This article first appeared in my weekly column with the Business Daily on July 29, 2018
Last week Ghana announced that it is recalculating its Gross Domestic Product (GDP) based on measurements from 2013 instead of 2006 to more accurately reflect recent activity in the petroleum, communication technology and construction sectors. The rebasing will likely add 30 to 40 percent to the size of Ghana’s economy. The rebasing of Ghana’s GDP is a reflection of how the size of African economies are often understated. This understatement is informed by three factors.
Firstly, the actual number and size of businesses actively operating in Africa and contributing to GDP is unknown. Most African governments do not have the operational muscle to conduct research and analysis on the number of functioning business in the economy, their size, profits, or turnover. This is partly informed by the fact that the private sector in Africa is dominated by informal businesses, most of whom are Micro and Small Enterprise (MSE) primarily engaging in subsistence business activity. The combination of millions of MSEs operating in informality coupled with the lack of data gathering and statistical capacity in African governments to collect business activity data translates to notable inaccuracies in terms of the actual number and size of operational businesses on the continent.
Secondly, private sector in African tends to understate business size and profit earnings in order to minimise tax liabilities. Again, African government capacity is limited as African taxmen do not have the ability to ensure all companies are posting accurate tax returns. Most companies on the continent have two books of accounts they keep: the official audited reports that are submitted to investors, tax authorities and government bodies, and the internal books that reflect what is actually going on in the business. Given limited tax surveillance muscle, it relatively easy to dodge tax penalties and, most African taxmen are happy taxes are being voluntarily submitted and thus often do not bother to ensure if profits and tax liabilities are being accurately reported. The effect is again, an understating of how much money businesses are making on the continent.
Finally, there are incentives for African governments themselves to understate GDP size. Dimitri Sanga, ECA Director for West Africa echoes my view that some African countries purposefully avoid rebasing GDP upwards to reflect current realities in order to avoid graduating from low income to middle income countries. Low income status comes with certain perks such as cheap loans, generous aid packages and charitable trade agreements.
In short, evidence seems to indicate that there is more money being made in Africa than is being reported and thus GDPs in Africa are probably higher than what is officially captured. And while some countries will rebase GDP upwards in order to access larger loans and shift debt-to-GDP ratios into favourable terrain, it is up to African governments to determine whether rebasing or deliberately understating GDP is in their national interest.
Anzetse Were is a development economist; email@example.com
This article first appeared in my weekly column with the Business Daily on June 3, 2018
The National Treasury tabled the Income Tax Bill 2018 which, among other actions, has the general thrust of taxing individuals and companies at higher rates than previously was the case. The focus here will be on the opposite ends of the financial spectrum: large companies with taxable income of more than KES 500 million and Micro and Small Enterprise (MSE) most of whom have fewer than 5 employees and generally operate informally, outside what government considers to be the tax net.
Treasury’s rationale for the new taxes and tax hikes is simple: government needs to raise more money in order to plug the fiscal deficit and reduce borrowing in the spirit of fiscal consolidation. But the core question should be: Are these tax hikes justified? With regards to the Corporate Tax, while it can be argued that large companies can afford to pay the 35 percent, the core question is, why? What will corporations get in exchange for the additional amount charged? Rather than approaching the income tax bill from a perspective of service enhancement, government is motivated by more aggressive revenue generation. Given the reality of high costs of doing business in Kenya, the proposed increases simply add another stone on an already heavy load. Perhaps if costs such as electricity, land and transport were more manageable, the effect of added costs in the form additional taxes would be less pronounced.
The proposed presumptive tax on the informal sector, of 15 percent payable by individuals with incomes below KES 5 million applying for single business permits, is unfair and short sighted. At the moment, government provides basically no services to MSEs to support their productivity, profitability and growth. Most MSEs operate in dilapidated shacks with no electricity, water and sanitation, and often next to open sewage and piles of garbage. Government, at both national and county level, seem unable to invest in supporting MSEs, yet here is government introducing a punitive new tax. The question MSMEs will have is, again, why? What will MSEs get in return for paying this new tax? The presumptive tax may motivate informal MSMEs to go further underground because they know they are the new tax target, and since most operate at a subsistence level, any additional cost will truly pinch. Thus, rather than creating an enabling environment for MSEs, government introduces a tax that will make it even riskier for MSEs to conduct business in an already difficult environment.
