The determinants of value added tax revenue in Kenya

Abstract

Kenya introduced Value Added Tax in the year 1990 to replace the Sales Tax which had been in operation since 1973. VAT has been the choice instrument for unexpected expenditure by increasing VAT rates. This study evaluates VAT revenue productivity for the period 1995/96 to 2009/10. The objective of this study was to evaluate the determinants of VAT revenue and come up with a model for predicting VAT revenue in future. The study utilized secondary data obtained from the KRA database for the financial years 1995/6 to 2009/10. The analysis showed that the determinants of VAT revenue have a significant effect on the responsiveness of VAT revenue. This implies that the growth in VAT revenue during the period of study was accounted for by changes in its determinants. In the VAT revenue equation, the positive intercept effect is counteracted by negative effects that are greater the higher are standard tax rate, inflation rate and foreign exchange rate. This study also finds that multiple rates, higher range between highest and lowest non-zero VAT rates, and the longer the VAT has been in operation (age of the VAT) are associated with higher revenues. This study provides decision makers with an analytical framework which can be used to estimate the associated revenues for a VAT in Kenya and guidance to policymakers in countries planning to introduce a VAT. It identifies the determinants of VAT revenues which when properly understood, documented, and captured in relevant tax revenue models, would make it possible to estimate accurately VAT revenues within a specified period of time. Although past studies advocated for raising rates within the existing system as the most obvious approach for increasing revenues, policy makers should note that this study finds that the tax rate cannot be pushed too high without markedly reducing VAT revenue. The study also contributes to the existing literature on the VAT structure in Kenya and stimulates further research in the area of VAT. Researchers should study the impact of Electronic Tax Register (ETR) and Withholding VAT on VAT revenue. The study concludes that Kenya’s VAT revenue is very responsive to changes in its determinants and supports other researchers’ findings that the determinants of VAT revenue have a significant effect on VAT revenue.