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What are Tax Expenditures?
When a government wishes to financially support a vulnerable sector or community, it can do so in various ways. For example, to address period poverty in Kenya by improving girls’ access to sanitary pads, the Kenyan government could decide to provide free or subsidized sanitary pads to schools by allocating funds to the relevant ministries for their provision. This would be reported as a direct expenditure.
Alternatively, the government could exempt pads from value-added tax (VAT) to reduce their cost. As a result, the government by foregoing tax that could have been paid by girls when they were purchasing sanitary pads, would attempt to achieve the same goal of ending period poverty through a different means. This is also an expenditure of the government, but more specifically, a tax expenditure.
Tax expenditures are the revenue foregone by a government due to tax exemptions, incentives, deferrals or allowances that the government allows. Essentially, any deviation from what the actual tax rate is supposed to be is a tax expenditure.
The Importance of Tax Expenditure Reports
In the same way that reporting on direct expenditures by government ministries is treated as a crucial aspect of the budget-making process and inspires public confidence, so too should reporting on tax expenditures. Tax expenditure reporting enhances the transparency and accountability of the government in public finance management. Tax expenditure reports help us understand how much the government is losing, or foregoing, due to various tax incentives and exemptions. Further, understanding who the beneficiaries of these exemptions and incentives are, as well as the underlying purpose of these tax concessions, enhances public participation in revenue conversations. It enables the public to evaluate whether tax concessions are meeting their intended purpose e.g., increasing foreign direct investment, and helps governments ascertain how efficient the tax incentives provided are.
Kenyan Tax Expenditure Report 2021
Despite the importance of tax expenditure reports, many African countries still lag behind other countries in publishing them. The Kenyan government only recently began publishing its tax expenditure reports; and even then, the 2021 Tax Expenditure report was published following much pressure from international financial institutions such as the IMF to increase fiscal transparency and tax efficiency.
One of the most important aspects of a tax expenditure report is the level of detail within the report.. The ideal report includes every tax waiver, and in Kenya, this is supported by the Kenyan Constitution. Ideally, the report should outline all the waivers provided by the government and then provide estimates of the revenue loss occasioned by this. Kenya’s 2021 Tax Expenditure report attempted to achieve this, however, surprisingly, a number of tax regimes including the tax incentives that the government provides within special economic zones (SEZ) and export processing zones (EPZ) in Kenya were missing from the report.
This is particularly important because in the past few years, there have been calls for reviewing the efficacy of EPZs and SEZs. The benefits of these zones in comparison to what is being lost through tax incentives have been questioned. Publishing the tax expenditures of these zones would enable a cost-benefit analysis to be conducted and allow for more informed decision-making.
Another missing detail within the tax expenditure report was the income tax concessions provided for foreign aid by the Kenyan government. Tax exemptions on foreign aid are a controversial subject as evidenced by the general uproar following the income tax exemptions provided by the Kenyan government to Japanese firms, consultants and personnel who are undertaking projects that are financed from grants. These were 16 projects that amounted to around Ksh 328 billion. Further, double tax relief measures should be included under the tax expenditure report. Kenya currently has 14 double taxation agreements in force. Double taxation agreements often provide lower rates of taxes and in some instances, they are exploited leading to double non taxation. Since Kenya is increasingly widening its double taxation treaty, it is important that tax expenditures under double taxation agreements be included regularly in the report.
The 2021 Tax Expenditure report indicated that value-added tax (VAT) in 2020 had the highest tax expenditure at 2.18% of GDP in comparison to tax expenditures under corporate income tax (CIT) which was at 0.53% of GDP. However, tax expenditures under CIT could potentially be higher than under VAT once some of the important aspects that were omitted in the 2021 report are included.
What next?
It is highly commendable that Kenya has publicly released its first tax expenditure report. To ensure that the government is held accountable, it is essential that tax expenditures be included in the budget-making process and presented on an annual basis. Further, it is necessary to ensure that all incentives are included in tax expenditure reports, including those provided under the EPZs, SEZs and other preferential tax regimes as well as double taxation agreements. . In the absence of any specific tax expenditure reporting, is should be imperative that reasons be provided for any exclusion of tax concessions. This will ensure that fiscal policy is shaped in a manner that is fair, equitable and efficient.
Further, the reports should be used to evaluate tax expenditures. With the data generated through the tax expenditure reports, it is important for the government to carry out cost benefit analyses on the tax concessions provided. Are they meeting their intended objectives? This data will be very helpful in shaping Kenya’s tax policy especially regarding tax incentives.
By Everlyn Kavenge Muendo
Everlyn Kavenge Muendo is the Policy Assistant for Tax and Investment at the Tax Justice Network Africa. For any inquiries please contact her at emuendo@taxjusticeafrica.net