Revenue collected through tax payment is the engine power behind every sovereign state in the world.
That notwithstanding, tax collection, since time immemorial, has never been the easiest of disciplines. It is an affair that calls for striking a delicate balance between ensuring taxpayers pay their fair share accordingly, and making the environment within which tax revenues are generated, as conducive as possible.
With this in view, it has been incumbent on tax administrations to explore possible ways to make tax payment a more appealing experience and at the same time recruit additional taxpayers. One way through which this has worked well is provision of tax incentives and exemptions. Kenya, for instance, has a tax incentive and exemptions framework whose objective is not only to promote the local taxpayers but also woo investors to invest in the country.
Such an incentive is the capital investment deduction where an investor who incurs capital expenditure on building and/or machinery used for manufacture is entitled to an investment deduction equal to 100% of the cost. Value Added Tax (VAT) exemptions granted to local manufacturers on specified products and donor-funded projects also constitute part of an array of tax incentives provided by the government.
Despite the vibrant economic activities on the ground spurred by these incentives and exemptions, which correspond to the growth of the gross domestic product (GDP), the same does not reflect in the revenues collected. The place that tax revenues could have taken ends up being taken by the exemptions or incentives. Within the economic and tax realms, such incentives are known as tax expenditures.
There are five classes of tax expenditures. The first class is known as tax exemptions. As the word suggests, this means that where a tax exemption has been granted, there is no tax due for the taxman’s collection. Another class of tax expenditure is allowances, which involves allowing certain deductions on the base revenue before allowing the standard tax rate to apply. A classic example is industrial building deductions and mining deductions. The third class is credits, which entails deductions from tax liabilities such as income tax relief granted to individual taxpayers every year.
Fourthly, there is rate relief, which translates to reduced tax rate. In light of the prevailing global pandemic of Covid-19, the government has granted a number of tax reliefs to cushion citizens during these hard times. For instance, a 100 per cent tax relief has been granted to employees who take home less than Sh24,000 per month. The VAT rate has also been reduced from 16 per cent to 14 per cent further exemplifying instances of tax relief. The fifth category of tax expenditures is tax deferral where there is a legal delay in payment of tax liabilities. For instance, the 10-year tax holiday enjoyed by the Special Economic Zones (SEZs).
As noted earlier, the rationale behind granting of tax incentives and exemptions is to primarily spur investment growth. However, because of the various tax incentives and exemptions we have in place, the amount of tax expenditures continues to sour up every year. According to a recent study by the Kenya Revenue Authority (KRA) on the Economic Impact and Cost-Benefit Analysis of Tax Expenditures in Kenya, the amount of revenue foregone annually to the tax incentives in place has snowballed from Sh100 billion in 2012 to Sh478 billion in 2017.
On the cost-benefit analysis of tax incentives vis-à-vis investment, the study which covers the period from 2014 to 2019 shows that the manufacturing sector accounted for the highest level of capital-related deductions at 24 per cent compared to other sectors. Despite this benefit, the sector’s investment rate for the period of analysis was only 0.116 per cent. The study further estimates that for the period covered by this analysis, the country forewent revenue to a tune of Sh216.9 billion to tax incentives. Again, the foregone revenue outweighed the accrued benefits from the tax incentives. Annually, the corporate income tax foregone to capital expenditure deductions is Sh60.367 billion which outweighs the accruing benefits by Sh36.691 billion.
The above analysis and a myriad others conducted in the recent past demonstrate that there is a dire need to review our tax incentives and exemptions framework with a view to ensuring that the accruing benefits outweigh the foregone revenue. This intervention will go a long way in bridging revenue deficit in the country.
Ms Kariuki is a Development Policy Analyst with a bias in Private Sector Economic Enablers