Influence of Tax incentives on the Performance of the capital Markets in Kenya

Abstract

Capital markets in an economy play a substantial social value by facilitating efficient use of the economy’s existing productive capacity and allocation of scarce capital, promoting the efficient division of available resources, and facilitating the allocation of risks. On this account, the Government of Kenya has over the years introduced various tax-based policy initiatives to support the growth of the capital markets. However, the prevailing studies have not established whether these tax incentives have made any influence to deepen the capital markets or have been revenue leakages. The main objective of this study was to investigate the influence of tax incentives introduced in the tax law and policy actions on the performance of the listed and over-the-counter capital markets in Kenya from 1990 to 2020. The specific objectives of the study were to assess the effect of equities tax incentives, establish the influence of debt tax incentives and evaluate the effect of trading incentives all on the performance of capital markets. The study was underpinned by several theories including efficient market hypothesis, information asymmetry theory, signalling theory, and optimal tax theory. The study employed an explanatory research design. It focused on select tax incentives in the capital markets from the year 1990 to 2020 and reviewed their influence on the performance of capital markets measured by trends in equity and bonds turnover. The study relied on secondary data obtained from the analysis of tax statutes, policy documents, and CMA periodic reports on capital markets' performance. The study relied on data from Kenya. The study findings indicated that equities tax incentives (β= -11.46910, P=0.0148), and debt tax incentives (β= -5.651615, P=0.0135) paradoxically had a negative and significant effect on capital market performance in the short run. Trading tax incentives did not have a statistically significant effect on capital market performance (P-value =0.6060 > 0.05). The study concluded that equities tax incentives often serve as a signal for investors to stampede out of the markets, hence occasioning a negative and significant effect on capital markets performance in Kenya. The study recommendation was that the government need not employ the tax incentives associated with equities and debt capital markets such as corporation tax and withholding tax on interest because these incentives do not positively influence the overall performance of capital markets and maybe an opportunity loss on revenue collection. However, trading tax incentives influence the sustaining of market liquidity and ought to be sustained.