However, the strongest argument against the tax hikes is corruption and the flagrant lack of fiscal accountability. This Bill is being tabled in the context of one of the largest cases of the mismanagement of public funds Kenya has seen in recent years. Ergo, Kenyans will wonder whether these new tax hikes will improve service provision, or whether the money will be used to buy public officials new properties and cars after being diverted into personal accounts.
Unless government demonstrates that it is a responsible custodian of public funds, tax rates can continue to be escalated without translating into tangible benefits. Rather than scrutinise its own failings, government is being intellectually lazy and increasing tax on an already stretched private sector. Perhaps with some self-reflection and tough action within government itself, government would find it can live within its current means and need not saddle private sector with additional taxes.
Anzetse Were is a development economist; firstname.lastname@example.org
This article first appeared in my weekly column with the Business Daily on August 27, 2017
Fiscal policy in Kenya over the past 5 years has been characterised by several features the first of which is aggressive growth in expenditure. Cytonn Investment makes the point that over the past 6 years, total expenditure in annual budgets have grown at an average of 14.7 percent yet revenue growth has only increased by 12.7 percent. This has led to more borrowing and expanding fiscal deficits with an increase in debt levels from 40.7 percent debt to GDP in 2011 to the current 54.4 percent. While some argue that Kenya’s debt is not at distress levels, if current patterns of spending continue the distress point will be quickly reached. Thus, it is important to ask how policy should be structured over the next 5 years to put the country on a more sustainable fiscal path.
At national level, fiscal focus should target cutting non-essential expenditure; government needs to be very firm on this and make the hard decisions required to prevent profligate spending, particularly in recurrent expenditure. Cytonn makes the point that recurrent expenditure accounts for 58.8 percent of the 2017/2018 budget. One way to address this issue is through robust support to the Salaries and Remuneration Commission (SRC) to cut salaries and better align compensation packages to reflect the economic reality of a developing African economy. The current association between public office and wealth accrual needs to be severed and stern fiscal policy backed by political commitment can make this happen. Further, a keener eye should be cast over the efficiency of government spending; procurement at national and county must focus on value generated for funds spent. Without doing so, Kenya will find itself on a path where careless and inefficient spending leads to debt accretion that doesn’t stimulate the economic growth required to meet debt obligations.
Secondly, revenue generation needs to be ramped up; expenditure is growing at 14.7 percent and revenue collection by only 12.7 percent. Revenue collection has to grow faster than expenditure if the country is to have greater funds available for public investment. One way to do this is by better supporting the KRA to prevent illicit financial flows from the country; a serious problem for African countries. The United Nations Economic Commission for Africa estimates that Africa loses more than USD 50 billion through illicit financial outflows per year. Devex points out that companies evade and avoid tax by shifting profits to low tax locations, claiming large allowable deductions, carrying losses forward indefinitely, and using transfer pricing. Government ought to undertake an audit of tax policy, restructure outdated tax laws and correct faulty tax arrangements with multinational companies; KRA needs to be supported to improve enforcement of these laws.
At county level, fiscal policy needs to be characterised by, again, cutting down on unnecessary spending. County governments have to take the initiative on this and so far there have been encouraging signs of newly elected governors choosing to fully or partially redirect massive inauguration budgets to more productive areas; this should be encouraged. Further, county government budget processes ought to be more transparent; at the moment there are significant gaps in understanding how county budgets are formulated and implemented. More counties should follow in the footsteps of Elgeyo Marakwet county and develop a transparent, formula-based budget development process that prevents elite capture in budget formulation and deployment.
