In 2013, the Value Added Tax (VAT) Act passed by parliament increased the number of taxable goods – by reducing the number of exempt and zero rated goods. The government hopes to raise an additional Sh. 10 billion per month in doing so. The standard rate of VAT remains 16%.
In theory, this is what we should aim for. VAT has several advantages: it covers both goods and services. It is also less risky when it comes to revenue leakage. VAT is self-enforcing – it uses an invoice-based credit mechanism in its administration, which facilitates collection and enforcement; even if revenues are missed in one stage, they will still be collected in other stages. Likewise, a taxable business can only claim for the refund of input VAT if the claim is supported by purchase invoices. This provides an incentive for firms to keep invoices of their transactions and is a good means for tax authorities to check for enforcement. It therefore has greater revenue potential than its alternatives.
The taxes replaced by VAT in many developing countries (in Kenya, VAT replaced Sales Tax in 1990) are usually complex in their structure and riddled with narrow bases, multiple rates, and numerous exemptions, all leading to lower rates of revenue collection. VAT is less complex to administer than other types of consumption taxation, and it reduces overall collection costs (defined as the combined cost of compliance on the taxpayer’s side, such as ETR machines and an invoicing system, and administration cost on the tax authority side).
A Brief History of VAT
To understand the revolutionary nature of VAT, perhaps we have to start from the beginning. VAT has been attributed to two people: a German businessman named Wilhelm Von Siemens in 1918, and an American economist, Thomas S. Adams, who wrote about it between 1910 and 1921.
Von Siemens saw VAT as an innovation which improved on turnover tax. VAT allowed for the recovery of taxes paid on business inputs and therefore avoided the cascading problems that arise with a turnover tax, easier understood as the “tax on tax effect”.
Turnover tax is imposed on every stage of the production/distribution chain. The tax base of a good at any single stage includes the sales value of the goods plus the tax charged cumulatively in previous stages, known as the cascading effect. This generates a trail of cumulative distortions carried from the first stage of production on to the final stage of retail distribution. VAT, unlike turnover tax, is collected at the final sale of the good, avoiding this effect.
Adams saw VAT as an alternative to business income tax. He focused on federal tax policy, and since there was no national sales tax then in the USA, his concern was not with technical modification to the existing tax regimes but with a major alteration of the existing federal income tax system. He felt that VAT was a suitable alternative for the complicated corporate tax in the USA, because it was much simpler. VAT was first implemented at a national level in France, in 1954.
For VAT to be efficient, it must satisfy certain standards: it needs to be flat rate, based on consumption as opposed to production units, broad-based (everyone who buys a VAT-able good must pay VAT) and it must be applied at the retail stage of the goods distribution cycle with minimal exceptions.
VAT has three main varieties: the New Zealand model, the European model and the Japanese model. The New Zealand model is widely touted as the most effective, levied at 15% and exempting very few items from VAT. The European model is marked by multiple rates and varying degrees of exemptions per country. Japan’s model is similar to the European VAT system, requiring re-calculation and payments to the tax authorities at each transaction point in the onward sales chain.
Kenya, and many other African countries, implemented the European model of VAT, however, with the recently enacted VAT Act, we seem to be moving towards the New Zealand model – few goods being exempt from VAT. Theoretically, this makes sense. On the ground, however, the standard of living for Kenyans has already begun to worsen.
The Impact of the Act on Corporations
Lower rated goods, such as electricity, fuel oil and industrial diesel saw the VAT rate increase from 12% to 16%. The 12% rate served as an incentive to manufacturers to cushion them from high energy costs. This 4% increase is likely behind the recent increase in the cost of many manufactured goods we have seen. Manufacturers are no longer able to claim it from the Kenya Revenue Authority (KRA) as there are only two rates in application now – either 0% or 16%. The cost is therefore passed on to the consumer.
