Macroeconomic determinants of taxes on income, Profits and capital gains in Kenya

Abstract

This study sought to identify the macroeconomic determinants of tax revenue from income profits and capital gains otherwise referred as tax on income, profits and capital gains (TIPC) for Kenya. The macroeconomic factors studied included national output which was proxied by gross national income (GNI), gross domestic savings (GDS), and gross capital formation (GCF), general government final consumption expenditure (GGFCE), foreign direct investment (FDI) and price level represented by consumer price index (CPI) .The study used time series data for the period from 1971 to 2011. Augmented Dickey-Fuller (ADF) test was used to check for stationarity. Johansen cointegration and error correction method were applied to determine the long-run and shortrun relationships. Post-analysis tests were carried out to ensure the model was stable, residuals normal and that the model did not have either serial correlation or heteroscedasticity. Pairwise Engle-Granger causality test was carried out to determine the direction of the relationships established. From the cointegration results, the error term was estimated and a long-run relationship between TIPC and macroeconomic factors established. The variables explained 83.76% of the model in forecasting tax revenue from income, profits and capital gains. Moreover, the error correction model estimated for the short-run dynamics of the independent variables and their rate of return to an equilibrium state. The study established that each of the variables corrected for disequilibrium in TIPC within two years. A unidirectional causality was established from CPI to TIPC. The study showed that high cost of living in Kenya would result in lower tax revenue from income, profits and capital gains hence the government should ensure cost of production reduce to make goods and services cheaper.