Anzetse Were is a development economist; email@example.com
This article first appeared in my weekly column with the Business Daily on June 19, 2016
The informal economy has been a theme of mine this year and since the budget speech, even more so. The government seems to have caught on to the financial potential of tapping into this sector for revenue generation purposes, and understandably so. The informal economy is estimated to contribute to 34 to 35 percent to the country’s GDP and currently generates over 80 percent of jobs created in the country on an annual basis. My concern is that what will happen is a heavy handed reflex from government to over-regulate and intimidate informal economy players into paying taxes. I think this would be the wrong approach due to several reasons.
Firstly, the Kenya Revenue Authority (KRA) has already taken a step in the right direction by introducing itax and making it easier for individuals and businesses to pay taxes. As a result, some informal economy players who found the tax process too difficult to comply with voluntarily registered and started paying taxes. Another useful initiative the KRA is doing to facilitate tax compliance is working with county governments to recruit informal economy businesses who have established business premises such as in malls or office buildings, to pay taxes. To be clear, there is a difference between facilitating compliance and intimidating people and businesses into it. Thus I think the KRA should continue to focussing on facilitating tax compliance and scaling up their efforts on sensitising the general public on how to file taxes as well the benefits of doing so; benefits such as having a paper trail of tax compliance that make it easier for small businesses to qualify for financing or become suppliers for government contracts.
Secondly, there should be a distinct effort by government to improve the efficiency, productivity and profitability of the informal economy. As it stands, informality tends to overlap with poverty and low income. Due to the fact that it is often the poorly skilled who find themselves stuck in the informal economy as the qualifications for employment in the formal economy often serve as automatic disqualifiers, informal economy players need to be supported in building their ability to manage and scale up their businesses, as well as making their businesses more profitable. Therefore, government bodies should work with county governments to seek input from informal economy players on the factors they think constrain the growth of their informal businesses. There is already a sense that training in areas such as bookkeeping, business management, and market access strategies would be valuable for this sector. Thus rather than aiming to squeeze out as much as possible from a sector that is still largely defined by poverty, government should support informal businesses to become more profitable. This would likely then make more in the informal economy willing to pay their share of taxes because as it stands, most feel they are too broke to pay taxes as they are already struggling to get by.
Finally, the government should give tax amnesties to informal businesses that register and start the journey towards tax compliance. Government should give such business at least a three to five year tax amnesty period. The reason why this amnesty is so important is that it not only allows small businesses to develop the capacity to comply, it also provides a time period over which support to the informal businesses, such as that detailed above, can be deployed. This amnesty would also allow government to collect much needed information and data on the informal economy that can be used to better support the sector. Government could then, for example, use such data to establish realistic tax bands for small businesses.
In short, the informal economy is too valuable a sector of the economy to me intimidated out of existence or pushed further underground by threats of punishment for failure to comply with tax obligations. The priority should be for the KRA to continue facilitating tax compliance as other arms of government work to support players in the sector to become more profitable. Only then can a realistic conversation about more robust tax compliance occur.
Anzetse Were is a development economist, firstname.lastname@example.org
This article first appeared in the Business Daily on February 7, 2016
The National Treasury has expressed concern over counties borrowing money domestically without permission from national government. In the 2014/15 Financial Year four counties borrowed a total of Sh1.9 billion, with Nairobi being the biggest borrower at Sh300 million. Technically, counties are only allowed to borrow from the domestic market to fund capital projects with high economic growth potential in line with the Public Finance Management Act. As a result, Treasury has instructed all bank and non-bank financial institutions to stop lending to counties and start recovery of un-guaranteed loans.
Counties however argue that they are being forced to borrow because government routinely fails to send money in on time to meet their financial obligations. In fact a county official with whom I talked to about this issue said that if government released funds on time, counties would have no need to seek commercial loans to finance their activities. The official further added that the process of government releasing county funds to county accounts is long, cumbersome and bureaucratic and thus counties always find themselves with pending payments they cannot meet thus pushing them to seek loans to meet their obligations. The Treasury argues that there is no need for counties to seek credit because counties have been leaving billions of shillings idle in their reserve fund accounts at the Central Bank of Kenya. The county official asserted that this is not the whole story; for example some counties have activities that need to funded such as arrears in bills left by previous county governments that need to be settled urgently, yet the procedures for applying for funds are so long and laborious that they have to borrow to meet short term costs. However, the real issue here is not the bickering between central and county government, the issue is uncovering the implications for the country in counties racking up debt in an unchecked manner.
