Vat Reforms and Revenue Productivity in Kenya (1990 - 2010)

Abstract

Kenyan government has been faced with constantly increasing development and recurrent expenditure with limited additional sources of revenue. A number of factors have contributed to this increase in government expenditures namely; prolonged drought over the years, high rate of inflation, demands for salary increment, implementation of new constitution among others. Consequently, the government budget deficit is becoming huge and may be unsustainable in future. We therefore carried out this study having identified Kanya's VAT as one of the revenue sources that is not fully utilized to find out whether it can help to generate additional revenue to the government to help in financing the growing budget deficit. The approach that this study took was to evaluate VAT reforms that have been undertaken on VAT since its introduction in 1990 aimed at boosting its revenue generating capacity. We hoped to identify areas that need further reforms to increase VAT compliance rate which has been relatively low over the years. We established that Kenya's VAT has been subjected to a number of reforms since its introduction for instance rationalization of VAT rates and lowering of VAT ceiling to minimize tax evasion and to increase competitiveness of local products together with other reforms discussed in this paper. To estimate the revenue productivity of VAT, we used elasticity and buoyancy models. VAT buoyancy was estimated using actual VAT data which did not require to be adjusted for government discretionary tax measures. On the other hand, data used to estimate VAT elasticity had to be adjusted using proportional adjustment method (PAM) to eliminate changes in VAT revenue occasioned by discretionary tax policy measure taken to boost VAT revenue. The study found Kenya's VAT to be inelastic and non-buoyant, with elasticity and buoyancy coefficients being less than unity. This confirmed that the VAT as a source of revenue is grossly underperforming and there is need for further reforms on VAT to boost its revenue productivity. We therefore proposed a number of policy measures to be undertaken to increase revenue generating capacity of Kenya's VAT.