The Act also deems business carried on in Kenya to be separate from that carried on outside Kenya. This will affect transactions between companies and their branches, as such transactions will now be treated as if they are between two separate entities. This goes against the Companies Act which perceives the company and its branches as one. Companies may now have to claim input VAT against transactions they have carried out with their own branches, further complicating doing business in Kenya.
VAT with regards to services also experienced a shift. The act defines the export of a service as “a service provided for consumption outside Kenya” but also provides that if the supplier of the services is based in Kenya, the services will be deemed to have been supplied in Kenya. It is not far-fetched to imagine that KRA may exploit this and try to charge VAT on services performed in Kenya even though such services are consumed outside Kenya.
The Impact of the Act on Kenyans in General
The most controversial area is the schedule of exempt and zero rated goods and services.
Zero rated goods and services are counted as taxable, but at the rate of 0%. This means that when you supply goods to consumers, you supply them at the rate of 0% tax, and are allowed to claim refunds for any input tax you have been charged by your suppliers. Exempt goods and services, on the other hand, are not taxable. Suppliers of exempt goods cannot claim refunds for input tax they have been charged by their suppliers, if any. Goods and services are zero rated or exempt so as not to deter their consumption by making them more expensive.
The VAT Act 2013 moved the following from exempt to standard rated status: newspapers, mobile phones, charcoal, helicopters and airplanes, guns and military weapons. Petroleum oils and fuels remained exempt under a 3 year transitional arrangement, after which they will also become standard rated. This has resulted in the increase in price of these commodities, of course, as the manufacturers passed on the cost to the consumers.
The cost of newspapers, through which many Kenyans stay informed, has increased from Sh. 50 to Sh. 60. Many I spoke to who used to buy two newspapers have reduced this to one, and those who find one too expensive will now have to settle for receiving their information from another source. While this may lead to an increase in revenue for the government, is the cost of a less informed populace one they are willing to risk or pay? Is the trade-off worth it?
For services, the following are notably no longer exempt: management of unit trusts and collective investment schemes, credit reference bureau services, sanitary and pest control services provided to households, postal services, tour operation and agency services and airport landing and parking fees.
While this is the international precedent, the effects on our economy will be grave. The VAT on postal services may accelerate the death of Posta Kenya, which is already struggling as a going concern. The financial services sector also has to bear increased costs on credit reference services as they are now subject to VAT. Management of unit trusts and collective investment schemes is also subject to VAT – this may reduce the attractiveness of these investments, as Kenyans may prefer to invest their reducing savings in less expensive ways.
Stakeholders in the airline industry will no doubt be affected by the introduction of VAT on airport landing and parking fees. This will increase the cost of landing in Kenyan airports, thus increasing the cost of flights to Kenya (both direct and connecting). Coupled with the recent fire at our airport, there is little reason to see why landing at JKIA, or any other Kenyan airport, would be attractive. VAT on tour operation services and agencies also makes Kenya a less attractive travel destination as compared to Asian countries like India, Thailand and Malaysia, which are constantly trying to make it cheaper for tourists to visit.
The following key goods moved from zero rated to standard rated status: Liquid Petroleum Gas (LPG), animal feeds, human blood, photographic film, insecticides, printed materials, tractors and other agricultural implements, textile machinery, computers and computer software, generators, bicycles and motor cycles, prime movers and passenger vehicles with a capacity of over 25 persons, ambulances and medical equipment, baby nappies, aircraft and aircraft operations parts and materials for construction of tourist hotels.
The following services are also no longer zero rated: services supplied by hotels to foreign tourism promoters, supply of electricity to households (restricted to 200 kilowatt-hours), supply of services to goods in transit, supply of water drilling services, transportation services in respect of unprocessed agricultural produce, supply of taxable services to ships and supply of services to film producers.