Firstly, a real concern is that the rates at which counties are getting access to credit and whether these are sustainable and realistically serviceable. Indeed, if left unchecked county debt could create a scenario where money is siphoned away from required expenditure to meet debt obligations.
Linked to the point above, borrowing by counties does not seem to be informed by the ability of counties to generate independent revenue to not only finance local activities, but debt obligations as well. County revenue generation at county level in Kenya is anemic; in the financial year 2013/2014 county generated revenue accounted for a mere 25 percent of their budgets. Further, counties have been lazy in gunning for the tax option to raise revenue and the resistance they face on this means it may take time for counties to raise significant revenue locally. Yet counties have already started borrowing in a manner not necessarily informed by their revenue generation capacity. Thus, a scenario could unfold where counties have to seek bail outs from central government to meet their debt obligations.
Thirdly, the potential escalation of county government debt in the regions with little transparency is particularly problematic. Until county governments demonstrate a commitment to transparency and anti-corruption, county level indebtedness may not lead to development or economic growth. As a result county governments may find themselves servicing what has been essentially dead debt.
Finally, county government debt accumulation may mean that the government as a whole becomes increasingly leveraged, the extent of which is uncertain. It is crucial that central government keeps track of total government debt divided between central and county governments. A threshold level of debt accrued by county governments has to be determined so that any county level borrowing does not cross an upper limit that could over leverage the country.
Anzetse Were is a development economist; email@example.com
This article first appeared in my weekly column with the Business Daily on December 6, 2015.
Last week a slate of new taxes were effected increasing the prices of goods such as bottled water, cars, beers and cigarettes. Although these items can be viewed as luxury items rather than essential commodities, the tax hike calls Kenya’s tax policy into question. The government has made it clear that it seeks to expand its tax base and rope in more individuals and businesses into the tax net as well as introduce new taxes to strengthen revenue generation. However, does the current tax policy contribute to or detract from revenue generation as well as economic growth?
On one hand are those of the view that current tax policies are subpar for several reasons. Firstly, some analysts argue that of the 2.4 million people who are formally employed, only 1.4 million (including corporations) are taxed. This is important because, according to the Institute of Economic Affairs (IEA), of the total tax revenue collected by the government over the last decade, the largest contributors are income tax, about 40% followed by VAT at 28%. Secondly, even of those taxed, the limited reach of the taxman, and laxity and corruption therein, facilitate tax evasion. For example, many businesses especially in the informal sector are not taxed; this should be rectified. Thus those in this camp are of the view that KRA can do more to expand the tax base, curtail tax evasion and collect more revenue.
On the other side of the equation are those of the view that Kenyans are over-taxed. In a country where 45% of the population lives at or below the poverty line, how much money can be extracted from such a population in the form of tax? Further there are tax equity questions; IEA makes the point that of the total labour force (15-64 years) of slightly over 10 million, less than 20% bear the burden of paying PAYE tax. Therefore the idea here is that government focus should not be on introducing new taxes or increasing taxes, effort should be placed on increasing levels of employment so that a larger portion of the labour force is formally employed and therefore can be taxed. This could eventually create scenario where higher overall employment widens the base of those taxable such that individual tax burdens can be reduced.
Another issue that ought to be considered in tax policy is the Laffer curve. The curve suggests that as taxes increase from low levels to higher levels, tax revenue collected by the government also increases. However, if tax rates increase after a certain point this reduces incentive to work hard or work at all, thereby reducing tax revenue. Where does Kenya’s tax policy sit on the Laffer curve? Such research ought to be done to determine if the current tax policy is optimal or not.
Finally, and perhaps this is the most compelling point: if Kenyans are of the view that their taxes are being misused and misappropriated in the form of corruption by public officials, there will be limited incentive to be tax compliant. Kenyans have the right to expect the provision of services from government in return for paying taxes. At the moment, there are far too many corruption cases pointing to the blatant misuse of public funds as a result, there is little reason for the average Kenyan to feel compelled to pay taxes. Therefore, the onus falls on government to demonstrate that taxes are being used appropriately and efficiently. Perhaps then incentive will be created in every individual and business in Kenya to be tax compliant.
