Before we introduce VAT on petroleum, let us ponder likely policy implications

When global oil prices are coming down, governments across the world normally harvest more revenues in the form of increased taxes.

That is also the time when countries that subsidise product costs withdraw or reduce subsidies. Psychologically, consumers are less likely to notice or feel the changes as long as the net effect is reducing pump prices.

Last week, a newspaper article indicated that the Treasury had agreed with the International Monetary Fund (IMF) to introduce 16 per cent value added tax (VAT) on all petroleum products.

Currently only liquid petroleum gas and industrial fuels are charged VAT. From the article, the implication was that this was a quid pro quo for IMF to release a Sh62 billion loan for budgetary support.

I sincerely hope that the VAT and the loan subjects are not directly related. VAT has far reaching and long term implications on the country, while a support loan is only a short term budgetary quick fix.

I know IMF has a fixation on the subject of VAT for anything that is tradable. And I have no particular problem with additional petroleum taxation. What I have an issue with is the apparent insufficient analysis of the overall socio-economic consequences of such fiscal actions.

And I have two examples of recent IMF-induced tax actions which I think were imprudently applied.

First is the introduction of VAT on animal feeds which drastically reduced both the activity and productivity in the animal husbandry sector, which is considered a huge employment multiplier.

The opportunity cost of reduced economic activity in the sector is most likely more than the tax realisations from animal feeds. The second example is the much discussed “keg beer/sorghum” case study.

Increasing excise duty on keg beer negatively impacted a new and flourishing sorghum agricultural enterprise which was offering new economic opportunities and jobs to semi-arid counties.

Simultaneously, low income alcohol drinkers who previously relied on cheaper keg beer turned to alternative unhygienic liquor with serious social impacts and fatal consequences.

The additional tax from keg beer may probably never be large enough to balance the negative socio-economic impacts resulting from this fiscal action.

I will now relate a past story of policy-driven petroleum taxation. In June 1979, I was requested by a deputy secretary in the Treasury (the late John Gachui) to provide expert assistance to prepare a petroleum tax framework for the forthcoming budget. He wanted a structure that would reduce negative impacts of the sudden and huge oil price increases prompted by the Iranian revolution.

Together with two Treasury officers, we were given a few tax policy guidelines. Firstly, to protect the all-important agricultural sector which was the main source of foreign exchange and jobs.

Secondly, to safeguard poor households from the oil price shock. Thirdly, find a way of reducing oil demand and hence the oil import bill which stood at about 30 per cent of total national imports.

We were also given a total annual tax figure that had to be collected from petroleum. I could see the political significance of this exercise as President Moi had just taken over leadership of this country and the high oil costs presented a major economic (and political) challenge.

Prior to this exercise, taxes for petrol, kerosene and diesel were all equal. The team defined diesel as a critical “economic driver” especially for agriculture and therefore must be protected with lower taxes.

Kerosene we defined as a poor household fuel that must also carry reduced taxation. We classified petrol as a “discretionary” fuel whose demand can be reduced significantly by simply “compelling” consumers to change their driving habits. Petrol users, therefore, had to be “punished” with high taxes.

Our recommended taxes were a shocker to car owners. The easing of taxes on diesel and kerosene was all loaded on to petrol. The products’ tax differentials created in 1979 persisted until 2010 when the Treasury, faced with similar escalating oil prices, and guided by similar socio-economic policy drivers, selectively reduced taxes on diesel and removed all taxes from kerosene, while leaving petrol taxes intact and high.

During the 1979 exercise the team also recommended minimum airport prices for Jet A-1 to curb an ongoing irresponsible transfer pricing on international jet fuel.

Oil re-exports had to deliver increased dollar value to warrant their foreign exchange allocation for imports. We also recommended that Uganda imports their oil direct instead of buying from Kenya to ease balance of payments burden.

Introducing a 16 per cent VAT uniformly across all products (as required by the IMF) is not advisable. The taxation instrument for petroleum products should remain the excise duty, not VAT.

The Treasury can then vary excise duty differently from product to product, and from time to time, as economic conditions shift.

It is not practical to achieve this with a fixed 16 per cent VAT. Use of excise duty also lessens the burden on VAT refunds

To complete my 1979 story, I was actually in that year a manager working for a multinational oil company and was the designated oil industry liaison person with the Treasury on price increase matters.

To cover myself on the issue of conflict of interest, I actually did seek and receive clearance from the oil industry CEOs.

With reduced oil prices there is scope for increased taxation on petroleum, but it should be excise duty increase and not introduction of VAT. It should also be policy driven and not IMF pushed.

George Wachira is the director, Petroleum Focus Consultants. [email protected]