Handling blood donations and transfusions has become more expensive, as it is now taxable. “Human blood” includes collection, storage, supply and importation of natural blood products. The increase in price of ambulances and medical equipment will no doubt also lead to the increase in price of medical services. Crises like the Westgate terrorist attack must have been a financial burden on those involved due to these increased costs. In retrospect, this seems like an ill-advised move.
School textbooks fall under printed materials, meaning that their prices have also increased by 16% or more. This undermines whatever progress we have made in Free Primary Education (FPE) as some parents may no longer be able to afford books. The government is effectively giving with one hand and taking with the other – giving FPE and asking more for books, through which education is delivered. For reading Kenyans, myself included, the cost of books has also become prohibitive. We say that we want to encourage a reading culture in Kenya, to kill the culture of ignorance. Why, then, are we taxing books?
Nourishment has also become a luxury for many Kenyans. Initially, milk, flour and ordinary bread had been included in the VAT Bill 2013. After much pressure from citizens, the government excluded flour and ordinary bread (both white and brown) from the list of taxable goods. However, heat-treated milk remained taxable while unprocessed milk remained exempt as at the time the act was passed. After more pressure from Kenyans, heat-treated milk was recently included under unprocessed milk by KRA.
While this was a minor triumph, charcoal and LPG now attract VAT. It may be argued that charcoal is bad for the environment, but we cannot escape the fact that many Kenyans use it to cook, and until cheaper alternatives are widely introduced, we are effectively sentencing many Kenyans to a life of malnutrition by increasing its price. This move may have been intended to discourage the use of charcoal, but the more environmentally friendly alternative, LPG, is now also subject to VAT – quite counterintuitive. Kerosene may be exempt after a recent amendment, but with the regular increases in fuel prices, it is still unaffordable for many. Already, some of those I spoke to who live in Mukuru Kwa Njenga had stopped having tea and bread for breakfast and switched to uji (porridge) as it is much cheaper. They are also skipping meals since the cost of feeding has gone up.
Kenya is an agricultural economy – most people subsist through farming. Their lives have become much harder with the introduction of VAT on animal feeds, tractors, agricultural implements, insecticides, fungicides and pesticides. This increases the cost of farming, and as if this is not enough, supply of water drilling services (many farmers construct boreholes to ensure constant water supply) and transportation of unprocessed agricultural produce are also taxable. By the time goods reach the market, their price has almost doubled. The price of sukuma wiki (collard greens), for example, is telling. At my local market, one can no longer buy a Sh. 5 bunch. The least one can spend on a bunch there is now Sh. 20.
The ICT sector in Kenya, which has been fast growing and hailed as a leader in Africa, has also been dealt a major blow with the introduction of tax to mobile phones, computers and computer software. The price of the Nokia 105, for example, was Sh. 1,750 before the VAT Act was passed. After, it became Sh. 2,000. This is an extremely basic phone. Others have experienced a price increase of as much as Sh. 15,000. Mobile phone penetration which in turn led to the success of innovations like M-Pesa, could slow down due to the increase in cost of hardware and software. This, in turn, will lead to a reduction in the rate at which we innovate. This joint statement by industry stakeholders indicates this.
What this means for our economy going forward
You will find that the government has resorted to exempting the goods that Kenyans have protested about, as opposed to zero rating them. This ensures that suppliers cannot claim back input VAT, which is present most times. This serves to placate the consumer as she no longer pays VAT but it leaves suppliers in a worse off state financially as they are forced to absorb the cost, or pass it on to the consumer as a direct cost of production. This may be part of the reason why the cost of some goods (like bread) has increased even though they are exempt.
On paper, the VAT Act 2013 will increase revenue for the government, but in reality, it will wildly distort the market. The cost of running a Kenyan household has increased exponentially – food, water, electricity and cooking fuel have become very expensive. Since the cost of building materials has also increased, shelter has become costly. Transport is set to become more expensive with the introduction of VAT on passenger vehicles with a capacity of over 25 persons, as well as the impending increase in fuel prices. Since the cost of doing business has increased, unemployment could be a possible consequence as businesses reduce members of staff to cut costs. How will people afford to live with such high prices if they are unemployed?
