By Tax Justice Network Africa (TJNA), the East African Tax and Governance Network (EATGN), and Africa Centre for People, Institutions and Society
What are tax expenditures?
When a government wishes to financially support a vulnerable sector or community, it does so in various ways.
For example, to address period poverty in Kenya by improving girls’ access to sanitary pads, the government could decide to provide free or subsidised sanitary pads to schools by allocating funds to the relevant ministries for their provision. This would be reported as a direct expenditure.
Alternatively, the government could exempt pads from value-added tax (VAT) to reduce their cost. In doing so, the government would be foregoing the tax that girls would have paid when purchasing sanitary pads. This is also an expenditure by the government, but more specifically, a tax expenditure.
Tax expenditures are the revenues foregone by a government through tax exemptions, incentives, deferrals, or allowances. Essentially, any deviation from what the actual tax rate should be, is a tax waiver.
The importance of tax expenditure reports
In the same way that reporting on direct expenditures by government ministries is treated as a crucial aspect of the budget-making process and inspires public confidence, so should reporting on tax expenditures.
Tax expenditure reporting enhances the transparency and accountability of the government in public finance management. Tax expenditure reports help the public understand how much the government is losing, or foregoing, due to various tax incentives and exemptions.
Further, understanding who the beneficiaries of these exemptions and incentives are, as well as the underlying purposes, enhances public participation in revenue conversations. It enables the public to evaluate whether tax concessions are meeting their intended purposes (e.g., increasing foreign direct investment), and helps governments to ascertain how efficient the tax incentives are.
Kenya’s 2021 Tax Expenditure Report
Despite the importance of tax expenditure reports, many African countries still lag behind in publishing them.
The Kenyan government only recently began publishing its tax expenditure reports; and even then, the 2021 Tax Expenditure Report was published following much pressure from international financial institutions such as the IMF, to increase fiscal transparency and tax efficiency.
One of the most important aspects of a tax expenditure report is the level of detail. The ideal report includes every tax waiver, and in Kenya, this is supported by the Constitution.
Ideally, the report should outline all the waivers provided by the government, and then give estimates of the revenue loss occasioned by this.
Kenya’s 2021 Tax Expenditure Report did not achieve this. Surprisingly, several tax regimes, including the tax incentives that the government provides within the country’s special economic zones (SEZs) and export processing zones (EPZs), were missing from the report.
This is particularly important because in the past few years, there have been calls for reviewing the efficacy of EPZs and SEZs. In essence, the benefits of these zones in comparison to what is being lost through tax incentives have been questioned. Publishing the tax expenditures of these zones would enable a cost-benefit analysis to be conducted, and allow for more informed decision-making.
Another missing detail in the tax expenditure report is the income tax concessions provided for foreign aid by the Kenyan government.
Tax exemptions on foreign aid are a controversial subject as evidenced by the general uproar following the income tax exemptions to Japanese firms, consultants and personnel who are undertaking projects that are financed through grants. These involved 16 projects that amounted to about Ksh328 billion.
Further, double tax relief measures should be included in the tax expenditure report. Kenya currently has 14 double taxation agreements in force. Double taxation agreements often provide lower rates of taxes, and in some instances, they are exploited, leading to double non-taxation.
Since Kenya is increasingly widening its double taxation treaty, it is important that tax expenditures under double taxation agreements be included regularly in the report.
The 2021 Tax Expenditure Report indicated that value-added tax (VAT) in 2020 had the highest tax expenditure at 2.18 percent of GDP, in comparison to tax expenditures under corporate income tax (CIT), which was at 0.53 percent of GDP.
However, tax expenditures under CIT could potentially be higher than under VAT once some of the important aspects that were omitted in the 2021 report are included.
It is highly commendable that Kenya has publicly released its first tax expenditure report. To ensure that the government is held accountable, it is essential that tax expenditures be included in the budget-making process and presented annually.
Further, it is necessary to ensure that allincentives are included in tax expenditure reports, including those provided under the EPZs, SEZs, and other preferential tax regimes, as well as double taxation agreements.
In the absence of any specific tax expenditure reporting, it should be imperative that reasons for such exclusion are provided. This will ensure that fiscal policy is shaped in a manner that is fair, equitable, and efficient.
Further, the reports should be used to evaluate tax expenditures. With the data generated through the tax expenditure reports, it is important for the government to carry out cost-benefit analyses on the tax concessions provided. Are they meeting their intended objectives? This data will be very helpful in shaping Kenya’s tax policy regarding tax incentives.
This article is part of activities of the forthcoming African Parliamentary Network on illicit Financial Flows and Taxation (APNIFFT) Conference, plus the Pan African Conference (PAC) on Illicit Financial Flows and Taxation, to be held in Lusaka, Zambia, from 26-29, September 2022.