Kenya: Costly subsidies make life affordable – but is this sustainable?

By Herald Aloo
Posted on Tuesday, 12 July 2022 16:09

March to Decry High of Living in Nairobi, Kenya - 07 Jul 2022
A Kenyans man holds a Kenyan flag during a march to decry the high cost of living on Saba Saba Day on 7 July 2022. (Boniface Muthoni / SOPA Images)

Although subsidies are supporting Kenyan citizens to navigate the cost of living crisis, a more sustainable way forward may be a reduction in taxes.

However, this is a direction that the government is unlikely to take considering huge maturing external debts, tightening fiscal policies by central banks of big economies, and pressure to fund a massive KSh3.3trn budget for the current 2022/23 fiscal year.

“The conversion of subsidies into indirect tax cuts would be an adoption of lower indirect taxes as a long-term measure,” says Mihir Dhakir, an economist. “But by resorting to subsidies, the government is clear to development partners and citizens that these are just short-term measures.”

Election promises

Average retail prices of 2kg maize flour, 2kg wheat flour, and 1 litre cooking oil have soared by 90%, 64%, and 97% respectively over the past 12 months. Salaries, however, have remained stagnant since 2018.

Hoping to curry favour with citizens, given the upcoming election, the Jubilee administration rolled out several subsidy programmes that are expensive and bearing huge political cost among top presidential contenders.

Former Prime Minister Raila Odinga and Deputy President William Ruto have both promised that if elected, they will stop the high cost of living through, among other things, increasing farm inputs, guarantee schemes, and inject capital funding.

Inflation now surpasses election jitters as the top concern for the country’s economic growth, which is expected to slow down to 5.0% in 2022 from 7.5% in 2021, according to Fitch Solutions, a global firm offering country-by-country microeconomic environment analysis.

Costly subsidies

Subsidies and other interventions remain costly. A circular from the Office of Government Spokesperson shows that the State’s interventions over the past four months have cost about KSh79.28bn, excluding the KSh100bn the Treasury has spent on fuel subsidies for the fiscal year 2021/22.

Fuel subsidies remain active, and the state prioritised allocating the fuel kitty KSh49.29bn in the second supplementary budget signed last month. This comes despite the fact the Treasury announced – in June – plans to gradually phase out the programme by the end of 2022.

The tax environment is unfriendly not because of the tax rates, but because of complicated and multiple collection mechanisms

Other subsidies on fertiliser, electricity, cooking gas subsidies and now a tax waiver on maize importation are all in operation to support low-income households navigate these difficult times.

As such, households are currently enjoying a 15% cut in electricity bills, with a second 15% cut expected for those in most need. The second cut has been delayed by three months, however, as energy distribution company, Kenya Power, awaits tariff compensation from the Treasury.

Plans to distribute around 60,000 subsidised 6kg liquid petroleum gas (LPG) cylinders is also expected this month, targeting a few low-income households in Nairobi identified by the State, but identification criteria remains unclear.

This is the second attempt to revive the cooking gas project whose first phase was estimated at KSh3bn, but ended on funds misappropriation in 2018.

Tax collection

Despite the government spending massively on subsidies, high commodity prices are working in favour of the Kenya Revenue Authority (KRA), which has already exceeded its KSh1.976trn revenue collection target for the 2021/2022 fiscal year that ended in June, collecting KSh2.03trn – the highest in Kenyan history. As such, the KRA has more than doubled the next targets to KSh6.831trn for the fiscal year 2023/24.

Collection of VAT, which is one of the key tax heads the government relies on to fund its budget, has recorded a growth of 24% in the fiscal year 2021/22, which KRA attributed to “enhanced compliance efforts” and “the economic recovery”.

“Growth in tax revenue is [also based on] a major crackdown on businesses perceived as non-compliant [as well as] an increase in prices due to inflation,” says Dhakir.

“The tax environment is unfriendly not because of the tax rates, but because of complicated and multiple collection mechanisms, such as withholding VAT [Value-Added-Tax] and multiple filings of single tax transactions,” he says.

This requires “increased manpower” and amplifies chances of “non-compliance” by businesses “due to difficulty to understand procedures”, says Dhakir.

The idea is to maintain a steady tax regime and only intervene to stabilise prices as appropriate

Kenya has a multi-layered taxation system. On fuel products, for instance, there are about nine different taxes and levies, with excise duty and VAT taking the biggest chunk.

Importation of essential food, such as maize and wheat grains, attracts three different charges – certificate of conformity fee, phytosanitary charges, and Import declaration fee all collected by various state agencies.

This has forced KRA, starting next month, to start implementing new technology called Tax Invoice Management Systems (TIMS) to scrutinise VAT remittance in efforts to boost revenue collection.

The tax rates are bound to remain the same or even higher as treasury, under the draft National Tax Policy, proposes to set the minimum VAT at 12%, signalling increased taxes on goods currently charged at 8% VAT rate.

Tax reduction?

On one hand, the record-high tax collection implies the government is trying to raise funds to support the many subsidy programmes. However, maintaining a balance that works for people and the state is becoming hard – a sign that interventions maybe short lived despite the potential public outcry.

Manufacturers have been calling for tax cuts to help, given higher commodity prices, but some experts believe cuts will negatively impact subsidies because they affect different people.

“It is these taxes that are used to subsidise items such as fuel. The idea is to maintain a steady tax regime and only intervene to stabilise prices as appropriate,” says Robert Waweru, a tax expert at Ichiban Consultant.

“Otherwise, the tax rates on fuel, for example, would be constantly moving based on external factors such as cost of crude oil. Such volatility is not good for business,” he says.

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