Abstract
This selected issues paper assesses Kenya's revenue performance, the labor market, and the health of the banking sector. It analyzes Kenya's revenue potential, tax system, and economic activity while increasing revenues; assesses the labor market; and also notes the nonperforming loans (NPLs) in the Kenyan banking sector, especially in public sector banks, and suggests structural measures to reduce cost pressures in the banking sector, lower the NPLs, and reduce the spread between lending and deposit interest rates. It also provides the detailed statistical appendix of Kenya.
II. Scope for Increasing Kenya’s Revenues over the Medium Term1
A. Introduction
5. The fiscal situation in Kenya is currently precarious, and revenue-enhancing measures are needed to help strengthen fiscal performance and achieve fiscal sustainability while protecting important pro-poor spending. This section analyses Kenya’s revenue potential over the medium term. It finds that there is scope for streamlining the tax system, widening the tax base, and removing disincentives to economic activity, while increasing revenues. Taxpayers in Kenya generally regard themselves as highly taxed, as they have to comply with numerous taxes and levies. This section finds that taxes in Kenya are only moderately higher than in comparable African countries, but that the tax system is characterized by a high degree of complexity and nontransparency. Compared with other countries in the region, Kenya’s revenue performance, as measured by central government revenue-to-GDP ratio, is nevertheless, quite good (see Table 1). This measure, however, may be misleading, as there are indications that nominal GDP in Kenya is significantly underestimated. Improving the tax system should help to support the economic recovery and the development of the private sector.
Kenya: Consolidated Central Government Tax Revenue for Selected African Countries, 1996–2000
(In percent of GDP)
Fiscal year ending June 30.
Data for financial year 1999/2000.
19 Countries were included in the sample.
Kenya: Consolidated Central Government Tax Revenue for Selected African Countries, 1996–2000
(In percent of GDP)
| Tax Revenue | |
|---|---|
| Kenya1 | 21.7 |
| Uganda | 10.4 |
| Tanzania2 | 10.1 |
| South Africa | 25.2 |
| Zambia | 17.9 |
| Botswana1 | 16.9 |
| Ethiopia1 | 12.7 |
| Lesotho | 36.8 |
| Swaziland1 | 27.4 |
| Mauritius | 17.5 |
| Zimbabwe | 24.4 |
| Unweighted average for Africa3 | 17.4 |
Fiscal year ending June 30.
Data for financial year 1999/2000.
19 Countries were included in the sample.
Kenya: Consolidated Central Government Tax Revenue for Selected African Countries, 1996–2000
(In percent of GDP)
| Tax Revenue | |
|---|---|
| Kenya1 | 21.7 |
| Uganda | 10.4 |
| Tanzania2 | 10.1 |
| South Africa | 25.2 |
| Zambia | 17.9 |
| Botswana1 | 16.9 |
| Ethiopia1 | 12.7 |
| Lesotho | 36.8 |
| Swaziland1 | 27.4 |
| Mauritius | 17.5 |
| Zimbabwe | 24.4 |
| Unweighted average for Africa3 | 17.4 |
Fiscal year ending June 30.
Data for financial year 1999/2000.
19 Countries were included in the sample.
6. The rest of this section is structured as follows. Subsection B describes the recent revenue performance in Kenya, and Subsection C compares tax rates in Kenya with those in neighboring countries and selected emerging economies. Subsection D briefly outlines possible measures for reform.
B. Overview of Recent Revenue Performance in Kenya
7. Since the mid-1990s, central government revenue has declined steadily from the relatively high level of 29 percent of GDP in 1995/96 (July-June), to 21.6 percent in 2001/02. This decline in revenue, as well as the collapse of donor support, furthermore, led to a significant increase in domestic financing and a corresponding rise in domestic interest payments. The largest contributor to the decline in revenue was the policy-induced shrinkage of receipts from corporate taxes and excise duties.2 The perceived high level of taxation and nontransparency of the current tax regime, in addition, may have increased tax avoidance and tax arrears. Tax revenues have, moreover, been constrained by a small and stagnant tax base, owing mainly to the emergence of a large informal sector (see Section II) and tax exemptions and remissions.
8. Taxpayers in Kenya generally regard themselves as highly taxed, as they have to comply with numerous taxes and levies. The schedule of taxes includes the following: income tax, value-added tax, customs duty, excise duty, dumping duty, Kenya Bureau of Standards levy, industrial training levy, insurance levy, business permit fee (payable by Nairobi residents to the Nairobi City Council), Transport Licensing Board fees, and various other license fees (payable to the Nairobi City Council). There is also a catering levy, the National Hospital Insurance Fund, the fuel levy, the motor vehicle road license fee, the import declaration form fee, television and radio license fees, driving license fees, the rural electrification levy, the Electricity Regulation Board levy, and the exchange rate surcharge (levied by Kenya Power and Lighting), the stamp duty, the Dairy Board levy, and the Sugar Authority levy.
