Kenya debates introducing consumption taxes to offset non-compliance

In mid-June 2018 the cabinet secretary of the National Treasury unveiled a comprehensive raft of tax administration measures tailored towards financing the government’s KSh3trn ($29.4bn) budget for FY 2018/19. Some of the measures were a reiteration of proposals envisaged in the Income Tax Bill, 2018, the Tax Laws (Amendment) Bill of that same year, and recommendations from the 2018 Budget and Appropriations Committee report to the National Assembly.

While the ultimate focus of the measures was skewed towards broadening income taxes, as opposed to consumption taxes, commentators continue to query the country’s over-reliance on the former. In any economy, income taxes such as corporate and personal taxes are levied directly on labour and capital, while consumption taxes such as value-added tax (VAT) and excise duties are charged upon purchase of goods and services.

Kenya is largely an informal economy that is characterised by high levels of tax non-compliance. In the past, the country has relied on individual income taxes as one of the main sources of revenue. However, high unemployment levels and a growing class of low-income earners, resulting from stagnating wages due to a concentration of non-labour intensive economic activities, have led to shrinking personal tax revenues.

In an ideal situation consumption taxes reduce the need to directly tax business earnings, including net profits, interests and dividends. In addition, they can widen the tax base and bring in more taxpayers, especially those operating in the informal economy, consequently leading to increased tax collections. Moreover, most economists support consumption taxes since they encourage savings. Thus, a carefully planned, non-punitive, progressive and graduated consumption tax model would be both fair and equitable, with far-reaching economic benefits. Following recent growth in the digital economy, policymakers have proposed that online activities should be taxed at the place of consumption. The EU, for example, has proposed that a 3% digital tax on certain online activities be applied in the country of origin. Before an international framework can be established, however, any successes in the meantime will be based on how well consumption taxes are harnessed.

Some critics argue that consumption taxes generate less revenues than income taxes. Others believe that if a commodity is produced and consumed in different countries, then consumption taxes could only be wholly collected in the country where the commodity is consumed, posing fiscal deficiency for the producing country. The producer would lose out on the manufacturing taxes, unless both countries agree to revenue-sharing mechanisms. As such, consumption taxes would work well in countries sharing similar trade interests under economic blocs such as the EAC. Nonetheless, a consumption tax system benefits poor countries since they produce less but consume more, and this can help to address economic disparities between developed and developing nations globally. Several countries around the world have undertaken or proposed indirect taxes reforms such as a uniform consumption tax policy. India, for instance, has introduced a single goods and services tax as a replacement for VAT and custom and excise taxes, among others. The ruling has been applauded for making Indian products competitive in global markets and reducing the overall burden on taxpayers.

In Kenya, consumption tax reform could earn major revenues for the government, providing the reforms do not distort consumer spending habits. However, an intensive consumption-based tax system would significantly affect low-income earners, who spend the bulk of their income on necessities such as food, clothing and rent. Although consumption taxes would raise government tax revenues, the move could be economically counterproductive, due to the reduced consumption and production of goods and services.