Kenya’s economic landscape is profoundly shaped by its fiscal policies, with the annual finance bills setting the tone for tax laws and other financial measures. These bills play a crucial role in determining the country’s revenue streams, budget allocations, and overall economic strategy. However, the implications of these policies, particularly the taxation of motor vehicles, have sparked significant debate about their broader economic consequences.
Let’s begin with the economic impacts of excessive taxation. At the heart of Kenya’s fiscal strategy is the mobilization of revenue to fund government expenditures, including public services, infrastructure projects, and social programs. Yet, high taxes can have far-reaching and often detrimental effects on the economy.
High taxes directly cut into the disposable income of consumers, leading to reduced spending on goods and services. This decrease in consumption can stymie economic growth as businesses face diminished demand. For instance, Kenya’s VAT rate of 16%, among the highest in East Africa, erodes consumer purchasing power and escalates the cost of living.
The Kenya National Bureau of Statistics (KNBS) reported an inflation rate of 8.6% in April 2024, largely driven by high taxation on essential goods. There is a likelihood to see both international and local businesses shut down their operations due to the changes proposed in the finance bill. The proposed high tax rates create a less inviting environment for business investment.
Kenya’s corporate tax rate of 30% is notably higher than the 20-25% average in many emerging economies, discouraging both domestic and foreign investments. According to the World Bank’s Ease of Doing Business Report (2023), Kenya ranks 60th out of 190 countries, with high taxes cited as a significant barrier. Elevated operational costs due to taxes reduce profitability, prompting businesses to cut costs, often through layoffs or reduced hiring.
Excessive taxation stifles entrepreneurship by diminishing the potential returns on new ventures, dampening innovation, and slowing the establishment of new businesses. Kenya’s GDP growth rate slowed to 4.2% in 2023 from 5.8% in 2022, partly due to restrictive tax policies. High taxes reduce incentives for productivity improvements, thereby slowing overall economic growth.
Despite the government’s efforts to crack down on tax defaulters, the need to ensure credibility and target is far reached. The introduced tax rates are likely to see an increase in tax evasion and avoidance. When tax rates are perceived as punitive, taxpayers are more likely to engage in illegal activities to evade their obligations.
The Kenya Revenue Authority (KRA) estimates that tax evasion and avoidance cost the country approximately KES 220 billion annually. The former KRA Commissioner General Githii Mburu once noted, “Our biggest challenge remains the high levels of tax evasion and avoidance, which undermine our revenue collection efforts.”
This not only reduces the effectiveness of tax collection but also fuels the informal economy, complicating fiscal management.
The Case Against High Motor Vehicle Taxes
Among the various taxes proposed in Kenya’s finance bills, those levied on motor vehicles have generated considerable debate. The taxation of motor vehicles encompasses import duties, excise taxes, and VAT, significantly inflating the final price of vehicles.
Shifting the focus to affordability and accessibility, high motor vehicle taxes make car ownership unaffordable for many Kenyans. The import duty on motor vehicles in Kenya is 25%, supplemented by an excise duty of up to 35% and a VAT of 16%. These taxes create substantial barriers to personal transportation, particularly for lower-income individuals.
According to the Kenya Motor Industry Association (KMIA), the cost of owning a new car in Kenya is approximately 45% higher than in neighboring countries like Uganda and Tanzania. This exacerbates economic disparities, limiting mobility and access to opportunities for a significant portion of the population.
The automotive industry bears the brunt of high motor vehicle taxes which has led to a decline in vehicle sales, adversely affecting local dealerships, manufacturers, and the broader supply chain. In the first quarter of 2024, new vehicle registrations in Kenya dropped by 10% compared to the same period in the previous year, as reported by KNBS.
This downturn results in job losses across the industry, impacting not just manufacturing but also sales, maintenance, and ancillary services. The automotive sector contributes approximately 6.5% to Kenya’s GDP, and such declines can have severe economic repercussions.
While high taxes on conventional vehicles might be justified to reduce environmental impact, they must be balanced with incentives for cleaner alternatives. Promoting the use of electric and hybrid vehicles through tax breaks or subsidies can help transition towards more sustainable transportation.
Currently, electric vehicles (EVs) constitute less than 2% of Kenya’s vehicle market, partly due to the lack of substantial tax incentives. Additionally, investment in public transportation can provide viable alternatives to private vehicle use, alleviating traffic congestion and reducing pollution.
However, if high taxes are not accompanied by such measures, they may fail to achieve their intended environmental benefits while imposing significant economic burdens.
The government’s reliance on motor vehicle taxes for revenue generation is understandable, it however, can be problematic if it discourages vehicle ownership to the extent that it reduces overall tax intake.
In 2023, the Kenya Revenue Authority collected KES 180 billion from excise duty, a significant portion of which came from motor vehicle taxes. However, a balanced approach that includes moderate taxes and incentives for environmentally friendly vehicles can maintain revenue streams while promoting public welfare.
Would finding a balance save the day?
Policymakers face the challenge of striking a balance that ensures sufficient revenue without stifling economic growth or placing undue burdens on citizens and businesses. Excessive taxation can undermine economic activity, discourage investment, and reduce the standard of living. Therefore, a nuanced approach is essential.
A strategic tax policy involves moderate and well-targeted taxes that do not excessively burden consumers or businesses. Setting tax rates at levels high enough to generate necessary revenue but low enough to encourage compliance and minimize evasion is critical.
For motor vehicles, this could mean lowering import duties and excise taxes while offering incentives for environmentally friendly vehicles. This may include reducing the excise duty on electric vehicles
to 10% which may encourage their adoption, balancing environmental goals with economic considerations.
To foster a conducive business environment, the government could implement tax incentives aimed at attracting foreign and domestic investment. These incentives might include tax holidays, reduced rates for specific sectors, and exemptions for activities that promote economic growth and job creation.
Kenya could look at models from countries like Rwanda, which offers tax incentives to attract investors in high-potential sectors, leading to a GDP growth rate of over 8% annually in recent years.
Improving tax compliance is another critical component.
Strengthening tax administration, increasing transparency, and leveraging technology to streamline tax collection processes can enhance compliance. The KRA has made strides in digital tax systems, but further improvements could ensure that the government collects due revenues while reducing the scope for evasion and avoidance.
President William Ruto emphasized the importance of compliance, stating, “We must leverage technology to seal revenue leakages and ensure every shilling due is collected.”
This could be the time to walk the talk
Ensuring that the tax system is equitable and fair is crucial. Progressive taxation, where higher-income individuals and corporations pay a larger share, can help address social inequalities. Measures such as targeted tax reliefs and subsidies for essential goods and services can protect low-income households from the adverse effects of taxation.
For instance, removing VAT on basic food items can significantly alleviate the cost of living for the most vulnerable populations.
Kenya’s annual finance bill is a critical tool in shaping the country’s fiscal policy and economic trajectory. While the government’s efforts to mobilize revenue through taxation are necessary, excessive taxation can have unintended negative consequences. High taxes on motor vehicles, in particular, pose significant challenges by making car ownership unaffordable, impacting the automotive industry, and potentially undermining environmental goals.
Policymakers must navigate these complexities by adopting a balanced approach that promotes economic growth, encourages investment, and ensures social equity.
By implementing moderate and well-targeted taxes, enhancing compliance, and providing incentives for sustainable practices, Kenya can achieve its fiscal objectives while fostering a thriving and equitable economy.
