Tough options for Ruto after court blow to Finance Act 2023

President William Ruto faces the reality of having the Finance Act 2022 as the most recent major money law but one that cannot assist his administration in raising more tax revenue. 

This was the last money law drafted and passed in the final days of President Uhuru Kenyatta’s tenure in the months leading upto the August 2022 General Election. 

At the time, Kenyatta’s administration was under heavy fire from Ruto, the then deputy president who was fighting it out with Azimio leader Raila Odinga for the presidency. The tax riddle was the bone of contention and Ruto’s corner hit at Kenyatta at every point for imposing high tax rates on Kenyans at a time they could ill afford it.

Ruto, sworn into office on September 13, 2022, implemented the Finance Act 2022 for the better part of his first year as president although he had little to do with its crafting. 

This week, his first Finance Act 2023 was found unconstitutional by the Court of Appeal, which upheld a similar ruling by the High Court. The government has since appealed the decision at the Supreme Court noting that it stands to lose Sh164 billion in tax revenues should the Act be scrapped. 

Punitive tax measures

This comes shortly after President Ruto was forced to withdraw the Finance Bill 2024, which was expected to enable the government to raise Sh346 billion through new and additional tax measures. This was after countrywide protests against the punitive tax measures proposed in the Bill that would have further pushed up the cost of living.

Should the Supreme Court find the Finance Act 2023 unconstitutional, it would mean cheaper petroleum products with the Value Added Tax (VAT) rate reverting to eight per cent from the current 16 per cent, while Pay As You Earn (PAYE) rate for high income earners would reduce to 30 per cent from 35 per cent for Kenyans earning over Sh800,000 and 32.5 per cent for those earning between Sh500,000 and Sh800,000 per month.

And while there were measures that hit Kenyans with higher taxes, there were those that offered Kenyans some reprieve in certain areas. 

The Finance Act 2023 reduced the cost of cooking gas by zero-rating VAT on Liquefied Petroleum Gas (LPG) from eight per cent. This is expected to revert to eight per cent – the same level as other petroleum products – should the Supreme Court uphold the Court of Appeal ruling. 

It had also zero-rated VAT on export services, which would revert to 16 per cent. Excise duty on calls and data, and money transfer services by banks will now be 20 per cent instead of 15 per cent, import declaration fee (IDF) for imports would increase to 3.5 per cent and not 2.5 per cent while the Railway Development Levy (RDL) that is levied on all imports would go up to two per cent from 1.5 per cent.

Ken Gichinga, Chief Economist Mentoria Economics said, the Finance Act 2022 becomes a reference point following the withdrawal of the Finance Bill 2024 and if the Supreme Court finds the Finance Act 2023 unconstitutional.

Ease pressure on resources 

It however might not do much for the government as the tax measures that came into effect then are already entrenched.

“When a Bill or an Act is either withdrawn or found to be unconstitutional, it means that one has to refer to the previous year and in this case, the Finance Act 2022 will become the benchmark or point of reference for the way forward,” Gichinga said.

“We are in unprecedented territory, which obviously means that the budget deficit might be quite sizable. There could be areas for budget cuts especially in areas considered non-essential that provides shedding off that excess fat,” he added.

He explained that to navigate the impact that the absence of a Finance Bill has on revenue raising, the government will need to be innovative in introducing other revenue-raising measures as well as look into ways to reduce pressure on government revenues.

“From a revenue-raising perspective, the government will need to be quite innovative and in a way that is not overbearing to the public because part of the reason we are is because of approaches that have been overbearing to the public and have been rejected,” said Gichinga.

“One could argue that there is a need to seal revenue leakages as well as certain exemptions… it will mean going through with a tooth comb to be able to get additional areas to increase revenues. If you look at counties in terms of their own source revenue, it has been low. So assisting counties in building their own source revenue so that it can ease pressure on the resources available.”

Nikhil Hira partner at Kody Africa LLP said one of the best options the government has would be to significantly cut expenditure. The National Treasury in the first Supplementary Budget that was supposed to factor in the missed revenues following the withdrawal of the Finance Bill 2024, implemented budget cuts resulting in the overall budget going down to Sh3.8 trillion from Sh3.99 trillion, with the development expenditure taking a major hit.

Hira said should the Supreme Court uphold the ruling by the Court of Appeal, the government would have to further implement deeper cuts. “What options does the government have? The obvious one is that they cut expenditure,” he said adding that another option that Kenya has would be to borrow, which could be difficult considering its debt levels and also recent sentiments from the market. Moodys, the global rating agency in early July downgraded Kenya’s rating following the withdrawal of the Finance Bill 2024,” he said.

“The other option is that to finance all this, they will have to borrow and that is not as easy as it used to be, especially after Moodys gave a negative rating on our debt. That means it’s more difficult to get debt and as it is, we are quite heavily indebted.”

“The support from the market may also not be as easy because even recently the government has issued Treasury Bonds and the subscription has been nowhere near where they were expecting. I think the appetite to lend to the government is also down.”

Hira also looked at different outcomes of the appeal at the Supreme Court as well as the options that the Treasury has before the apex court hears and determines the case.

Predicament

“If the government goes to the Supreme Court, it may ask the Court of Appeal to give a stay on its judgment so that the government continues to collect taxes until the Supreme Court makes a ruling,” he said.

“But if no stay order is given, then we are back in this position where we have expenditure but we do not have some of the tax revenue. So we will have to cut expenditures or we will try to borrow both of which are probably unpalatable. They are in a fix.”

“If the Court of Appeal does not give a stay and we stop paying the taxes imposed by Finance Act 2023, and then the Supreme Court in future rules that the Finance Act 2023 is constitutional, it raises another question then as to whether KRA will come to taxpayers and say that you should have been paying because the Supreme Court has overturned the ruling of the Court of Appeal. Taxpayers could find themselves in some situation,” he explained.

Hira believes that the government might try and amend certain laws and introduce additional tax measures in the coming months as it tries to raise revenues. He said that the government would need to tread cautiously and not anger Kenyans, whose protests have resulted in the current predicament.

Former President Kenyatta’s regime introduced the Tax Laws (Amendment Bill), 2020, which reduced the number of taxes aimed at cushioning Kenyans against the harsh impact of Covid-19 pandemic. The law reduced corporation tax to 25, PAYE to 25 per cent and scrapped PAYE for people earning less than Sh24,000 per month. These were however reversed in January 2021 through another tax law (Amendment Bill).

President William Ruto might introduce such a Bill but with the aim of increasing certain taxes or fees and levies.

“One of the options that the government has is to do what President Uhuru did in 2020 when Covid-19 hit us and issue a tax laws Amendment Bill. Even then,the government has to be careful because it cannot introduce everything that was in Finance Bill 2024 because that was the big issue that the Gen Z had,” he said.

“Tax laws Amendment Bills were issued in both years (2020 and 2021) and made changes in the Excise Duty Act, the VAT act and the Income Tax Act and the Miscellaneous Fees and Levies Act. That is definitely a possibility… they will have to issue some measures.”

The rejected Finance Bill 2024 and the Finance Act 2023 that is being contested in courts had many measures that had been recommended by the International Monetary Fund that had sought to help the government increase tax revenues. Their rejection could put President Ruto’s regime at loggerheads with the Bretton Woods Institution and could delay disbursements from the extended credit facility agreed on in 2020.