New VAT Law Is A Money Machine For Government
The implementation of the long awaited new VAT law is in the offing if the step taken by the Finance Minster during his presentation of this year’s budget statement is anything to go by. Following the presentation of the VAT Bill 2012 in the parliament, there is only one hurdle before the new law becomes a reality.
The lawmakers now have the big task of determining fate of the Bill. The objective of the VAT Act overhaul described as “simplification and modernization” of the VAT legislation is expected to have far-reaching ramifications on the power of consumption on a majority of poor population. VAT has been a major source of revenue for governments world over and has in the recent past received significant attention due to its ability to marshal huge tax revenues. Considered key source of revenue, Kenya has undertaken several measures to expand VAT coverage over the years.
VAT has been regarded as a steadier source of revenue than an income tax because consumption constitutes more stable base than income which tends to vary greatly from year to year for individuals and particularly for corporations. By taxing consumption, VAT encourages investment and capital formation which foster economic growth.
In addition, evasion is more difficult and less likely than under an income tax, as each business has a financial interest in ensuring the VAT it pays on purchases is accurately recorded so that it gets credit against its VAT liability. At root, however, what makes VAT attractive is its ability to raise a substantial amount of revenue for the government with relative ease.
Arguably, Kenya’s fiscal situation could be described as weak. Although the country’s current deficit has garnered a lot of attention, of greater concern is the long-term mismatch between projected revenues and spending - gaps too great to plug with borrowing for fear of triggering a debt crisis.
The government desperately needs new revenue sources. To raise revenues, the policy makers would point to the corporate and individual income tax, urging the closing of loopholes on the corporate side and the raising of top marginal rates on the individual side. But the prospects for substantial new revenue from these sources are dim. The idea of raising the individual income tax is politically toxic since Kenyans already feel overtaxed. On the other hand global competition constrains increases in the corporate income tax.
As a matter of fact, a new source of revenue is required which has the ability to finance a robust public sector aimed at realization of the Vision 2030. Based on the existing constraints on the increase of income taxes, the easiest available option is properly designed VAT system. Most liberals reflexively describe VAT as regressive. The government appears to have been hoodwinked by the VAT’s attractive features at the expense of the ordinary citizens - chiefly its ability to raise a significant amount of revenue with relative political and economic ease while advancing its regressivity feature on the citizens.
VAT has been described by some people as tax that is “too good a money machine” that would fuel an unchecked expansion of government. Critics have touted that this tax would forever expand the size of government and transfer billions from productive private hands to the uneconomical hand of government.
The revenue-raising promise of the VAT has been overshadowed by aversion toward its regressive nature. A regressive tax is one that falls more heavily on lower income households. VAT is considered regressive because individuals and families at the bottom end of the income spectrum tend to spend everything they make with the accompanying tax taking a greater share of their income than it would for the affluent, who spend only a portion of their income and save the rest. The new VAT law appears to have not been exquisite in attaining the progressivity feature, a key element the ordinary mwananchi has been thirsting for.
Of great concern is the fact that the basic necessities which hitherto enjoyed zero-rated and exempt status will be taxed at the standard rate of 16%. The submissions made by the public against such a move and the amendments aired by the Cabinet while approving the Bill appear to have fallen on deaf ears. Amongst the major quest by the Cabinet was the need to zero-rate the basic commodities to cushion the ordinary citizens from the high cost of living. The raft of changes included in the new law is clearly a mockery of the famed reform process with the ability to derail the trajectory towards the achievement of the Vision 2030 as well as undermining the spirit of the new constitution which aims at enhancing a dignified life for every Kenyan.
The new law will see the scrapping of the reduced VAT rate of 12% applicable on electrical energy and heavy diesel. The increase in the VAT rate will undoubtedly increase the manufacturing costs which will ultimately be pushed to the final consumer. A number of basic necessities which were hitherto zero-rated will be liable to VAT. Such items include maize and wheat flour, milk and cream. In addition, a number of services that previously enjoyed zero-rated status will be liable to VAT.
These include the supply of water drilling and incidental services, transportation services in respect of unprocessed agricultural and agro forest produce, goods or services for use in the construction of grain silos, among others. Sanitary and pest control for domestic households which were previously exempt from VAT will be taxable at 16%. Services in connection with the disposal of the remains of the dead will not be spared either - VAT will be chargeable at the standard rate. The withdrawal of the zero-rated and exempt status on these supplies will lead to increased prices impacting negatively on the consumption power of low income earners.
The new VAT law may not bring anything to write home about for many Kenyans. For this law to be truly progressive and responsive to the needs of the average Kenyan, it needs to be designed carefully with its regressive edges smoothed out. A progressive VAT could be designed to soften the blow on spending by the poor. This can be accomplished through zero –rating necessities such as food and medicines. Whether this will be done before the finalisation of the new law is an issue many would want to vigorously debate on.
The writer is a tax expert with Ernst & Young. Email: email@example.com
Views expressed are not necessarily those of Ernst & Young.