Kenya’s tax increase a risky gamble

Increasing taxes in an environment of high cost of living is usually detrimental to a country’s overall economic growth.

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In an environment characterised by high unemployment and escalating living costs, the Kenyan government’s decision to raise taxes poses a significant threat to the country’s economic growth. Increasing taxes in such a precarious economic landscape risks exacerbating financial burdens on both citizens and businesses, potentially leading to a deeper economic downturn.

This strategy could affect consumption, hinder investment, and ultimately result in a declining GDP.

The detrimental effects of high taxation during economic hardship are evident in several African countries. For instance, amidst hyperinflation exceeding 600 percent and high unemployment, Zimbabwe introduced a 2 percent tax on electronic transactions in 2019.

This policy led to reduced economic activity and a shift towards the informal sector, contributing to a significant GDP contraction from 3.5 percent in 2018 to -8.1 percent. Similarly, a few years ago an inflationary South Africa imposed high tax rates on individual and corporate incomes that led to dampening of investment and consumer spending, resulting in a 5.96 percent GDP decline.

Nigeria also faced high inflation and unemployment rates, yet its government imposed multiple taxes, including VAT increases.

These measures strained household finances and reduced economic growth, contributing to a 1.8 percent GDP decline in 2020, its steepest since the 1960s. In Ghana, the government introduced high taxation in a high inflationary environment where the cost of living was already high and this led to reduced consumer spending and shrinking business investments, slowing GDP growth to 0.4 percent in 2020.

Therefore, increasing taxes in an environment of high cost of living is usually detrimental to a country’s overall economic growth.

Instead of increasing taxes, the Kenyan government can adopt several strategies to stimulate economic growth and improve government revenue. One approach is to broaden the tax base by integrating the informal sector into the formal economy.

Simplifying tax compliance and offering incentives for small businesses to register can help achieve this. For instance, Rwanda’s approach to formalising its economy through streamlined tax systems and SME incentives has been quite effective.

Improving tax collection efficiency through digital solutions can also boost revenue. KRA’s iTax system, which has streamlined tax filing and payment processes, can be further enhanced to reduce tax evasion and improve compliance, thereby increasing revenue without raising taxes.

Promoting domestic investment and attracting foreign direct investment (FDI) can also significantly boost economic growth. Creating a favorable business environment through regulatory reforms and infrastructure development can attract investors.

Effective management and monetisation of natural resources can generate substantial revenue. For example, Botswana’s prudent management of its diamond resources, ensuring that proceeds are invested in infrastructure and education, has ensured economic prosperity. Kenya can adopt similar strategies with its natural resources including tourism.

Encouraging innovation and supporting startups can drive economic diversification and growth. Implementing policies that attract venture capital, support research and development (R&D) and reduce bureaucratic hurdles can foster a vibrant entrepreneurial ecosystem.

Nigeria’s tech sector, supported by investments in innovation hubs and incubators, illustrates how fostering entrepreneurship can lead to economic growth and diversification. Even though Kenya has done a commendable job in attracting technology investments, more needs to be done in order for the economy to be transformed into a technology integrated economy.

In conclusion, raising taxes amid high unemployment and high cost of living is a risky strategy that could hinder Kenya’s economic growth.

The experiences of Zimbabwe, South Africa, Nigeria, and Ghana and others highlight the dangers of such policies. Instead, Kenya should focus on broadening the tax base, enhancing collection efficiency, attracting investments, leveraging natural resources, and fostering innovation.

These strategies can boost economic growth, improve living standards, and increase government revenue without imposing additional burdens on an already strained populace.

By adopting these approaches, Kenya can navigate its economic challenges and pave the way for sustainable development and prosperity.

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