In an environment of high unemployment and escalating living costs, the government’s decision to raise taxes poses a significant threat to the country’s economic growth.
Tax increases in such a precarious economic landscape risk exacerbating financial burdens on citizens and businesses, potentially leading to a deeper economic downturn. This strategy could stifle consumption, hinder investment, and ultimately result in a declining GDP.
The detrimental effects of high taxation during economic hardship are evident in several African countries:
Zimbabwe: Amidst hyperinflation exceeding 600 percent and high unemployment, Zimbabwe’s two percent tax on electronic transactions, introduced in 2019, led to reduced economic activity and a shift towards the informal sector. This policy contributed to a GDP contraction from 3.5 percent in 2018 to -8.1 percent.
South Africa: In 2019/20 even when faced with an unemployment rate of around 30 percent and rising cost of living, the South African government imposed high tax rates on individual income and corporate income that dampened investment and consumer spending. This resulted in GDP decline by 5.96 percent.
Nigeria: Even when facing high inflation and high unemployment rates, Nigeria’s government imposed multiple taxes, including VAT increases. These measures strained household finances and stifled economic growth, contributing to a GDP decline of 1.8 percent in 2020, its deepest decline since the 1960s.
Ghana: With high inflation rates and increasing cost of living, Ghana’s high taxation on goods and services has led to reduced consumer spending and shrinking business investments, slowing down GDP growth to 0.4 percent in 2020.
Those are just a few examples to illustrate why increasing taxes in an environment of high cost of living is detrimental to a country’s overall economic growth.
Instead of increasing taxes, Kenya can pursue several strategies to stimulate economic growth, improve living standards, and enhance government revenue,
Integrating the informal sector into the formal economy can increase revenue without raising rates. Simplifying tax compliance and offering incentives for small businesses to register can help achieve this. For instance, Rwanda’s approach to formalising its economy through streamlined tax systems and SME incentives has been quite effective.
Improving tax administration through digital solutions can boost revenue collection. Kenya’s iTax system, which has streamlined tax filing and payment processes, can be further enhanced to reduce tax evasion and improve compliance, increasing revenue without raising taxes.
Promoting domestic investment while also attracting foreign direct investment can significantly boost economic growth. Creating a favouable business environment through regulatory reforms and infrastructure development can attract investors.
Ethiopia’s industrial park strategy, offering tax holidays and other incentives, has successfully attracted significant FDI, leading to job creation and economic growth.
Effective management and monetisation of natural resources can generate substantial revenue. Botswana’s prudent management of its diamond resources, ensuring that proceeds are invested in infrastructure and education, has driven steady economic growth. Kenya can adopt similar strategies with its natural resources, such as minerals and tourism.
Encouraging innovation and supporting startups can drive economic diversification and growth.
Implementing policies that attract venture capital flow, support research and development (R&D), reduce bureaucratic hurdles etc can foster a vibrant entrepreneurial ecosystem.
Nigeria’s tech sector, supported by investments in innovation hubs and incubators, illustrates how fostering entrepreneurship can lead to economic growth and diversification. Kenya is also doing a commendable job in supporting tech entrepreneurs.
Raising taxes in an environment of high unemployment and high cost of living is a risky move that could stifle Kenya’s economic growth. The experiences of Zimbabwe, South Africa, Nigeria and Ghana underscore the dangers of such policies.
-The writer is an economist based in the United States
