More headache for Treasury after court finds 2023 Budget unlawful

The government might have to further cut down its spending after the Court of Appeal on Wednesday declared the Finance Act 2023, unconstitutional. 

This comes barely a month after President William Ruto yielded to public pressure and withdrew the Finance Bill 2024, following countrywide protests.

The rejection of this year’s Bill has seen the National Treasury unveil a leaner Budget, cutting spending on some non-essential areas while increasing the amount that it plans to borrow to bridge the gap between expenditure and revenues.

But the Treasury may now be forced to make more adjustments.

The tax measures introduced by the Finance Act, 2023, include the Affordable Housing Levy, the additional eight per cent Value Added Tax (VAT) on petroleum products, the higher Pay As You Earn (Paye) for high-income earners and three per cent turnover tax on small and medium businesses.

The law, which kicked in on July 1 last year, was expected to help the Kenya Revenue Authority (KRA) collect an additional Sh289.3 billion.

The State had further expected to raise Sh346 billion through measures proposed in the Finance Bill, 2024.

The government could be in for more problems, as analysts note that following the court ruling, Kenyans might start asking for refunds on taxes that they have already paid but have now been found to be unconstitutional.

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“Following the decision by the Court of Appeal finding major sections of the Finance Act 2023 unconstitutional, a separate application pleading for a refund might be necessary,” said Ken Gichinga, Chief Economist Mentoria Economics.

Housing levy

Among the higher costs loaded on Kenyans by the Act was the housing levy, which was one of the most contested clauses in the Act, that sought to raise Sh63.2 billion over its first year of implementation. 

It introduced a levy of 1.5 per cent on employees’ gross salary that is then matched by employers also at 1.5 per cent to finance the government’s affordable housing project.

Collections through the levy were projected to gradually grow to Sh70 billion over the current financial year, according to the budget documents that National Treasury had published earlier this year, then to Sh78 billion over the 2025.26 financial year and hit Sh89 billion over the 2026/27 financial year.

The levy has however been off to a faltering start, having been subject to numerous court cases.

The government collected Sh26.8 billion over the six months to December, according to a report by the Parliamentary Budget Office (PBO).

The government has been eyeing the funds collected through the levy to make a reality its affordable housing promise and has earlier this year said the money that it will be spending on building houses will go up by more than 800 per cent to Sh92.5 billion in the financial year that ends June, 2024, from Sh10.2 billion in the 2022/23.

“The total government expenditure on housing is expected to increase by almost ten times to Sh92.5 billion in 2023/24. The increase was attributable to the allocation made for the Affordable Housing Programme (AHP),” the government disclosed in the Economic Survey 2024 published in May by the Kenya National Bureau of Statistics.

Higher fuel prices

The Finance Act, 2023, increased VAT on petroleum products to 16 per cent from eight, leading to increased pump prices, which in turn slowed consumption.

The higher VAT was also among the tax hikes that were hugely contested when the Parliament subjected the Bill to public participation. Industry players, including transporters, manufacturers and motorists, noted that transport costs would go up and further push up the cost of many essential items.

Higher prices saw a drop in the quantity of petroleum products by nearly a third as many motorists and industries reduced consumption.

Usage of fuel dropped to 4.3 million metric tonnes in 2023, a 27 per cent drop from 5.9 million tonnes in 2022.

“The quantity of petroleum products imported decreased by 27.6 per cent to 4.3 million tonnes in 2023 (from 5.9 million tonnes in 2022), signalling a continued shrinking of petroleum demand in the country,” said the Economic Survey.

“This was mainly attributed to shrinking demand for petroleum products domestically due to increased prices.”

Pump prices rose to a record high of Sh217.97 per litre of super petrol in Nairobi in November. Other factors that were at play, however, include a weak shilling that resulted in Kenyans paying more to import the same quantity of petroleum products last year compared to 2022.

New Paye rates for high income earners that came into effect in September last year saw Kenyans earning between Sh500,000 and Sh800,000 pay at a rate of 32.5 per cent up from 30 per cent. Employees earning over Sh800,000 pay a higher tax of 35 per cent.

KRA was expected to increase tax collected through Paye to Sh682.23 billion over the financial year to June 2024 from Sh494.9 billion in the year to June 2023.

This would translate to a 37.8 per cent growth, a big jump considering that income tax from individuals grew by seven per cent in 2022/23 to Sh494.9 billion from Sh462.36 billion recorded in 2021/22 financial year.

The new Export Investment Promotion Levy was expected to protect local manufacturers by making some imports more expensive. This, however, did not help the local industries, as manufacturers said it resulted in higher costs for imported raw materials.

Unintended consequences

According to an analysis by the Kenya Association of Manufacturers, there were unintended consequences in such sectors as paper, steel and cement. It noted that the cost of construction had gone up by at least 40 per cent.

Government data shows that construction grew at a slower rate of three per cent in 2023 compared 4.1 per cent in 2022.

Consumption of key inputs such as cement, iron and steel, cement clinkers and non-ferrous metals went down. Imported clinker, critical in the manufacture of cement, dropped by 77.5 per cent.

Treasury had sought to expand the number of products that pay levy in the Finance Bill, 2024, to include raw materials for manufacturing of paper packaging materials, critical for packaging food products and household items.