Taming runaway tax expenditure

Tax revenue is the main source of finance for most governments globally. It is even more critical in countries that do not have major non-tax sources of revenue such as Kenya.

In the absence of sufficient tax collections, the government mainly relies on debt to finance its budget obligations. There has been a growing concern about Kenya’s debt level, and this has jolted the government into action to ensure long-term debt sustainability.

The Treasury recently released the 2023 tax expenditure report. The report summarises national tax expenditure in a particular year of income. The expenditures entail foregone taxes through exemptions, tax deductions, tax credits, zero-rating and concessional tax rates, among others.

It is the difference between whatever tax would have been paid under a defined benchmark tax law and the amount paid to the revenue authority.

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Generally, tax expenditure is a form of subsidy since it is expected to lower the cost of goods or increase disposable income. They may also be used as a tool to influence behaviour by encouraging preferred economic activities.

The government has indicated that it is putting in place measures to slow down the annual growth in public debt without compromising service delivery to citizens. A lot of effort has thus been put into expanding revenue mobilisation through a mix of tax policy changes and administrative changes to enhance compliance.

Reducing tax expenditure by eliminating unproductive tax incentives has been identified as a key measure to protect the country’s tax base. The government has indicated that it will focus on enhancing tax expenditures that promote investments.

According to the 2023 Tax Expenditure Report, in 2022 the total tax expenditure increased to Sh393.6 billion, which was equivalent to 2.94 percent of the gross domestic product (GDP). This was an increase from Sh292.9 billion in 2021, which was equivalent to 2.44 percent of the GDP.

Domestic value-added tax (VAT) was the largest contributor to the tax expenditures at 36.94 percent with corporate income tax following with 19.87 percent while VAT on fuel contributed 16.38 percent.

According to the Medium-Term Revenue Strategy for 2024/25 to 2026/27 the ordinary revenue collection as a percentage of GDP declined from 18.1 percent in 2013/14 to 14.1 percent of the GDP in 2022/23. This has been attributed to an increase in tax expenditure and low tax compliance, among other reasons. Notably, tax collections have grown from Sh0.8 trillion in 2013/14 to Sh2.4 trillion in 2022/23.

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Some of the key interventions that the government intends to implement in the next three years include the review and rationalisation of exemptions on entities and individuals, tax reliefs, and exempt or zero-rated supplies on individuals.

The review and reduction of tax expenditure might be a low-hanging fruit for the government in its quest to increase tax revenue collections.

This is largely due to the ease with which relevant tax changes can be made and the almost predictable revenue gain from a change in the relevant laws.

The government has indicated that it will mainly focus on tax expenditures that promote investments. Notably, certain tax expenditures play a crucial role in the economy such as reducing the cost of goods, increasing the disposable income and increasing access to certain goods or services, among other purposes. These may have other societal impacts such as reducing income inequality and protecting vulnerable persons, among others.

It is thus critical that the government considers broader economic aspects and not just the investment promotion impact in rationalising tax expenditures. This will ensure that the positive economic impact of certain tax expenditures is not eroded at the expense of additional tax revenue collections, which may not have the same impact on society.

By and large, an all-round analysis of each tax expenditure should be performed to determine the pros and cons of repealing related exemptions, incentives, or other measures. This is important in ensuring that an overzealous attempt to increase tax revenue collections does not compromise the general welfare of the citizenry and more so vulnerable persons in the society.