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Kenya: Treasury to Unveil New Taxes, Cut Reliefs in IMF Reform Package

The government plans to introduce new taxes and cut back on existing tax exemptions as part of a reforms package funded by the International Monetary Fund (IMF).

To get the latest Sh257 billion loan from the IMF, the National Treasury has also promised to control the government wage bill, in what signals tough days ahead for government employees.

Loans from the Breton Woods institution are relatively cheap, but come with tough conditions on financial discipline on the part of the borrower.

This has seen the National Treasury sign on a raft of tax reforms to boost the revenue base at a time the country is dealing with the Covid-19 pandemic, which has seen many Kenyans lose their livelihoods.

“A key pillar of the strategy is to bring the tax-to-GDP ratio back to levels achieved in recent years (from 12.9 per cent of GDP in FY20/21 to 15.6 per cent in FY23/24), so as to generate resources to meet Kenya’s development needs.

“This objective is supported by measures already taken as well as a commitment to undertake further tax policy measures of 0.8-0.9 per cent of GDP per year in FY22/23,” the document explaining the IMF Kenya deal reads in part.

Treasury notes the country will continue to make Kenya’s tax system more efficient by streamlining exemptions.

“Our own analyses and IMF TA have identified substantial tax expenditures associated with a long list of tax exemptions and incentives,” Treasury Cabinet Secretary Ukur Yatani said in a joint letter to the IMF with Central Bank Governor Patrick Njoroge.

Mr Yatani says the proliferation of tax expenditures in past years has made Kenya’s tax system less efficient, contributed to a decline in the revenue-to-GDP ratio and has generally not had desired effects such as price reductions for consumers or expansion of production.

“IMF TA has identified potential revenue gain of 2.6 per cent of GDP within the VAT from further removal of exemptions outside agriculture and limiting of zero-rating. IMF TA has also identified revenue potential of 0.8 per cent of GDP from more equitable taxation of capital income as well as substantial potential for further revenue from excise taxes,” the document says.

“The new minimum alternative tax is a valuable tool in an equitable approach to taxation that has the potential for further enhancements. We will act within these areas to reach the programmed revenue targets, closely coordinating with the Kenya Revenue Authority (KRA) to ensure administability and timely implementation of tax policy change,” the document adds.

Treasury is also counting on the recent reversal of tax reliefs to collect an additional Sh124 billion. This excludes inflation adjustments to excise taxes introduced in October 2020, which had an estimated revenue yield of Sh6 billion in FY2020/21.

In the joint submissions with CBK, Treasury says to help protect high-priority social and development spending in the context of limited fiscal space, Kenya intends to gradually reduce the ratio of the government wage bill to GDP by about 0.5 percentage points by the financial year 2023/24.

“This will be accomplished through continued restraint in hiring and wage awards (including in the four-year wage agreement that will come into effect in FY2021/22) and by improved wage-bill management,” the submissions to IMF read in part.

Treasury has also committed to regular cleaning of the payroll to eliminate ghost workers and review and rationalise the number of allowances earned by civil servants. Treasury also says the government will improve functionality of its payroll management systems to cut down government expenditure.

In the implementation, Treasury says by June 2021, it will have harmonised and rationalised the categories, rates and rules for allowances. Treasury will also issue a decision to implement across ministries, departments and agencies (MDAs), counties, and semiautonomous government agencies (SAGAs) a common payroll system linked to the Integrated Financial Management Information System (Ifmis) by end of June this year.

“Payrolls would prior to being transferred to the new common system be cleaned and audited. By December 2022, complete the automation of personnel expenditure using the new payroll system in at least 50 per cent (by value) of MDAs, counties and SAGAs,” the document adds.

The reform package will also rope in nine parastatals among them Kenya Airways, Kenya Airports Authority (KAA), Kenya Railways Corporation (KRC) and Kenya Power.

Structural reform agenda

The IMF document also lists the Kenya Electricity Generating Company, Kenya Ports Authority and the three largest institutions of higher learning – Nairobi, Kenyatta and Moi universities – among those to be reformed.

“The structural reform agenda during the first phase of the programme will address urgent policy needs. In the near term, key priorities will be addressing challenges in SOEs (state-owned enterprises) and governance,” the document reads in part.

Kenya has also refreshed its commitment to make public procurement information available as part of the conditions for the loan.

The document says the Kenyan government plans to ensure comprehensive information on public tenders, including beneficial ownership information of the awarded entities, are publicly available on the government procurement information portal, and that bidders are subject to dissuasive sanctions for non-compliance.

This is not the first time the government has committed to make information on public tenders available, only to drop the ball once it has received funding. President Uhuru Kenyatta has also issued directives on the matter in the past, but state entities still choose what to make public and what not to.

