Kenya's outdated tax policy discourages savings and investment

What you need to know:

  • Indeed, despite great efforts by the Kenya Revenue Authority (KRA), the country is reaching the limits of what its patched up taxation policy could achieve.
  • Today, every Kenyan reaches the top tax bracket of 30 per cent of income at the income level of close to Sh38000 per month.
  • Mobilisation of domestic savings is partly constrained by low incomes but also affected by the low interest income on regular savings.

Apart from the passage of a new law to govern Value Added Tax (VAT), Kenya has not had ambitious tax reform in the last two decades.

What happens instead is piecemeal reform of taxes, mostly driven by the need to ensure that overall tax collection increases.

Compared to its neighbours and countries of a comparable income level, Kenya’s total tax remains impressive at 20 per cent of GDP, yet this comparatively high tax collection does not necessarily mean this policy is economically rational.

Indeed, despite great efforts by the Kenya Revenue Authority (KRA), the country is reaching the limits of what its patched up taxation policy could achieve.

This is because taxation policy is driven by overall spending needs and not by the quest to provide incentives for saving, investment and efficient utilisation of resources. resulting in incoherence like the creation by the government of Railways Development levy (RDL) to fund a long term investment in the Standard Gauge Railway.

In order to create more predictable policy and use taxation as a signal for activity, government should treat investment and consumption differently from each other.

Reforming Kenya’s taxation policy would be a good arena for cooperation between the national government and the counties on one hand, and the Legislature and the Executive on the other. This cooperation should be informed by the principles of public finance management contained in Article 201 of the Constitution.

Creating consistent principles to inform taxation would guide the Executive on proposals and create a benchmark against which Parliament would debate taxation measures. This feature of consistent principles is critical because it could also guide county governments in assigning revenue targets.

Starting with the fact that up to 40 per cent of taxes in Kenya are raised from the personal incomes of workers and profits of corporations, the reforms should consider the design of income taxes.

Today, every Kenyan reaches the top tax bracket of 30 per cent of income at the income level of close to Sh38000 per month. These tax brackets were established nearly two decades ago, and have been maintained despite inflation that has cut the real value of this sum by more than 50 per cent.

While income taxation is a sensitive issue for Kenya’s parliamentarians, the need to adjust these tax brackets upwards is one that must be seriously considered.

At the corporate taxation level, the Legislature should consider the removal of many distortions that ensure firms are not subjected to the same treatment. One example is an innovative piece of legislation introduced a while ago to provide an incentive for private firms to list at the Nairobi Securities Exchange.

Measured against the intent of this policy, it is clear the taxation incentive has failed to ensure that a large number of firms actually list. What the policy does is ensure that the subvention is appropriated by a few firms, and the financial advisors who handle the listing processes.

There’s no doubt that the social value of this listing incentive is not only much lower than anticipated but also that it is spread to Kenyans who work in the financial sector. It should be wiped out to prevent uneven treatment and distortion between listed and unlisted firms.

In addition, this taxation policy merely diverts taxes from other sectors and lower income earners to a rich industry. There is no economic rationale to maintain it.

Its existence reflects the power of the financial sector lobby and not a rational economic policy, given the profile of firms in Kenya.

Taxation policy also influences whether firms and individuals decide to invest through savings or consume their incomes. Considering that most of Kenya’s taxation revenue comes from employment and corporate investments, it is helpful to consider how to design taxation to improve savings.

Compared to many countries in Asia, Kenya’s savings rates are comparatively low. Mobilisation of domestic savings is partly constrained by low incomes but also affected by the low interest income on regular savings.

This could be altered by a policy change that exempts all savings from taxes and thereby provide an incentive to defer consumption.

Properly designed taxation policy is an effective policy tool with which to expand prosperity for nations. However, to get this policy right requires a decisive change from an ad hoc approach, and more towards trying to encourage savings and to ensure equal treatment of firms.

This policy approach for taxation design is required for coherence involving all tax heads, from Income Tax, Value Added Tax, Excise Tax and other methods for revenue generation.

Kwame Owino is the Chief Executive Officer of the Institute of Economic Affairs (IEA-Kenya), a public policy think tank based in Nairobi. Twitter: @IEAKwame