‘E’ for Economy: Experts decry lack of strategic tax reforms

Paper napkins: Alarming fumbling afflicts Kenya’s economic management lately.

The unprecedented IMF talks on November 7, with Kenya Association of Manufacturers (KAM) poking taxation in the domestic economy, knocks Kenya’s sovereignty; and the laments of the Controller of the Budget (COB) on budgeted corruption and tax cuts for the corporate sector questions our direction.

KAM upped its game of seeking tax favors from government by laying their woes in a warm-up act directly to IMF, a tongue-in-cheek watchdog of mismanaged countries.

Question: Can IMF take the work of the National Treasury? The COB earlier decried a lack of strategic tax reforms to optimise tax revenue and dismissed short-sighted tax increases and budgeted corruption.

Pointedly, she lamented her approval of payments for public debt representing borrowed money is untraceable to actual economic activity… I cannot see the things I am paying for... COB won’t be the last to call out the current spree of tax increases and budgeted theft.

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On taxation increases, her question is valid. There lies in the dustbin of taxation theory and practice an annoying revenue proposition, the Laffer Curve (LC), that some repeatedly try to revive, only to see reality toss it back in the bin.

The National Treasury may be the latest practitioner to officially make the trip. It will backfire. Countries trying to cut taxes to favor the rich while piling pain on the underclass face a dilemma.

British PM Liz Truss and her erstwhile Chancellor Kwasi Kwarteng based their fairy tale tax cuts on the LC and were tossed out in weeks after almost crushing the British economy.

Despite being unattractively presented like a camel’s hump, LC is the fiscal darling of conservative governments justifying tax cuts for the wealthy, the idea of an economics Professor from University of Chicago.

He drew it on a paper napkin at an indulgent dinner in the USA with Republican honchos, and it matched their politics of shifting taxes to the poor as he spoke in tongues, and from two sides of his mouth.

If there were no taxes, so it goes, the government would earn zero revenues. As tax rates rise, labor still comes to work as disposable incomes (earnings left to workers after taxes) are still worthwhile. Government revenue thus rises.

But it hits a tipping point when at high tax rates of top income earners, say 100 per cent, people may choose leisure over work. Increased government revenues evaporate. Why work only for government to vacuum into its pocket all of the 100 per cent extra income?

Better to go swimming at the beach. Thus, was born supply-side economics: and a false conjecture that cutting back high-level tax rates to below the tipping point could entice workers back to work; and to an increase government revenues and spending.

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Government can then spend large. Except that most people at high incomes and tax brackets are rich, returning from the beach only reluctantly. Tax cuts they receive may dissuade big government spending, while they may not plough it back to the economy as investment.

The government’s dream of higher revenues and spending is undermined. The economy contracts.

Kenya never learns: Consider the evidence in Fig.1. The KAM looks for tax cuts and varied incentives to entice fleeing corporates back to work. And for direct foreign investors packing their bags to reconsider.

Contrary to justifying a tax cut, within an overall medium-term strategy of taxation (that does not even exist in Kenya) the global evidence portrays the distorted reasoning of an acquiescent National Treasury readying to cut corporate taxes, Laffer curve style. It is symptomatic of our unthinking sycophancy to foreign influencers. 

The muddle which I first presented in The Weekly Review in February, comparing Kenya’s tax rates with global averages and for 31 African countries, with data published in 2020 by OECD, is so telling it bears repeating.

It is hard to find a reputable economist who thinks the downward slope is the credible step to take in Kenya. Corporate taxes (11 per cent of GDP) already are among the lowest rates in the world, even compared with 31 African countries (19 per cent). Personal Income Taxes, and taxes other than VAT, are higher in Kenya than the average in 31 African countries.

One US President, George H. W. Bush, even called such frameworks voodoo economics. Unbelievably, Kenya’s attempt also flies in the face of a stunning deepening of problems already reported by KRA on niggardly corporate tax compliance and official contradictions.

