Albeit being welcome by most of the analytics in the Economic sector, there is still a quibble that the head of state still need to do more to the public which will help in shielding Kenya from the adverse impact of COVID – 19 to the economy.
The measures announced by the President on Wednesday which included scrapping income tax on those who earn less than Sh24, 000 monthly, reducing corporate tax to 25%, cutting Value Added Tax from 16% to 14%, reduction of Turnover Tax from 3% to 1%. Voluntary salary cut of 80% for head of state and his deputy, 30% for Cabinet Secretaries and their assistants and 20% for principal secretaries still being major proposals.
Though considered to be positive by most economists, the PAYE relief will only benefit a few who are the low income earners and those who attract the 30% leaving out quite a number of people, mostly the middle income earners, this makes me come into consensus with the FKE chief executive Jacqueline Mugo’s remarks; that the government should have considered a domestic relief to all the employees.
Just to provide an insight on the reduction of PAYE from 30% to 25%, the difference in your tax liability is not going to be 5% as many understood it but it will be 16.6%; thanks to Mr. Kwame Owino’s tweet illustration.
Assume you earn Sh100
PAYE Liability = Ksh30 at 30% and
KSH25 at 25%
The difference in the amount saved under lower tax rate will be (30-25) = Ksh5
The difference in your tax liability will be 5/30×100 which is 16.6% and not 5%.With this reduction, an employee’s disposable income will be increased.
Employers having asked the government to reduce the VAT by a margin of 50% that is from 16% to 8%, the government only agreed to reduce it by a margin of 12.5% and not 2% reduction as had been literally interpreted by many. See the illustration below;
From 16% to 14% it is not a change of 2% but 12.5%
(16-14) = 2% ×100 = 12.5% Change.
Assume one wants to make a purchase of a commodity which costs Sh125
Former rate = 0.16×125. =Sh20
Current rate = 0.125×125. =Sh15.625
Amount saved. =Sh4.375
The amount saved in the illustration above acts as a policy to increase an individual’s disposable income. Major implication of this VAT reduction is that it will drive down the prices and hence a rising demand of goods. It is important from the outset that there is a little doubt that permanent or temporary lowering of VAT rate on particular goods (or service ) sooner or later will lead to a reduction in the prices of good more or less correspond to the monetary equivalent of the lower VAT rate.
There is also little doubt that as prices slide, consumers demand for this particular good or service will sooner or later expand.
Consumers switch part of their demand towards the good with the lower tax rate because the prices are lower than before. Production and employment in the sector producing the good will correspondingly expand to meet the higher demand. If consumers react only weakly to lower prices, production and employment will not increase significantly, a true replica to the case for basic goods, for example food as consumers prefer to preserve their level of food consumption and use saved expenses to increase other types of less basic but more luxury goods. In contrast which best suits our current state of affairs – that is the COVID -19 crisis, if consumers act strongly to new prices due to a reduction in the VAT i.e. if consumption is price elastic, production and employment may increase significantly.
A study by Copenhagen Economics indicates that if production is very labor intensive, there seems to be a strong production and employment response of lower VAT rates in the industries affected, but since we are the victims affected by this crisis which has led to a curfew an euphemism for lockdown whereby those labor intensive production industries employers are forced to establish shifts and reorganize their operations and some are even laying off staff.
Curfew can be termed as a gross economic miscalculation step taken by the government while lowering VAT at the same time. I couldn’t agree more with the government on reduction of the VAT but we should ensure that policies passed are not counterproductive.
A reduction of the Turnover Tax from 3% to 1% is neither a good move by the head of state. As a result of this curfew nightmare, the SMEs which is the main sector paying this tax are really between a rock and hard place since this is the moment they will even be forced to make sales at a loss but will still be forced to pay this tax . The government should have considered scrapping the Turnover Tax altogether since it is charged on total sales.
Before time is overdue, I hope the government is coming up with some economic measures to save the MSMEs which are at their nadir and shutting down due to lack of cash flows. A notion that these MSMEs are informal, unregistered and unorganized enterprises that do not pay tax is not a valid report at all. According to KNBS MSMEs survey in 2016 there was 1.6Million licensed MSMEs which have employed 6.3Million people that are over and above the formal private sector three times, paying 34billion tax a month, Sh270billion a year which in 2016 was 23% of tax revenue. These MSMEs were paying workers/ owners Sh10billion a month and estimated to have contributed 1,780.0billion compared to Ksh5668.2 billion for the whole economy. See the table below.
It is understandable that there is a limit to what the government can do but these measures are not yet enough. The government should be ready to do more as situation unfolds because all these are to the benefit of the citizens, economy and to the government itself.
I’m primarily a Finance Scholar just getting started in Finance academia but also interested in reading and engaging in all sorts of social commentary.