Impact of indirect tax policy reforms on revenue performance in Kenya

Abstract

The largest source of government revenue in Kenya is taxation. Domestic revenue mobilization is a key priority for providing governments with funds to deliver public services, for sustainable development agendas and investing in development. Tax and non-tax revenue are critical components of domestic resource mobilization. Over the years, there have been major changes in tax systems of various countries including Kenya. The motivation for these reforms has varied from country to country. For many developing countries, the impending fiscal crisis has provided the need for immediate tax reforms to enhance revenues. Kenya has undertaken massive tax reforms since the late 1980s under the Tax Modernization Programme. The significance of Indirect taxes over direct taxes as a means of raising government revenue, has gained momentum and is viewed as more favorable for investment and growth. Little is known about the performance of the reforms in terms of its revenue raising capacity for each tax category. This study aims to examine the impact of tax reforms in respect to pre- and post- reform periods and the factors underlying the observed trends of indirect taxes as one of the revenue sources that is not fully utilized. The objectives of the study were to establish the effects of introduction of Withholding VAT agents, Introduction of EGMS and switching the tax system from hybrid to a uniform specific or ad valorem Excise tax regime on revenue collection in Kenya. Annual secondary data spanning the period 2010-2019 was used in the analysis. The source of the data was mainly Kenya Revenue Authority and Kenya National Bureau of Statistics. Impact evaluation techniques (regression discontinuity and difference-in-difference) also known as quasi panel analysis techniques were used in the analysis. Stata software was employed in the analysis. From the difference-in-difference model, the analysis reveals that the introduction of EGMS led to an increase in excise revenue by 81.2%. This was significant at 1% level of significance. VAT increased by 13.4 per cent following the introduction of VAT withholding agents. This was equally significant at 5% level of significance. These findings are expected to shape policy direction that is aimed at enhancing domestic revenue mobilization. Based on the findings, the study recommends that the Commissioner of Domestic taxes should map all Medium Taxpayers (MTO) based on risk assessment and enroll additional taxpayers who can serve as potential VAT withholding agents. Further, the study recommends the broadening of the scope of goods covered under the EGMS system, and amendment of the Excise duty act to revert to the hybrid system (Higher of specific or ad valorem rates).