Treasury is walking a fiscal tightrope

As he prepared the supplementary budget that was passed in Parliament this week, Treasury Secretary Ukur Yatani was truly walking a fiscal tightrope.

The biggest challenge he faced as he wrote the budget was how to rapidly increase resources to create additional room in the fiscal strategy to fund the fight against the coronavirus pandemic.

He had to ramp up the spending on testing equipment, personal protection equipment, ventilators, hospital beds, and at the same time make adequate provisions for basic services for people who have to be quarantined.

It was not going to be an easy task especially when you consider the fact that the supplementary budget was coming against the backdrop of a government that was already saddled with expensive debts, shrinking budget revenues, and a precarious health system that struggles to provide ordinary services, let alone responding to a pandemic.

Compounding the situation was the fact implementation of the raft of fiscal measures announced by President Uhuru Kenyatta to sustain the economy through the pandemic was going to cost the country a loss of Sh172 billion in annual revenues.

For instance, in reducing VAT from 16 percent to 14 percent as per the presidential directive- the Kenya Revenue Authority (KRA) was going to incur revenue losses amounting to Sh49 billion. In terms of income taxes-both PAYE and Corporation Tax, the estimated loss of revenues was Sh68 billion. In all, the measures announced by Mr Kenyatta were going to cost the taxman a total of Sh172.1 billion in revenue shortfalls.

How does one successfully navigate such a tight situation? From what I read, and after scrutinising the Taxation (Amendment) Laws, 2020, passed in Parliament this week, Mr Yatani calculated that the most expedient way between raising budgetary resources for expenditures on the coronavirus, and ensuring that the country does not plunge into fiscal ruin, was by implementing a thorough and comprehensive raid on tax exemptions.

According to the papers Mr Yatani tabled in parliament, he expects that raid on tax exemptions will generate for him at total of Sh117 billion.

Indeed, the raid on tax exemption is -by far- to be the most aggressive attack on the tax incentive in Kenya regime in years. But was Mr Yatani right in eliminating tax exemptions in the manner he has done? Was this action based on expedience or on sound economics? The jury is still out.

What is clear is that the idea of eliminating and rationalising the tax exemptions regime did not start with Mr Yatani’s regime nor pressures on the public purse by the coronavirus pandemic. Over the years, there have been growing concerns that our tax exemption regime had evolved into an arbitrary affair, changing at whim and fancy of influential wheeler dealers, depending on the individual wielding most of the power at the National Treasury.

A recent study by the World Bank estimated that the government loses about six percent of GDP every year through various tax incentives accorded to companies. The study found that in 2018 alone, the tax revenues forgone by the government because of tax exemptions were Sh535 billion.

On VAT alone, the study revealed that the government was losing Sh370 billion every year. And under the Income Tax Act,- PAYE, Corporation Tax and investment related deductions, revenues forgone was Sh91 billion a year. The study revealed that revenues forgone under customs duties, excise duty, Import Declaration Forms (IDF), Railway Development Levy and VAT on customs, annual revenues amounted to Sh74 billion.

What is clear is that - if the partial lockdown of the economy remains in place for a longer time, the challenges before the finance minister will be bigger than can be dealt with by merely tinkering with tax exemptions and by tweaking the development budget.

The National Treasury will remain overstretched like it has never been in many years. Cutting the development expenditure by eliminating projects that are not absorbing funds from the spending plan may have been the prudent thing to do.

But in the coming months, financial management will be reduced to a cut and paste job - with the National Treasury finding itself constantly juggling to create fiscal space for expenditures on the fight against the coronavirus pandemic.