Our already large grey and black markets can only grow larger. There could be a ready market for counterfeit agricultural goods such as seeds, fertilizer and machinery because they are cheaper than the genuine ones. This could also extend to mobile phones, computers and computer software – counterfeits will increase, so will theft. Theft of mobile phones and laptops is already rampant, but the demand for stolen ones is poised to go up as many will be unable to afford new ones. Many traders may also choose to avoid registration, thus not paying VAT, so that their goods may be cheaper and they may get more customers. The public could actively collude with suppliers to avoid paying tax, reducing the government’s revenue.
We could also see a reduction in investment across sectors – agricultural, ICT, manufacturing, tourism and energy due to the new changes. Many sectors have become unattractive with the increase in costs and the reduction of tax incentives as mentioned earlier. The government argues that while the tax burden may have increased, it is a necessary price to pay in order to invest in infrastructure and the provision of services to Kenyans. The system may be easier to implement for traders as it eliminates many opportunities for tax refunds, but it may harm their sales due to the increase in cost of goods.
Kenya also has a history of corruption. If we were certain that the additional funds would be directed towards infrastructure, we would be less disgruntled. For example, if the money was diverted to building roads in rural areas to enable transport of agricultural produce, this would reduce transport costs and make the goods cheaper in the end even with all the VAT. If the funds were diverted to building and maintaining hospitals and buying pharmaceutical supplies, many would go to public hospitals, which are much cheaper, and save on the amount they spend in private hospitals. The VAT would be justified. As it is, we have no assurance that this money will not be used to pay sitting allowances, buy more Mercedes Benzes or fund furniture buying trips to China.
VAT is a regressive tax, as compared to income tax, which is progressive. The more one earns, the more income tax one pays. With VAT, however, the less one earns, the higher the percentage of one’s income one spends on VAT. Someone earning Sh. 10,000 a month and someone earning Sh. 500,000 a month pay the same VAT on goods. Saving becomes impossible for many. VAT is harmful to a nation’s poor and is a lazy way for a government to collect revenue when most of its people live under the poverty line.
If the government is keen on progressively making VAT its main source of tax revenue, perhaps it should look into reducing income tax rates. As the rate of inflation and the tax burden keep increasing, salaries have remained stagnant, and the income tax rates have remained the same. If the respective rates applicable to income tax brackets were reduced, for example, we would have fewer complaints about the new act. Indeed, the potential for revenue generation through VAT is great but the funds collected as such would have to be utilized to ensure that the life of the average Kenyan becomes cheaper and more convenient.
Based on the Kenyan government’s past performance, which may be used as an indicator of future results, this is unlikely. Our attempt to tax ourselves out of poverty can be described by this Winston Churchill quote:
We contend that for a nation to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.
Value Added Tax Act, 2013, by the Kenya Revenue Authority, Retrieved from http://www.revenue.go.ke/notices/pdf2013/VAT%20%20Act%202013.pdf
“Exploring the origins and Global Rise of VAT” by Kathryn James, Retrieved from http://www.taxanalysts.com/www/freefiles.nsf/Files/JAMES-2.pdf/$file/JAMES-2.pdf
“Value Added Taxation: Mechanism, Design, and Policy Issues.” Paper Presented for the World Bank course on Practical Issues of Tax Policy in Developing Countries, by Tuan Minh Le, Retrieved from http://www1.worldbank.org/publicsector/LearningProgram/PracticalIssues/papers/Value%20added%20taxation/Value%20Added%20Taxation.doc
“Value Added Taxes in Developing and Transitional Countries: Lessons and Questions”, by Richard M. Bird, Retrieved from http://www.itdweb.org/VATConference/documents/Presentations/Plenary1_VAT%20in%20Developing%20and%20Transitional%20Countries_RBird.pdf