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Kenya teems with corporate tax leakages and evasion via transfer pricing and shenanigans of trade taxes. Even capital flight and company closures may carry elements of tax evasion by men in suits. It’s a game of cat and mouse – read the reports in detail.

KRA, the taxman, reports the impacts of the bungled tax framework in their books, and the revenue setbacks persist despite deployment of 1,400 service assistants with paramilitary training in the field to tweak tax compliance.

According to KRA statistics for the last fiscal year ended June 2023, only 129,313 out of 862,336 firms registered for Corporate Income Tax (CIT) paid their dues. This translates to 15 per cent compliance. Non-compliance stands at a staggering 85 per cent. This does not even count the nefarious methods used in the corporate world against taxes – transfer pricing, reporting losses etc, as tax evasion and avoidance strategies.

Or that in addition, Kenya features in well-documented findings (for instance, the commission at AU headed by former South Africa President Thabo Mbeki, showing the African continent loses at least US$50 billion annually to illegal transactions).

Bad omen for the economy: The KRA report on the National Treasury’s position on the problem ranks right up there with the infamous dinner and its napkins where supply-side economics was born for the rich, and who use it to press for tax cuts.

The proposed further lowering of already low corporate taxes to induce compliance and attract investors goes against the reality exposed in the KRA report. Key firms have declared profit warnings.

The economy can ill-afford a deteriorating formal sector with big enterprises failing in tandem with what remains of the low rates of formal employment, and with taxable corporate income pickings falling further.

This is the narrative in the current CBK Kenya Financial Stability Report. Kenya Power and Lighting Co, Kenya Airways, Unga Ltd, Express Kenya, Ltd, Eveready EA PLC, Centum, Old Mutual, Kenya, and now Sasini, currently have flagged profit warnings. Some 42 per cent of foreign investors (some 6,256) fled NSE.

About 60 per cent of SMEs are in default. For a banking system where, commercial banks thrive on high returns (from purchasing securities using customer deposits, rather than financial intermediation in core banking) the excuses for whetting the government’s borrowing appetites rather than lending to the private sector, are dressed as an easier sell by heaping blame on policy-induced Non-Performing Loans triggered by high interest rates. The current economic crush of private sector activity is thus as predictable as the collapse of revenue collection which we turn to. 

Why place the burden of adjustment on the poor? Checking the bottom-line, why has the fig leaf of corporate tax cuts not been offered for Personal Income Taxes, VAT, for instance, levied on Wanjiku? Are we back to colonial hut taxes enslaving Africans? Why are the poor (over 80 per cent living in the hand-to-mouth informal sector or even unemployment) paying higher PIT and non-VATs than corporates or African countries? Why collude with multilateral institutions to adjust economic hardships from the poor while sparing the rich?

Diminishing revenues: Much more intriguing is where the government expects the revenues to come from; clearly not from the grandstanding and aggressive behavior on taxes under way on baggage at the JKIA. Microeconomics teaches that consumers substitute or go without goods and services, and live poorer, pushing back on revenue uptake.

A contracting economy also pushes many into poverty. Fig. 2 tracks growth from the Second Quarter of 2021 when it was 11 per cent. Growth has trended freely downwards to as low as 3.8 per cent, and the plunge only recent rains halted the trend (not economic policy). From basic food production, not from economic recovery.

For macroeconomists, Kenya’s contemporary failure is to try to muddle through with obscure constructs such as the Medium-Term Revenue Strategy (MTRS) thrown by multilateral bodies (in 2016). It is a meatless bone to pick in the name of domestic revenue mobilisation when the economy is contracting. Such cut-and-pastes, without facing the duty to develop our own central framework and tools for medium-term economic recovery, will end in tears.

True north: output growth spurs revenue growth. As former President Mwai Kibaki demonstrated, after inheriting and reviving Daniel arap Moi’s collapsed economy, redirect the collapsed monetary sector and broken fiscal side; rebuild a policy mix for growth; repay debts; stabilise budget; improved household incomes. No one gets it despite the free fall in growth.

Dr Wagacha, an economist, is a former Central Bank of Kenya chairman and adviser of the presidency