Government's main task in taxing times

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By Musau Nelson

As the end of the government’s financial year 2011/12 approaches, we need to review the year’s statistics to understand the state of our economy and project the way forward. This comes in a time when numerous economies are facing a slowdown while others are at a recession.

A recession is a significant decline in economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, production, and wholesale-retail sales. It is caused by either a fall in aggregate demand or supply. Aggregate demand is composed of consumption, investments and net exports. A decline in any of these components would culminate into a recession.

In 2011, numerous factors such as macroeconomic stability, unemployment, inflation and interest rates, depict that the Kenyan economy has been flirting with a slowdown at best or a recession at worst. The economy struggled with a severe drought, food shortage and soaring fuel prices resulting to the anemic economic growth.

According to the 2012 economic survey, the Gross Domestic Product (GDP) grew by 4.4 per cent a drop from 5.8 per cent growth in 2010. Employment grew by 4.7 per cent with the informal sector contributing over 85 per cent to the growth.  The numerous challenges in the financial sector were countered by a tightened monetary policy to bridle the inflationary pressures and stabilize the exchange rate. The Central Bank of Kenya adjusted the Central Bank Rate to 18 per cent in December 2011 while the Cash Reserve Ratio finished at 5.25 per cent prompting the commercial banks to raise the interest rate hence reducing the liquidity in the market. The efforts were rewarded with a substantial ease of the pressure on the shilling culminating into a reversal of the inflationary trend.

The average interest rate for 91-day Treasury bills increased by 7 per cent to 18.3 per cent with the performance of the securities’ market slowing down as the NSE 20 Share Index dropped by 1,228 points to stand at 3,205 points as at the end of the year.

The Kenyan state of the economy might not be that bad. The world’s real GDP growth is estimated at 3.8 per cent while that of the OECD economies grew at 1.9 per cent. However, the Sub-Saharan Africa and the East African Community registered a higher GDP of 5.2 per cent and 5.9 per cent respectively.

The upcoming general election and the economic status of our trading partners present strong headwinds that may impede a robust growth in 2012. All these factors have an impact on how the firms and consumers will invest and spend respectively; which play a significant role in any economy.

The government is at task to tackle the lingering slowdown. In a slowdown we expect a drop in the expenditure by the private sector leading to an overall decrease in demand of commodities. Investments are also bound to drop and factories might reduce their production with most of the production going into inventories rather into final sales.  The factories may therefore be forced to lay off workers. The government may also register fall in tax revenue thus calling for a cut back on essential services such as security, infrastructure and education.

We need remedial measures, where inefficient and uncompetitive businesses and services are eliminated, costs are lowered, and ground is cleared for new growth. However, it is not every part of the economy that is well positioned to adopt the various corrective measures successfully. 

The government has to stimulate expenditure either directly or by introducing some incentives to the private sector to induce spending in order to avoid further slowdown.

An expansionary fiscal policy entailing government’s injection of funds into the economy or introduction of tax incentives will help. An efficient stimulus package will create jobs thus generating income for the workers. This creates demand for commodities in the market hence creating an incentive for firms to invest in production of more commodities which in turn creates more employment and further demand for commodities.

Ultimately, as the positive ripple effect continues, the tax revenues naturally rise due to increased economic activity and government’s deficit financing is no longer needed at some point. The rise in revenues will be used to reduce the budget deficit. Consequently, taxes, fiscal policies, and interest-rates will be adjusted to maintain the health of the economy and keep government budgets balanced.

The government has to source for funds to finance the expenditure so as to resuscitate the economy without increasing tax rates. Deficit financing is justifiable in this case. The currently widening merchandise trade deficit, deteriorating current and capital accounts balances are a huge disincentive to this quest. However, there are a few other options to explore. A move to combat tax fraud and cast the tax net wider to capture the highly untaxed informal sector will be of help. A partial amnesty for violators of tax laws might also boost the revenues and reduce the budget deficit.

If the economy is to grow in 2012/2013 financial year, the government has to juggle its balls wisely. After all, exceptional times call for exceptional measures.

The writer is a tax consultant with EY. Email: Views expressed are not necessarily those of EY.