Value Added Tax. In this region, we were the first country to introduce VAT.

It was supposed to be the pre-eminent tax – the tax for the future. We were told how the new system would deliver a wider tax-base, more equitable taxation, and a system that was going to be far superior in terms of ‘‘buoyancy’’ and ‘‘elasticity”.

It has not happened 20 years later. Today, the ghastly mess that passes as the VAT Act has exceeded the point where its impact on tax evasion far outweighs its value to the Exchequer.

We are at a point where, for every shilling of net revenue derived from VAT, the net burden on the economy and private sector runs into thousands of shillings.

The VAT Bill, 2011, which has just been published by the government, deserves the full support of those who believe in simple, transparent and equitable taxation. It is so far the most comprehensive attempt at reforming the system.

In the computer world, the phrase ‘‘user-friendly” is used to denote the designing of a computer with the needs and convenience of the user in mind.

VAT as currently administered is not friendly. It was designed to create work for accountants and tax consultants. The most obvious sign that the current system is dysfunctional is the back-log in VAT refunds.

I read somewhere that currently, the backlog is in the region of Sh20 billion. Clearly, the inordinate delay in processing VAT refunds is a major burden to the private sector.

The Kenya Association of Manufacturers has made several representations to the government over the matter.

Every month, the government allocates hundreds of millions of shillings to pay VAT refunds. But due to intrinsic weaknesses in the system, the refunds keep mounting.

Right now, it is estimated that the government spends 15 per cent of gross revenues on refunds. What is the point of collecting a tax when you know that you have to refund 15 per cent of what you have collected at the end of the day? It beats all logic.

How did we get there? It all boils down to exemptions and the long list of zero-rated good and services.

Over the years, it became practice that every new Finance minister would either introduce new exemptions or make changes to the list of zero-rated goods and services.

The list of zero-rated goods grew longer with each passing year, and so did the list of exemptions. The situation became complex and opaque. The introduction of Withholding tax in 2004 made the VAT regime even more complex.

If you were a government contractor, the government would pay you less the VAT. You lodged your refund claims later. The account for refunds increased exponentially.

How has the new Bill tackled the problem? First, it proposes to discontinue withholding tax altogether. But more critical, the lists of exemptions and zero-rating is to undergo major surgery. The lists are being reduced to a bear minimum.

It will require a great deal of political fortitude to reduce these lists. Already, there are murmurs about prices of exercise books going up.

Critics of the Bill have also argued that the poor will suffer as essential consumer goods are gradually removed from the list of exemptions and zero-rating.

Theory and practice have shown that tax incentives are a poor way of shielding the poor from high consumer prices.

Just the other day, the government removed VAT on imported maize. VAT on kerosene was also brought down. Did consumer prices go down? No.

If you want to shield the poor from high exercise book prices, do it from the government expenditure side, by introducing subsidies that are specifically targeted to the poor.

Where is the sense of giving a general tax break on exercise books to both the child going to Dr Livingstone Primary School in Nairobi’s Eastlands and the child attending Brookhouse School? This exemption gives tax breaks even to children who do not need it.

The VAT system must undergo major surgery. Everybody must pay tax.