Role of taxation as a stimulant of economic growth
By James Kirimi
Kenya like most states is heavily dependent on tax as the main source of government revenue. Taxation is founded on the principle that a citizenry must bear part-burden for the governance of the state. The citizens pay tax and in return the government is required to provide them with certain social amenities and also create a conducive environment to enable the citizens meet their economic pursuits.
Adam Smith in his book ‘An inquiry into the nature and causes of the Wealth of Nations’, opines that, whereas citizens of a state bear the burden of defraying costs for governance and administration, it behoves the tax authority to provide incentives to the taxpayers to ensure sustained economic growth.
The government is usually faced with two opposing objectives in tax administration: maximising tax collection vis-à-vis offering tax incentives and relief so as to encourage investments. Whereas on the one hand, maximum tax collection is an oft-desired optimum, the government must ensure that it retains a continuous flow of these taxes. It is foolhardy for the government to single-mindedly pursue tax collection with gusto and without due regard to taxpayers’ (mainly corporations) interests. Such a defeatist pursuit may result in the corporations migrating to other tax jurisdictions, which have more favourable tax policies. It would be the classical case of the government killing the goose that lays the golden eggs!
The challenge to our tax policymakers is to ensure an appropriate balance between the two opposing interests. I believe that the main consideration for any tax policymaker is to ensure a sustained economic growth, which would translate into better taxable profits for the companies and consequently more tax revenue. A sustained economic growth will be fuelled by, among other factors, a favourable tax regime which has relatively low tax rates, offers investments tax incentives and has an effective and predictable tax administration system.
The Kenyan tax regime offers little incentives for investments and any tax incentives introduced are either measly or inadequate in attracting potential investors. This bleak situation is further compounded by high tax rates and a plethora of taxes that are imposed on income, consumption and production. In fact Kenya’s tax regime is not an isolated case; many countries find themselves in the same dilemma due to the increasing cost of running the government. However, in contrast, many countries now realise that the path to sustained tax revenue is by retaining the existing taxpayers and recruiting new ones. This invariably means that tax incentives must be offered to attract investors.
In other countries, such as Mauritius, certain categories of companies are exempt from tax or are taxed at a lower rate. Examples, companies holding Category 1 Global Business Licence (GBL) are taxed at 0% or a lower rate of 15%. However the companies are also further entitled to a foreign tax credit of the actual foreign tax paid or 90% of the Mauritius tax payable where no there is no proof of foreign tax paid.
The GBLs are companies carrying on offshore business activities e.g. holding companies incorporated, and hence residents, in Mauritius and whose main activities are investments in shares in companies in other tax jurisdictions.
We have to appreciate that although, other considerations such as political environment, infrastructure and security, are important in attracting investors, taxation is by far one of the most critical considerations. Whereas the other factors indirectly influence a company’s profitability, taxation results in a direct reduction of a company’s profit.
Further, countries have endeavoured to reduce taxes by entering into double tax treaties with other countries. Double tax treaties are imperative in the realm of international tax as they ensurethat income derived from one country and remitted to another country is not subject to double taxation. However, it is disheartening to note that Kenya has entered into double tax treaties with only 8 countries and these do not include the other member countries of the East African Community!
The only major tax incentive, which currently exists in Kenya, is with respect to companies established as developers or operators in export processing zones (EPZ). These companies ideally manufacture goods for export. However the companies can sell their goods locally in which case, they will be subject to the normal taxes. During the 2004 budget, the Minister of Finance introduced an additional 2.5%, ad valorem, surcharge for all goods entered for domestic use from an EPZ. The EPZ companies angrily reacted to the introduction of this surcharge by threatening to close house. The reason for this is that the additional surcharge invariably makes these EPZ manufactured goods more expensive than even imports. In fact a leading EPZ company, Mecer EPZ Ltd, a computer assembly company ceased its operations. It argued that its operations were no longer sustainable since local assembly had become more costly whereas imported computers were zero-rated. Clearly the government shot itself on the leg, by seeking to increase revenue, without due regard of the consequence of its proposed action.
The government must reduce the tax burden on taxpayers to ensure that Kenya is perceived as an attractive destination for foreign investment.