Why Lowering Taxes Isn't Kenya's Path to Economic Prosperity

Recently, one of our seniors posted the question on whether taxbreaks can be a strategy to economic growth. Economically speaking, ?tax reduction is often heralded as a catalyst for growth. For instance, the senior used UAE as an example to question whether Kenya can follow the same path. ?The United Arab Emirates (UAE) thrives without levying income tax on individuals and maintains a minimal value-added tax (VAT) rate of 5%. Small businesses with revenues up to AED 3 million (approximately Ksh 100 million) benefit from tax reliefs, and mechanisms are in place for excise duty refunds. (Official Portal of UAE Government). This model prompts the question: Can Kenya emulate such tax strategies to spur its own economic breakthrough?

While the allure of tax cuts is undeniable, Kenya's fiscal landscape presents challenges that render this approach imprudent. A closer examination reveals that reducing taxes may not only be ineffective but could exacerbate existing economic vulnerabilities.

Kenya's Debt Dilemma

As of June 2024, Kenya's public debt stood at Ksh 10.6 trillion, accounting for 70% of the Gross Domestic Product (GDP). This figure surpasses the International Monetary Fund's recommended threshold of 50% for developing nations, signaling a high risk of debt distress.

In the fiscal year 2024/2025, the Kenya Revenue Authority (KRA) collected Ksh 2.407 trillion, a modest increase from the Ksh 2.166 trillion collected in the previous year. However, in the first half of 2024/2025, the KRA amassed Ksh 1.07 trillion, falling short of the Sh1.23 trillion required to meet the full-year target of Sh2.47 trillion. Projections suggest that by the end of the fiscal year, collections may total approximately Ksh 2.14 trillion. (Source KRA)

These numbers underscore a critical issue: Kenya's debt servicing obligations are consuming a substantial portion of its revenue. The total debt service obligation for FY2024/25 is Ksh 1.85 trillion, comprising Ksh 843.4 billion in debt redemption and Ksh 1.1 trillion in interest payments. This scenario leaves limited fiscal space for development initiatives and essential public services. So even if we were to lower taxes, the real issue of money circulation cannot be solved when we have much of our money not promoting development but goes to recurrent expenditure.

The Pitfalls of Tax Reduction

Advocates of tax cuts argue that reducing tax rates can stimulate economic activity by increasing disposable income, thereby boosting consumption and investment. While this theory holds in certain contexts, its applicability to Kenya is questionable. Given the country's substantial debt obligations, lowering taxes without a corresponding decrease in government spending would likely lead to larger fiscal deficits. To bridge the revenue gap, the government would be compelled to increase borrowing, further escalating the debt burden. This cycle could result in higher interest rates and crowd out private investment, ultimately stifling economic growth.

I argue that tax cuts at this stage could undermine the government's ability to fund essential services and infrastructure projects, which are pivotal for long-term development. Inadequate investment in sectors such as education, healthcare, and transportation could hamper productivity and deter both domestic and foreign investment.

What is the Strategic Path Forward?

Rather than pursuing tax reductions, Kenya should focus on comprehensive fiscal reforms aimed at enhancing economic stability and growth. There are three key aspects that would save Kenya from this state.

Eliminating Wasteful Expenditures

The government must critically assess and curtail spending on non-essential projects that do not contribute to economic value. For instance, substantial funds allocated to renovations of government buildings could be redirected to revitalize key industries such as agriculture and manufacturing, thereby creating jobs and stimulating economic activity. In recent times,? I have seen reports of renovation of the State House at a cost of more than 10 billion. It is possible to revive the whole sugar industry using this amount. There are more examples I could give. The bottom line is that when making a choice, the value chain that can be created by 10 billion when invested in a specific industry surpasses the need for renovation of statehouse.

Enhancing Parastatal Efficiency

One of the biggest problems we have in this country is how we run our State-owned enterprises (SOEs). ?Many of these SOEs are plagued by inefficiencies and financial losses. For instance, I have never understood why key parastatals like Kenya Railways Corporation, Kenyatta National Hospital, University of Nairobi, KU, KCC, among others. In fact, According to the National Treasury, 239 out of 510 state corporations are currently operating at a loss. This is where the government should start from. These parastatals should be operating at optimal, make profits, expand, and be competitive not only domestically but globally. They should be reporting profits to increase revenue to the government instead of reporting losses and getting bailed by the government. I think turning these entities around could reduce the fiscal burden and potentially increase government revenue.

Prudent Borrowing Practices

When in a hole, you must stop digging. A lot of people either do not know or underestimate the Kenyan debt problem. Kenyans ?must demand for the government to adopt a disciplined approach to borrowing. This involves limiting new debt, restructuring existing obligations, and prioritizing loans that finance projects with clear economic returns. Notably, 68% of Kenya's debt is owed to commercial lenders, which often carry higher interest rates. We have to shift focus from commercial to concessional loans with more favorable terms could alleviate fiscal pressures.

Conclusion

While the prospect of tax cuts may seem appealing as a tool for economic stimulation, Kenya's current fiscal realities necessitate a more nuanced approach. Prioritizing fiscal discipline, efficient public spending, and strategic debt management offers a more sustainable path to economic prosperity. By addressing the root causes of its economic challenges, Kenya can lay a solid foundation for long-term growth and development.

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