Tax policies are producing unintended results

A recent tweet from someone who shall remain anonymous went to great length explaining the Law of Unintended Consequences. Being the person who deals with tax matters on a regular basis, this tweet got me thinking about the large number of unintended consequences our tax policy is throwing up!

For those not familiar with the Law of Unintended Consequences, a quick Google search (is there any other kind of search these days?) takes one to the Wikipedia page, which describes “an unintended consequence as an outcome or outcomes that are not the ones intended by a purposeful action”.  

It goes on to say that there are three possible types of unintended consequences: positive, negative or one that creates a perverse effect. It’s rather unfortunate that most of the unintended consequences that arise from Kenyan tax policies fall in the latter two categories, begging the question as to why this happens.

Many observers of the country’s tax regime agree that spiralling government expenditure is encouraging the introduction of new taxes that produce short-term revenue gains but often end up with long-term pain for the taxpayer, and potentially to the entire economy.

Take the one tax that is dear to the hearts of many and was withdrawn with this year’s Budget only for the authorities to inexplicably re-introduce it in the recent Finance Act.  I am referring here to the notorious withholding VAT. 

Now here is a provision that to my mind lacks logic, reason and equity. I cannot imagine a more pointless way to raise revenue! In essence withholding VAT was designed to widen the tax net by ensuring that VAT registered businesses accounted for VAT. That was the intended consequence and it is debatable whether it has in fact been achieved.

The unintended consequence has been a significant rise in VAT refunds that is partly caused by the long wait for withholding VAT agents to provide taxpayers with certificates to reclaim the tax deducted at source. 

The pile-up of VAT refunds backlog has resulted in business having to borrow often at exorbitant costs to raise working capital. I would suggest that a significant proportion of the VAT refunds due by December 31, 2013 — estimated at Sh30 billion — arose because withholding VAT applied.  And yet we have reintroduced it in the recent Finance Act.

Let’s now turn to excise duty on bank charges which was introduced a couple of years ago. Not only did the new tax apply to bank charges but also to money transfers both in the banking and the cellular system. 

The intended consequence was clearly to raise additional revenue. The question must be how much has this tax raised? The Kenya Revenue Authority’s (KRA) own admission is that going by the target collections that were set when the tax was introduced, the amount so far raised is probably immaterial in the scheme of things. 

The unintended consequence has been and continues to be a significant rise in the cost of doing business. It is interesting to note that if one assumes that 60-70 per cent of the bank charges levied today is for business, then that percentage of the targeted collections will be tax-deductible by the payers. Effect — the target number goes down further.

The second unintended consequence and perhaps the more worrying is the excise duty on money transfers. The majority of Kenyans use mobile money. The addition of 10 per cent excise duty on the charges has perhaps significantly increased the cost of this service for people. Could that have been the intention?

Then there is the withholding tax that was introduced for the extractive industry on the sale of shares or transfer of rights. Thankfully it has been abolished in the recent Finance Act although its replacement is just as worrying. The intended consequence was for the extractive industry to pay tax for what is perceived to be gains made for the period they hold the licence.  In reality there were no gains being made by players in the industry.

All that was happening — and this is common in the industry — was that risk and financing was effectively being spread for commercial reasons. 

The unintended consequence for the nascent extractive industry has, however, been significant. What is clear is that the transfer of rights in this industry is not uncommon and happens globally as the players rush to explore and hopefully move to full-scale production.

A tax such as the one we introduced simply pushes investors away. Clearly not achieving the consequence we wanted. 

Without the industry players and their skills and knowledge, our natural resources will remain firmly in the ground — benefiting no one.

Back to excise duty which over the years was fondly (by some at least) referred to as a sin tax because it is usually levied on all those sinful things we enjoy. A rise in excise duty on some of these items, particularly alcoholic beverages, has the intended consequence of increasing revenue collections.

The reality, and here is the unintended consequence, is that people move away from the now more expensive drinks to the illicit market. The effect of this is clearly seen is an increase in the number of deaths from illicit brews. That surely could not have been the intention.

Secondly, a drop in sales as a result of increased excise invariably results in a drop in corporate profits. The effect is a reduction in corporate tax and VAT particularly given that nearly all traders in illicit brews are not in the tax net.

Any discussion of the unintended consequences of tax policy in Kenya cannot be complete without another look at VAT refunds. We have already dealt with one aspect of it — withholding VAT.  The level of VAT refunds is in the region of Sh30 billion and it is difficult to see that there is any intended consequence in having amounts of this magnitude due to taxpayers. 

The cynics amongst us may well take a different view. It is the unintended consequence that is of more concern. In essence these refunds are a form of interest-free borrowing for the government (and here is where the cynics probably have a point!).
But for business it comes with a significant cost in terms of additional working capital facilities.

The interest paid for additional borrowings would in itself have created many economic opportunities through employment and new investment. 

If we are to compete in the global market, this particular unintended consequence needs to be addressed once and for all. We have heard many promises and a lot of procrastination and yet refunds are not being made.  As I said, tax policy is littered with unintended consequences. It really isn’t clear whether this is being considered when new tax measures are introduced but I would strongly suggest that more in depth thinking is called for.

Mr Hira is a partner at Deloitte East Africa. Views expressed here are his own.