Balancing economic growth and tax revenue mobilisation

The National Treasury building in Nairobi. [File, Standard]

Have you ever noticed how every Marvel movie ends with a teaser, hinting at the next one? This builds anticipation, much like Kenya's National Tax Policy (NTP) and Medium-Term Revenue Strategy (MTRS), which outline a forward-looking approach to taxation.

These policies shape fiscal expectations and provide a roadmap for economic reforms.

Kenya's tax policies have evolved to reflect both domestic needs and global trends. The financial services sector has seen various tax regimes aimed at balancing revenue generation with economic growth.

The NTP seeks to expand the tax base, adopt international best practices, and reduce tax expenditures to minimise market distortions. The MTRS (2025-2027), themed "An Approach for Enhancing Domestic Revenue," provides strategies for implementing the national tax policy.

The Finance Bill, 2024 ('the Bill'), which was withdrawn, had proposed major tax changes, including limiting value-added tax ('VAT') exemptions and imposing VAT on financial services.

Despite its withdrawal, the government remains committed to the MTRS. We view this deferral as an opportunity to reassess potential risks and prevent market distortions and complexities in the financial sector.

Indirect taxes such as VAT and excise duty are key revenue generators. These taxes apply to goods and services rather than business income or profits.

The financial services sector, including banks and insurance firms, is also subject to these taxes, though applying VAT can be complex due to the intangible nature of financial products.

VAT is a broad-based consumption tax applied at different stages of production and distribution. However, international best practices highlight challenges in applying VAT to financial services due to difficulties in measuring value addition. Case studies offer lessons for Kenya.

For instance, the UK's VAT exemptions on financial services have supported competitiveness while ensuring revenue growth.

South Africa's reduced exemption model provides a balance between tax collection and economic activity. These approaches can guide Kenya in refining its VAT exemption policies for financial services.

Excise duty, traditionally a 'sin tax' to discourage the consumption of harmful products, has evolved to include financial services in Kenya. For example, excise duty is charged on money transfers and financial transaction fees.

Introducing VAT on excisable financial services will have a cascading tax effect since VAT applies to excise-inclusive values.

For instance, a 15 per cent excise duty on money transfer fees, coupled with 16 per cent VAT, results in an effective tax rate of 33.4 per cent. This multiplicity of taxes significantly increases costs for consumers.

Policymakers must consider the negative impact of layering VAT and excise duty on financial services, as it could undermine financial inclusion efforts.

The rise of fintech and digital financial services has expanded access to financial services, particularly for marginalised populations. These innovations also create employment opportunities, particularly for the youth.

As technology advances, policymakers should adopt a forward-looking approach, integrating tax breaks or concessional rates for emerging financial technologies to support growth while ensuring fair taxation.

Striking a balance between revenue goals and a competitive financial sector is crucial.

Transactional taxes are inherently regressive, applying uniform rates across all income groups without considering ability to pay. This disproportionately affects lower-income earners, who allocate a higher percentage of their income to such taxes.

The application of multiple taxes to financial services may discourage low-income individuals from accessing financial services, thereby worsening financial exclusion. Policymakers must ensure that tax reforms promote financial inclusion so that all citizens benefit from financial services.

While governments favour VAT's broad-based structure for its revenue-raising potential, other socioeconomic factors must be considered, especially in developing countries with high poverty levels and wealth disparities.

The combination of multiple transaction taxes misaligns with government policies aimed at improving the quality of life and supporting businesses. Increasing the tax burden on already struggling households contradicts economic empowerment efforts.

Effective tax policy formulation requires engagement with stakeholders, including financial institutions, consumer groups, and tax experts.

Collaborative efforts help identify potential challenges and develop solutions that balance revenue needs with economic growth.

Policymakers should prioritise inclusive stakeholder engagement to create sustainable tax policies. Failure to do so could have significant consequences for the financial sector and the broader economy.

The writers are in the Indirect Tax Services at PwC Kenya.