State rides ‘sin tax’ gravy train to increase revenue

Kenya Kwanza government is eyeing the “sin tax” as an easier option for collecting revenue to meet President William Ruto’s goal of increasing the proportion of tax collection to gross domestic product (GDP) to 22 per cent by the end of his term.

Excise tax, often referred to as a “sin tax”, is typically imposed on goods and services deemed harmful or undesirable, such as tobacco, alcohol, firearms, and activities like gambling.

The term “sin tax” stems from the notion that these goods and services carry significant externalities for both the consumer and society at large. The Finance Bill, 2024 presented to the National Assembly last week exemplifies this new focus. The Bill proposes a cap on excise duty at 20 per cent for most commodities, which is a departure from previous policies where many of these items were either exempt or subjected to lower rates.

Speaking on the new approach, Lena Onyango, a Tax and Exchange Control Partner at Cliffe Dekker Hofmeyr (CDH noted that a variety of goods, including financial services, which were previously exempt from excise duty, are now subject to it. Onyango who spoke to the Business Hub on the shift in the excise duty rates on the sidelines of a stakeholder breakfast meeting by CDH on the implications of the Finance Bill viewed the strategy as a method for the government to generate additional revenue.

Financial services

“We are seeing a reversion of excise duty rates in most of these commodity items capped at the level of 20 per cent. We are also seeing a lot of goods that were exempt from excise duty even financial services are now being subjected to excise duty so that is a way of them raising additional revenue,” she said. Alex Kanyi, who is also a Tax and Exchange Control Partner at CDH concurred with the view, saying that Excise Tax was an uncomplicated and efficient method for tax collection.

The approach, he said involves concentrating on the larger players in the market to collect the tax, simplifying the process for the government and ensuring effective revenue generation.  This strategy not only streamlines tax collection but also places the responsibility of collection on the major entities in the market.

“It is an easy target to increase and collect excise tax. You just target the large players to collect on behalf of the government,” Kanyi said. While speaking to a group of Harvard Business School students this week, President Ruto outlined his ambitious fiscal plan of boosting the tax-to-GDP ratio from the current 14 per cent to 22 per cent by the end of his term.

The first step in this strategy is to increase the tax rate to 16 per cent in the next fiscal year. This initiative is part of a broader effort to bolster the country’s revenue and decrease its dependence on borrowing.

The proposals, though bold have sparked widespread debate, with critics arguing that they could exacerbate the cost of living crisis while proponents assert their necessity for national development. Addressing methods of increasing taxes during an interview on  a local TV show, US Ambassador to Kenya Meg Whitman advocated for expanding the tax base through job creation rather than raising tax rates.

She stressed the importance of taxation consistency in fostering a stable economic environment in Kenya.

“Taxes are an issue in every country and what we hear in American companies is that Kenya just needs to be the lowest taxed but consistent; keeping the tax the same for three, four, or five years because businesses make investments with a return horizon,” she said.

“There’s two ways; to increase taxes and also expanding the tax bases which is the number of people (being taxed) and that’s why jobs, jobs are so important. Good paying jobs, with a steady paycheck and some benefits “When  more people have a steady income they can pay  taxes so you expand the number of people and not just go for the same people, “  Whitman added.

The Finance Bill has stirred controversy by eliminating VAT exemptions on crucial banking services and staple foods such as bread. This single move is anticipated to substantially raise the cost of these goods and services, affecting a wide swath of the Kenyan population.

It also retains a 15 per cent excise duty on financial and telecom services, encompassing essential services like money transfers and data services. It also proposes a 20 per cent excise duty on fees levied by digital lenders and banks.

In today’s digital era, where e-commerce and online transactions are commonplace, such taxes could potentially stifle entrepreneurial innovation and growth, tax experts said.

They called for transparency in revenue generation before implementing new changes, with Kanyi suggesting that tax increases should correlate with service provision, as taxpayers want to see how their contributions are utilized. He also advocated for a clear breakdown of tax collection and expenditure before introducing new taxes to fill any gaps.

Close the gap

“A good start should be how much taxes have we collected this year so far and how much of that for example is attributed to measures that were introduced in the Finance Act 2023, how have we used those taxes then you are able explain the gap and say we introduced these taxes but didn’t collect more that’s why we want to introduce more to close the gap,” Kanyi said.

Lydia Ndirangu, Equity Group’s head of tax, cautioned that the bill’s provisions could hinder financial sector progress. She noted that the new VAT, coupled with the existing excise duty, might drive Kenyans towards a cash economy to evade high transaction costs. This could lead to a cumulative 39 per cent tax hike on financial transactions, deterring the use of formal channels.