The debate over the proposed tax measures seems to generate more heat than light. While there is a general disaffection with higher prices for goods and services, there is little information on legitimate ways in which government can increase revenues to support service delivery. The debate is not limited to Kenya’s borders, it is also taking place on the global stage.
Last month, the Group of Seven advanced economies agreed to support a minimum global corporate tax of at least 15%. Since these developments are taking place simultaneously, it makes sense to consider the guiding principles that constitute a good tax.
Although there are several theories of taxation in public economics, notable contributions were made by Adam Smith in his book, The wealth of nations. He described four main criteria that characterize an appropriate tax. In its definition, good taxes are proportional to income or ability to pay, some rather than arbitrary, payable at times and in ways convenient to taxpayers and ultimately cheap to administer and collect. These principles provide us with a framework from which we can assess the adequacy of tax measures.
An effective way to assess the adequacy of taxes is to classify them into two broad categories: production taxes and consumption taxes.
Taxes on production focus on the supply side of the economy and include those incurred in the production of goods or services. They are closely linked to the factors of production; land, labor, capital and enterprise without which no form of production would be possible. They include corporate tax, personal income tax and property tax applied to the value of the land.
Consumption taxes focus on the demand of the economy and are levied on the consumption of goods and services. They include value added tax and excise tax.
Production taxes tend to easily meet Smith’s criteria. They are proportional to the ability to pay and easy to administer. However, consumption taxes such as VAT are regressive on income and tend to fall as a percentage of income as income increases. A business executive will pay the same VAT on a loaf of bread as a high school student despite remarkably different income levels. They are also very difficult to manage if only by the number of VAT cases before the courts.
As Kenya moves towards a new fiscal policy, policymakers should identify the right balance between production and consumption taxes needed to meet the country’s fiscal targets. Estonia is a good case study. For the seventh year, the country has been awarded the title of the best tax code from the OECD.
Key attributes include a 20 percent corporate income tax rate, a 20 percent flat-rate personal income tax, its property tax only applies to the value of the land, and it has ‘a territorial tax regime which exempts 100 per cent of the profits of national companies from national taxation.
Additionally, from a stability standpoint, Kenya should be cautious with consumption taxes given their historic role in triggering major uprisings. In the United States, the tea tax led to the American Revolution while in India an excise tax on salt led to the famous salt march of Mohandas Gandhi.