9. In addition to the large number of taxes and levies, Kenya also has various tax exemptions and remissions, which are reviewed annually at the time of budget. In the period 2000/01–2001/02, at least 86 different exemptions or remittances were made to the tax code (according to schedules 3 (A)-(C) of the Income Tax Act, 1973 (No. 16 of 1973)). This contributed to a narrowing of the tax base. It also created the impression that the government could easily be persuaded by pressure groups to grant exemptions to special interests. These developments have also raised concerns about the fairness and transparency of the tax system.
10. Despite some efforts to improve revenue administration in recent years, the tax regime in Kenya remains complicated and cumbersome to enforce. Although compliance rates for most taxes have increased, collection is still well under potential, especially for certain indirect taxes, such as the VAT and import duties.3 In a recent study on VAT compliance in Kenya, the Kenya Revenue Authority has found that the compliance ratio in 2000/01 was only 55 percent.4
11. In recent years, revenue forecasts have also changed frequently in-year, as projections have been complicated by the difficult political environment and problems in gauging the outlook for the economy. Moreover, the projected gains from new tax policy and administrative measures have tended to be too optimistic. This complicated budget management and contributed to an expansion in the stock of pending bills and stalled projects.
C. Comparison of Kenya Tax Rates with Those in Neighboring Countries and Selected Emerging Economies
12. Table 2 compares tax rates in Kenya with those in neighboring countries, as well as with rates in Kenya’s two main trading partners, South Africa and Egypt. The table shows that the rates for main tax categories in Kenya are only marginally above those in other African countries. The large number of other taxes and fees in Kenya, however, complicates both tax compliance and enforcement. The burden on the tax administration system of the multiplicity of taxes and fees is also high. Some of the minor taxes and fees do not generate large amounts of revenue and are perceived by taxpayers, especially businesses, as “nuisance taxes.”
Selected Tax Rate Comparisons
Revenue-to-GDP ratio for central government.
COMESA-Common Market for Eastern and Southern Africa
Ad valorem equivalent of specific rates.
Selected Tax Rate Comparisons
| Type of Tax/Duty | Kenya | Uganda | Tanzania | South Africa | Egypt |
|---|---|---|---|---|---|
| Revenue/GDP1 (percent) | 21.6 (2001/02) | 11.7 (1999/00) | 11.3 (1999/00) | 24.8 (2001/02) | 22.8 (1999/00) |
| Excise duties on beer: | 60 percent heavy beer; 85 percent light beer | 60 percent | COMESA,2 (US$.22/lit); non-COMESA, (US$.17/lit) | 2819.3c/lit (US$.35) on malt beer; 7.82c/lit (US$.01) on sorghum beer (US$1=R 8.00) | 100 percent3 (alcoholic beer) |
| Excise duties on cigarettes | 130 percent; cigars 30 percent | 122 percent | T Sh 14,000 per 1,000,000 | 194.25c/10 (US$.24/10) cigarettes | 141.4 percent3 |
| VAT/ GST rate | 18 percent (some items 16 percent or 2 percent) | 17 percent | 20 percent | 14 percent | 10 percent (standard rate) |
| Raw materials import tariff | 5 percent | 7 percent | 5 percent | 7 percent (some items 15 percent) | 3.5 percent |
| Personal income tax | 0-30 percent (five brackets) | 0-30 percent (four brackets) | 0-30 percent (four brackets) | 0-40 percent (six brackets) | 0-32 percent |
| Corporate income tax | 30 percent (40 percent for foreign branches) | 30 percent | 30 percent | 30 percent | 40 percent |
| Withholding tax on foreign remittances | 15 percent on interest, 10 percent on dividends, and 20 percent on management fees and royalties | 15 percent | … | Exemptions: R 1,000 on interest and R 1,000 on dividends (US$125.00) | No withholding tax on dividends |
Revenue-to-GDP ratio for central government.
COMESA-Common Market for Eastern and Southern Africa
Ad valorem equivalent of specific rates.
Selected Tax Rate Comparisons
| Type of Tax/Duty | Kenya | Uganda | Tanzania | South Africa | Egypt |
|---|---|---|---|---|---|
| Revenue/GDP1 (percent) | 21.6 (2001/02) | 11.7 (1999/00) | 11.3 (1999/00) | 24.8 (2001/02) | 22.8 (1999/00) |
| Excise duties on beer: | 60 percent heavy beer; 85 percent light beer | 60 percent | COMESA,2 (US$.22/lit); non-COMESA, (US$.17/lit) | 2819.3c/lit (US$.35) on malt beer; 7.82c/lit (US$.01) on sorghum beer (US$1=R 8.00) | 100 percent3 (alcoholic beer) |
| Excise duties on cigarettes | 130 percent; cigars 30 percent | 122 percent | T Sh 14,000 per 1,000,000 | 194.25c/10 (US$.24/10) cigarettes | 141.4 percent3 |
| VAT/ GST rate | 18 percent (some items 16 percent or 2 percent) | 17 percent | 20 percent | 14 percent | 10 percent (standard rate) |
| Raw materials import tariff | 5 percent | 7 percent | 5 percent | 7 percent (some items 15 percent) | 3.5 percent |
| Personal income tax | 0-30 percent (five brackets) | 0-30 percent (four brackets) | 0-30 percent (four brackets) | 0-40 percent (six brackets) | 0-32 percent |
| Corporate income tax | 30 percent (40 percent for foreign branches) | 30 percent | 30 percent | 30 percent | 40 percent |
| Withholding tax on foreign remittances | 15 percent on interest, 10 percent on dividends, and 20 percent on management fees and royalties | 15 percent | … | Exemptions: R 1,000 on interest and R 1,000 on dividends (US$125.00) | No withholding tax on dividends |
Revenue-to-GDP ratio for central government.
