The debate over proposed tax measures seems to generate more heat than light. While there is a general aversion to higher prices for goods and services, there is little insight into the legitimate ways governments can generate revenue to support service delivery. The debate is not limited to the Kenyan borders, it is also taking place on the global stage.
Last month, the Group of Seven Developed Economies agreed to support a minimum global corporate income tax of at least 15 percent. With these developments happening at the same time, it makes sense to take into account the guiding principles of a good tax.
While there are several theories about taxation in public economics, notable contributions have been made by Adam Smith in his book The Wealth of Nations. He outlined four main criteria that characterize a decent tax. By his definition, good taxes are proportional to income or solvency, safe and not arbitrary, payable at certain times and in a convenient way for taxpayers, and ultimately cheap to administer and collect. These principles provide us with a framework against which we can weigh up the appropriateness of tax measures.
An effective way to assess the adequacy of taxes is to divide them into two broad categories: taxes on production and taxes on consumption.
Taxes on production focus on the supply side of the economy and include those incurred during the production of goods or services. They are closely related to the factors of production; Land, labor, capital and companies, without which no form of production would be possible. They include corporation tax, income tax and property tax levied on the property value.
Excise taxes focus on the demand side of the economy and are levied on the consumption of goods and services. These include VAT and excise tax.
Taxes on production tend to easily meet Smith’s criteria. They are proportionate to solvency and are easy to manage. However, excise taxes like VAT are income regressive and tend to decrease as income increases as a percentage of income. A senior executive pays the same sales tax on a loaf of bread as a high school student, despite their remarkably different incomes. They are also very difficult to manage just looking at the number of VAT cases in courts.
As Kenya approaches a new tax policy, policymakers should find the right balance between production and consumption taxes necessary to meet the country’s fiscal goals. A good case study is Estonia. In its seventh year, the country has earned the title of the OECD’s best tax code.
Its main features include a 20 percent tax rate on corporate income, a flat tax of 20 percent on individual income, property tax only applies to the value of land, and the territorial tax system that divides 100 percent of the foreign profits of domestic corporations from the domestic Taxation.
In addition, given its historical role in sparking major revolts, Kenya should be careful about excise duties for stability reasons. In the US, the tea tax led to the American Revolution, while in India, a consumption tax on salt led to Mohandas Gandhi’s famous salt march.