Kenya’s Tax Expenditure Reports: A Comprehensive Review

The Institute of Public Finance (IPF) in August 2024 convened a meeting that brought together key government institutions to discuss tax expenditure reporting in Kenya. The meeting was informed by the Institute’s review of the 2022 Tax Expenditures Report.

Kenya has not always reported on tax expenditures. The country released its maiden report on tax expenditures in 2021 to comply with reporting commitments to the International Monetary Fund, but has since committed to annual reporting on tax expenditures. Publication of data on tax expenditures is an important marker of transparency. It is also a prerequisite for meaningful evaluation of tax expenditures as a policy tool for the government.

Tax expenditures pose an important cost to the government. As such it is critically important to evaluate whether they are an effective, efficient and equitable use of public resources. This cannot be achieved without comprehensive estimation of their costs (revenue forgone, administrative costs and compliance costs) and their benefits. IPF’s review sought to establish how well the Kenyan government has done in this regard.

How big are tax expenditures in Kenya?

Kenya’s National Treasury estimates that total revenue forgone due to tax expenditures increased from 239 billion Kenyan Shillings (Ksh) in 2020 to Ksh 394 billion in 2022. As a share of Gross Domestic Product (GDP), tax expenditures increased from 2.2 to 2.9 percent over the same period. These figures are significant, although lower than the global average which, according to the Global Tax Expenditures Database, lies slightly below 4 percent of GDP.

How does the Government estimate its tax expenditure?

Whereas high-level numbers on tax expenditure are useful, their level depend on how they are derived. Estimating tax expenditures is arguably more difficult than estimating budget expenditures. First, one must decide what to include and to exclude in this estimation. To do this, the government must first define the benchmark tax system – the tax system in the absence of tax expenditures, however, there will always be disagreements on how to define the benchmark. IPF’s report recognizes that these disagreements are expected but it is also important for the government to maintain a consistent benchmark. When changes are introduced (as it was the case in Kenya), it is crucial to provide a detailed justification. Second, tax expenditure numbers are very sensitive to inclusions and exclusions from the benchmark and hence, it would be useful for the government to provide alternative estimates based on the different definitions of the benchmark. Third, the government should move from just reporting changes in tax expenditures to including information on what caused these changes. Tax expenditure reports as currently produced do not tell us what caused the changes; yet it is important to isolate changes triggered by policy decisions from those changes that resulted from a change in the definition of the benchmark tax system.

Do tax expenditure reports provide comprehensive information about tax expenditures?

A comprehensive tax expenditure report should include a comprehensive definition of the tax expenditure concept and the benchmark tax system. It should also provide information on each individual tax expenditure provision, including policy objectives, beneficiaries, categorization by type of tax expenditure (such as exemptions, tax credits, reduced tax rates, tax deferrals), and the methodology used in estimating the cost or revenue forgone. The Kenyan government‘s reports so far only included some of this information. This is reflected in Kenya’s ranking in the Global Tax Expenditures Transparency Index (GTETI). Kenya ranks on position 49 (out of 104 jurisdictions assessed) with a score of 49.2. Some of the identified gaps are the lack of information on legal provisions, estimates of revenue foregone, inadequate information on policy objectives, and lack of information on beneficiaries.

Future reports should include more details on specific policy goals of tax expenditures, classify tax expenditure provisions by type and, more critically, include detailed information on beneficiaries and policy objectives of every tax expenditure.

Where does Kenya stand in evaluating its tax expenditures?

Beyond reporting on tax expenditures, it is equally important to evaluate whether they provide value for money and whether the government should reform specific tax expenditures. In Kenya, the main objectives of tax expenditures are to spur economic growth, increase investment, create employment and lower the cost of living. Other than these objectives being defined too broadly to support meaningful evaluation of tax expenditures, the government does not link the reported revenue forgone numbers to tax expenditures’ policy objectives.

When it comes to ex-post evaluations, comprehensive information about the intended goals of tax expenditures, as well as a methodology to determine if these goals are being reached, are lacking. Achieving the desired objectives of the use of tax expenditures requires institutionalized (as opposed to ad hoc) evaluations for informed decision making, which in some countries (such as Germany and Netherlands) is a legal requirement. When it is not feasible to conduct in-depth regular evaluations of tax expenditures, periodic evaluations should be considered. In the Netherlands, for instance, evaluations are carried out every four to seven years.

Going forward it would be important for the government to develop a framework for introducing, reviewing and evaluating tax expenditures as a basis for the introduction and review of tax expenditures. In addition, it was noted that beneficiaries of tax expenditures should support the evaluation process by demonstrating the additional employment they created and additional investment they made as a result of the tax expenditures.

Lack of an evaluation framework has also inhibited assessment of whether tax expenditures are efficient. The IMF, OECD, United Nations, and World Bank define efficiency of tax expenditures to mean that tax expenditures meet their objectives at low social costs. Evaluating tax expenditures with similar objectives for example is useful in eliminating redundant tax expenditures. Such evaluations should be sufficiently detailed to cover both obvious costs (such as revenue forgone and administrative and compliance costs) as well as their potential impact on other sectors of the economy. For example, if a tax incentive targets new firms only, then investors might set up new companies to enjoy preferential taxation for new firms. Therefore, the goal of preferential tax provisions should always be to support activities that would otherwise not take place. In the absence of an assessment, we cannot tell whether there are alternative policy options that can achieve the same policy objectives at lower costs.

The government has identified equitable distribution of income as a core objective of tax expenditures but fails to produce disaggregated data on their ultimate beneficiaries. Future reports should attempt to disaggregate data by income, age, sectors and region to support an assessment of whether tax expenditures enhance equity of the tax system or not.

Pathways forward

The participants at the IPF meeting identified disaggregated data as a basic building block in reforming Kenya’s policy on tax expenditures. This data would support evaluation of tax expenditures by government institutions such as the Kenya Institute for Public Policy and Analysis (KIPPRA) and the Kenya Revenue Authority. Deeper analysis such as microsimulations would only be made possible if the right data is availed. In this regard, the Kenyan National Bureau of Statistics plays a critical role. A starting point towards this journey will be a detailed chapter on the intended impact of tax expenditures in the upcoming tax expenditure report. Other institutions such as the Office of the Controller of Budget and the Parliamentary Budget Office (PBO) should also be involved as their engagement is critical in supporting parliamentary oversight in the use of tax expenditures in Kenya.

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