Why production subsidies could increase taxes

Customers shop for subsidized maize flour at the Naivas Supermarket.

Customers shop for subsidized maize flour at the Naivas Supermarket at the junction of Moi and Kenyatta Avenues in Nairobi. Production subsidies have been used by governments to reduce the cost of production in key industries and to control the prices of consumer goods they produce.

Photo credit: File | Nation Media Group

What you need to know:

  • If the government gives tax credits to producers who also happen to be large taxpayers, then the missed taxes have to be recovered from elsewhere.
  • That could, in the long run, result in an increase in indirect taxes such as VAT, ultimately negating the gains of subsidies.
  • The subsidies may also result in unfair competition in key markets by creating unfair market tendencies.

Recently, while attending a Parliamentary Group meeting in Naivasha, President William Ruto opined that his administration will no longer subsidise consumption but concentrate on production. 

Production subsidies have been used by governments to reduce the cost of production in key industries and to control the prices of consumer goods they produce.

When correctly implemented, producers are able to produce more goods and services, thus increasing the overall supply.

This, in turn, increases the quantity demanded of those goods and services, thus lowering the overall price paid by consumers.

The production subsidies that can be implemented in Kenya include tax credits or reimbursements, paying part of the production costs to producers, lowering electricity costs for producers of key consumer goods and a review of taxes levied on imports of raw materials directly used in production.

Most of the taxes on raw material imports are directly passed on to consumers, raising retail prices for key consumer goods like maize flour, wheat flour and bread.

But a review of taxes and levies also presents a new challenge. If the government gives tax credits to producers who also happen to be large taxpayers, then the missed taxes have to be recovered from elsewhere.

That could, in the long run, result in an increase in indirect taxes such as VAT, ultimately negating the gains of subsidies.

Unfair market tendencies

The subsidies may also result in unfair competition in key markets by creating unfair market tendencies.

The subsidy advantages will be enjoyed by large producers, to the detriment of the small-scale ones.

Large producers buy materials in bulk and produce in huge quantities, hence enjoying economies of scale.

For lack of resources and equipment, small-scale producers do not.

Lastly, production subsidies will reduce efficiency and innovation by creating a dependence on the government, rather than organisational efficiency and effectiveness, to control production costs.

A production subsidy must be well thought out to achieve the desired results.

Mr Onyango is a finance professional. [email protected]

Welcome!

You're all set to enjoy unlimited Prime content.