Reflex tax increase hurting Kenya's economy

Political stability, a good human capital base and a relentless private sector have continued to play a pivotal role in building the economy.

This has seen Kenya become one of the most attractive investment destinations in Africa.

A strong economy is boosted by massive infrastructural projects, such as roads, rail, power generation and energy distribution across the country. The Government has to raise money to undertake these projects and other obligations like recurrent expenditure.

Traditionally, when Government comes under pressure to raise more revenue, a quick place to turn to has always been the sin taxes that include alcohol. The general trend of raising taxes on alcohol, is however too important to be left to pass without analysis and thoughtful consideration.

One document that policymakers ought to look at every time this discussion comes up is a research paper that was authored by two foremost economists - former Central Bank of Kenya governor Njuguna Ndung’u and Mwangi Kimenyi.

The paper was titled Beer Taxation in Kenya: An Assessment. It is too big to condense here, but in summary it states that if cheaper beers and spirits are taxed excessively, consumers turn to illicit spirits of higher alcoholic potency. But this assertion doesn’t tell the whole story, especially if not put into context.

About three years ago, Treasury raised taxes on keg beer, a low-end beer in a bid to boost revenue collection. Prior to this action, demand for the lowly-priced Keg beer, retailing at an affordable price of Sh25 per serving, was growing steadily.

The product was credited for weaning a significant number of people out of the dangerous illicit drinks. The tax action in 2013 pushed consumer price - to Sh35 per serving. Being a highly price sensitive product, consumers found this expensive and started abandoning it for cheaper illicit drinks.

It had been predicted that consumers would not be affected by the tax hike, but this was not to be, as consumption dropped significantly. The crashing demand of Senator keg beer had very serious repercussions that reverberated across its entire value chain negatively affecting the Kenyan economy.

The dip in demand for the product caused by the tax hike did not only affect how much revenue was collected in excise tax, but also had a huge effect on the livelihoods of thousands of people who relied on the sorghum value chain. Senator keg is made from 75 per cent local materials, the biggest component being sorghum grown in the semi-arid parts of Kenya.

These were farmers who had market assurance for their produce as they had been contracted by Kenya Breweries Limited (KBL) to grow sorghum. Many businesses were also affected. Distributors wound up shop and retailers closed their premises rendering many of their employees jobless. With significant capital investment, many of these businesses solely and critically depended on Senator keg and the sorghum trade to stay afloat.

Before the tax hike, Senator Keg supported a thriving value chain comprising over 30,000 sorghum farmers, close to 100 Senator keg distributors and another 12,000 retailers. All the participants were earning good returns on their invested capital, and contributing positively to the growth of the economy. Evidently the value chain provided employment to many more Kenyans through ripple effect.

Although the situation has since positively changed after the tax remission on keg beer was reviewed at the beginning of the current fiscal year, there are many lessons to learn from this case.

The biggest lesson drawn from this is the fact that taking huge tax increases on alcohol year on year leads to higher consumer prices that have a negative effect on affordability and resultant demand. This in turn depresses growth across the total value chain.

The net effect on the economy is therefore negative and the Government may not achieve the overall objective of growing revenue collection.

There is therefore need for a balanced approach, and perhaps a more critical review of this measure.

Tax struggles are not unique to Kenya. Other countries like India have had their own challenges as well. Despite India’s progress, it still has a complex indirect tax system with separate, sometimes overlapping taxes administered by various federal, state, and local jurisdictions. Understanding that a complex tax regime is an obstacle to economic growth, India has been debating a fundamental reform of its indirect tax system.

Kenyans should indulge in similar debates. Big tax increases don’t just hurt the economy in the short term.

They also stifle entrepreneurship, which in turn lowers economic growth. When an entrepreneur or a sorghum farmer grapples with the decision to start a business, availability and certainty of the market for their products plays a large role in that decision.

Start-ups need large amounts of capital in their formative years. A common source of that vital capital is the income the business itself generates.

If taxes take too much, or lower consumption of what they intend to offer to the market, an entrepreneur might conclude that opening a new venture is too risky and pass on the chance.

This would mean fewer jobs created.