Anzetse Were is a development economist; firstname.lastname@example.org
This article first appeared in my weekly column the Business Daily on August 17, 2015
Kenya, like many other African countries, has a dualism issue in the structure of its economy that informs the patterns of the economic development of the country. Although there are several forms of dualism active in the Kenyan (and African) economy, the article will focus on formal vs. informal dualism.
The formal sector of the economy comprises of activities that are captured in GDP statistics, tend to comply with legal and regulatory requirements (i.e. tax compliance, implementation of labour laws etc), offer jobs that are financially secure and tends to be the wealthier section of the economy. However, the informal sector exists as well.
Informal sector activities are typically not captured in official GDP figures, are often not officially registered, are not formally regulated, do not necessarily meet legal operational requirements and are typically not tax compliant. According to the IEA, in Kenya, the informal sector is estimated at 34.3% and accounts for 77% of employment. Over 60% of those working in the informal sector are youth aged between 18-35 years, 50% of which are women. In the East Africa region, the sector is the source of 85% to 90% of all non-farming employment opportunities. According to NORRAG, the informal sector is no longer confined, in terms of practice or as an image, to the road-side mechanic or dress maker, the sector now includes other areas such as ICT and related service enterprises. In fact the informal sector is now present in a wide range of business operations where skills are demanded and where opportunities for productive employment generation are found.
There are multiple implications of this formal vs. informal dualism; firstly the lack of clarity on the precise size of the informal sector translates to a lack of certainty with regards to the size of the Kenyan economy. Do GDP figures capture the informal sector? Although the informal sector is said to contribute about 18% of the GDP, is this a comprehensive figure? Is it understated or overstated? Is the economy is actually bigger or smaller than assumed? To what extent is the informal economy ‘guesstimated’ into official GDP figures? The ambiguity of the size of the informal sector means that Kenya does not really know how big the economy is; this then informs the accuracy of statistics such as the debt-to-GDP ratio that provide useful information on the extent to which the country is leveraged.
This formal vs. informal dualism also inform factors such as the ability of the country to move comprehensively in one direction. Policies and laws pertinent to the economy are mainly implemented and monitored with regards to the formal economy, leaving the informal behind. Other issues include social protection; workers in the informal economy are generally not covered by adequate social protection. This makes informal workers a vulnerable and sizable proportion of the Kenyan population.
Quality assurance is an additional issue. The formal economy tends to comply with established standards and quality norms; this is not necessarily the case in the informal sector. Some may meet industry standards while others do not; this has implications for consumer protection rights. Another issue is productivity; most informal sector players cannot afford analysis that informs them of the productivity of their enterprise. Thus inefficiencies are likely to continue in the informal sector, dragging down the sector’s efficiency.
Skills transfer is an additional issue of importance. While the government may change curricula in Universities and TVETs, this does not truly affect the informal economy as 60% and 73% of informal sector employees (with less than 20 employees) acquire their skills through apprenticeships. So the formal sector is likely to benefit for updates in curriculum while the informal sector does not. There are already implications to this dualism because, for example, apprentices in informal auto mechanics sub-sector have dropped sharply because many of the “older master mechanics” do not have skills to handle the “newer versions of injection engines”, they only know carburettor engines.
While there may be efforts being made to formalise the informal sector the reality is that there is limited incentive for the informal sector to do so. Formalisation is often an expensive process with registration fees, lawyer’s fees, social insurance payments for employees and, the big one, tax. Why should informal business owners formalise if the exercise will be expensive with limited benefits accrued?
In terms of a way forward, the informal sector in Kenya should develop Informal Sector Associations, as seen in West Africa, which are tuned into skills updating and allow for an easier track of emerging training needs. Such associations also allow for self-regulation, make it easier for interventions to be implemented and facilitate easier and a more accurate monitoring and analysis of the sector.
Anzetse Were is a development economist; email: email@example.com