COMESA-Common Market for Eastern and Southern Africa
Ad valorem equivalent of specific rates.
13. Table 3 provides a further comparison of VATs in Kenya and some other selected economies. As is evident from the table, the VAT efficiency ratio5 for Kenya is below the average for the selected group of emerging market countries.6 Exemptions and low compliance largely account for this. The VAT efficiency ratio for Kenya is, however, above the average for Africa.
VAT Rates and VAT Revenue Efficiency Ratios for Selected Countries, 1998–2000
VAT Rates and VAT Revenue Efficiency Ratios for Selected Countries, 1998–2000
| VAT Rate (percent) | VAT Efficiency Ratio | |
|---|---|---|
| Kenya | 16.0 | 0.33 |
| Uganda | 17.0 | 0.20 |
| Tanzania | 20.0 | … |
| South Africa | 14.0 | 0.44 |
| Zambia | 17.5 | 0.33 |
| Turkey | 18.0 | 0.49 |
| Brazil | 20.5 | 0.42 |
| Colombia | 16.0 | 0.28 |
| Venezuela | 14.5 | 0.22 |
| Average for sample of emerging market countries | 16.6 | 0.37 |
| Average for Africa | 16.7 | 0.24 |
| Average for OECD | 17.6 | 0.40 |
VAT Rates and VAT Revenue Efficiency Ratios for Selected Countries, 1998–2000
| VAT Rate (percent) | VAT Efficiency Ratio | |
|---|---|---|
| Kenya | 16.0 | 0.33 |
| Uganda | 17.0 | 0.20 |
| Tanzania | 20.0 | … |
| South Africa | 14.0 | 0.44 |
| Zambia | 17.5 | 0.33 |
| Turkey | 18.0 | 0.49 |
| Brazil | 20.5 | 0.42 |
| Colombia | 16.0 | 0.28 |
| Venezuela | 14.5 | 0.22 |
| Average for sample of emerging market countries | 16.6 | 0.37 |
| Average for Africa | 16.7 | 0.24 |
| Average for OECD | 17.6 | 0.40 |
14. Notwithstanding the issues raised above, on the whole, the Kenya tax system has performed better than average for Africa. This is mainly attributable to a stronger tax administration system and a relatively large formal sector.
D. Possible Measures to Improve Revenue Performance Over the Medium Term
15. The following areas could form the basis of a medium-term program aimed at strengthening revenue collection:
a simplification of the tax regime, including a broadening of the tax base. Areas for possible broadening include the lowering of tax thresholds for main taxes, while eliminating smaller taxes and fees, with negligible revenue yields;
a rationalization of exemption system to avoid a further erosion of the tax base;
a strengthening of the Kenya Revenue Authority (KRA). This could include (i) the enhancement of KRA’ enforcement ability through improved staffing and training and better integration of KRA operations; (ii) the development of fully integrated automated and computerized systems for tax assessments; and (iii) improving the audit functions, especially through more frequent audits; and
a review/change of tariff rates and introduction of revenue-raising measures to compensate for possible losses arising from any further liberalization of the trade regime.
Prepared by Davina F. Jacobs.
Kenyan authorities sought to encourage private sector investment by reducing taxes. Their original aim was to reduce the tax burden to close to 24 percent of GDP by 1999/2000.
See N. H. Ngari, “Tax Reforms and Revenue Productivity in Kenya” (unpublished; Lilongwe, Malawi: University of Malawi, 2000).
See Kenya Revenue Authority, VAT Micro-Simulation Model (Nairobi, Kenya: Kenya Revenue Authority, 2002).
This ratio is used as a measure of VAT performance and is defined as the ratio of VAT revenue to GDP divided by the VAT rate. An efficiency ratio of 0.33 means that a 1.0 percent increase in the VAT rate would generate an increase of about 0.33 percentage point of GDP in VAT revenue (Liam Ebrill and others, The Modern VAT (Washington: IMF, 2001).
The group of emerging market countries was selected on the basis of the availability of data and comprises South Africa, Turkey, Israel, Brazil, Chile, Colombia, Peru, and Venezuela.