As a tax, value added tax (VAT) works better in a country with a large formal sector with established practices of good record keeping and where the level of tax compliance is high.
Kenya is the opposite. Here, the informal sector accounts for between 60 to 80 per cent of the economy. We also know that out of a working-age population, only 1.8 million are on formal wage employment. The majority are in the informal sector.
There is a second reason why implementation of VAT in our context is bound to be problematic. The threshold for registration under VAT is annual turnover of Sh 5 million. In other words, 90 per cent of private enterprises in this economy operate below the VAT threshold.
Accordingly, all VAT that they incur on their inputs and purchases sit on them as a ‘final tax’. They can’t charge VAT on their sales but must absorb VAT on their purchases. In other words, they must adjust prices whenever there is an increase of VAT.
If you are registered, you are able to offset the VAT you have paid to the amount you are due to pay the Kenya Revenue Authority (KRA).
What is my point? It is that before you levy VAT on a critical input in the economy –for instance- petroleum products or fertiliser or agrochemicals you must calculate the likely impact on the majority of the population.
In our context, where VAT is a final tax to a large swathe of enterprises in the private sector, any minor upward adjustment will ripple through the supply and value chains, causing havoc and exacting big changes in consumer prices.
Didn’t we all hear the Agro Chemical Association of Kenya protesting that the proposal to increase VAT on agro chemicals by 16 per cent was going to increase their costs by 50 per cent? The East Africa Farmers Federation also came out to protest, pointing out that their costs would go up by 40 per cent.
Which brings me to the controversy over the introduction of VAT on petroleum products.
When the proposal to impose 16 per cent VAT on petroleum products came up, the MPs decided to kick the can down the road for two years. Clearly, our policymakers did not look at the picture.
Because petroleum products are a critical component in three areas of the economy - transportation, power, cooking and lighting, we should have given the idea of imposing VAT on it a little more thought.
Take the example of cement. Transporting clinker to the factory will now go up by eight per cent. Burning the clinker in the ovens will require power whose cost will go up by eight per cent of fuel cost adjustment. To ship the cement to customers- I have to incur eight per cent more cost on fuel. When the transporter- who will be an SME not registered under VAT- the cement to the building site, they also incur the extra eight per cent VAT.
The point here is this. An eight per cent increase on VAT on petrol does not mean that consumer prices will go by a mere eight per cent.
Because of the ripple effect, the increase in prices to the final consumer may go up by a massive 50 per cent because of this telescopic effect.
This is the point our policymakers missed when they sought to give the impression that bringing down VAT on fuel from 16 per cent to eight per cent was such a big concession.
Even as we were obsessed with VAT on petrol, a bigger crisis is looming in the important agriculture and food sector.
VAT on agrochemicals and pest control products was surreptitiously moved from zero rating to VAT exempt.
The upshot of that is that VAT on inputs can no longer be claimed as before.
The immediate reaction by the agrochemical industry was to apply VAT from July 18 which is the date of assent of the Finance Bill. The industry went further to warn farmers to expect to pay 50 per cent more on agro chemicals and pest control products.
We are staring at higher prices to farmers, less use of agro chemicals, and higher food prices. Farmers are not as influential as motorists when it comes to influencing policy.