An assessment of tax revenue performance before and after liberalization of exchange rate in Kenya: 1972-2000

Abstract

This paper evaluates the performance of tax revenue before and after liberalization of exchange rate market in Kenya. The recently developed econometric techniques associated with cointegration of time series are applied.

Analysis of stationarity was done for both the exchange rate function and the three behavioral tax revenue models. The real exchange rate measure used in this paper is a relaxed version of Edwards (1989), which does not impose the purchasing power parity (Ppp) that has been under immense criticism.

The estimation of dynamic error-correction models, usmg the ordinary least squares estimation technique found that the real exchange rate has a positive effect on the Direct and Customs Duty Tax Revenues, while real exchange rate lagged once has a deleterious effect on Other Indirect Tax Revenue. The coefficients of all the revenue functions were found to be significant at 5% level. In order to verify the reliability of the models specified, several diagnostic tests were carried out. The outcome of these tests confirmed that the model is well specified and it is consistent with the statistics.

The outcome obtained after estimating the error correction dynamic specification demanded prudence in the use of the real exchange rate policy. It also demands that the fiscal policy architects be cautious of the impacts of the real exchange rate on the tax revenue while dealing with important fiscal decisions.