“Work on the State Procurement Portal is being expedited to be completed by end of April 2021. This will be complemented by reforms to strengthen public procurement,” the document notes.

To sweeten the deal, Kenya has also committed to finally operationalise the Access to Information Act, which was enacted in 2016.

“This critical piece of legislation is overdue, and next steps to fully implement it – through the enactment of the regulations and introducing proactive disclosure across ministries – are key to enhancing transparency and accountability,” the document notes.

The structural reforms are part of the commitments Kenya made before the IMF approved a fresh Sh257 billion loan for Kenya through a 38-month programme, at a time the country is struggling to repay its mountain of debt.

External financing gaps

In their joint letter of intent to the IMF, Mr Yatani and Dr Njoroge asked the lender to have the loan disbursed as budget support.

“Along with support from development partners and other financing sources, including from our participation in the G20 Debt Service Suspension Initiative, the proposed arrangements will fill our fiscal and external financing gaps as we embark on a multi-year consolidation effort,” the letter said.

The National Treasury says the first disbursement of Sh33.7 billion will happen immediately, while a second tranche of Sh44.2 billion will be released by June 30, 2021.

“The balance will be disbursed following subsequent programme reviews conducted approximately every six months,” Treasury said.

The IMF document notes that state-owned enterprises have emerged as an important source of fiscal risk.

It says profits of public entities outside the central government declined by a third in FY19/20, to Sh62.5 billion (0.6 per cent of GDP), as many SOEs saw reduced profits and a handful showed huge losses.

“While the deteriorating income position of the SOE sector reduces its contribution to the budget, additional fiscal pressures could arise from SOE debt on-lent or guaranteed by the government,” the document notes.

For several SOEs, the Covid-19 shock exacerbated pre-existing underlying financial weaknesses.

For example, public universities have been registering persistent losses for an extended period. Kenya Power has over the past five years experienced declining financial performance driven by increasing costs, below-expectation demand growth and tariff approval delays.

Accumulating losses

Despite rising revenues, Kenya Railways saw a significant worsening in profitability in FY19/20 as it started to service on-lent loans contracted by the national government for the construction of the Standard Gauge Railway.

Kenya Airways, which like other airlines was hard hit by the travel restrictions introduced in early last year, had been accumulating losses since 2015.

“A staged approach is envisaged to evaluate the extent of fiscal risks from the SOE sector and begin addressing them,” the document adds.

The reforms will see the government conduct a financial evaluation of the nine parastatals with largest fiscal risks to the FY2020/21 budget. This will be completed by end of March 2021 (prior action).

“The evaluation will cover Kenya Airways, Kenya Airports Authority, Kenya Railways Corporation, Kenya Power, Kenya Electricity Generating Company, Kenya Ports Authority and the three largest public universities,” the document notes.

It adds that the evaluation will serve as a basis for extraordinary SOE support to these SOEs in FY20/21, which should be limited to exigent needs (the supplementary budget provides for 0.3 per cent of GDP).

By end of May 2021, the National Treasury will also be required to prepare an in-depth forward-looking financial evaluation of the top 15-20 SOEs representing the largest fiscal risks as well as a strategy for addressing financial pressures in the SOE sector.

This will include a framework for deciding on interventions and reforms while taking into account the limited fiscal space and the programme’s fiscal targets (structural benchmark).

The IMF says reforms to improve the oversight, monitoring and governance of SOEs will aim to enhance their resilience. Concrete measures will include completing a draft blueprint that will identify necessary actions and legal reforms to enhance governance. This will be done by July 2021.

Deep-rooted corruption

The government will also be required to develop an integrated monitoring and reporting system by September 2021 and establish a performance management monitoring and evaluation framework as well as initiate a review of institutional structures.

There will also be a component of transparency. The document says transparency of fiscal risk reporting will be improved.

“By end of September 2021, an expanded fiscal risk analysis that quantifies contingent liabilities from high-risk SOEs and PPPs will be included in the annual Budget Review and Outlook paper (structural benchmark),” the document notes.

Kenya has also committed to scale up resources at the Treasury’s Government Investment and Public Enterprises (GIPE) Department, while expressing interest in continued IMF technical assistance in the areas of fiscal risk analysis and legal reforms.

The government has also committed to fight deep-rooted corruption in these parastatals as part of the package.

“The authorities’ governance reform agenda reflects priorities to enhance the anticorruption framework,” the report notes.

Kenya will also need to review the current legal framework for asset declarations of senior public officials and conflict of interest rules; and, given that corruption is inextricably intertwined with the need to launder its proceeds, an effective implementation of anti-money laundering and combating the financing of terror (AML/CFT) measures.

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