The determinants of tax Revenue in Kenya
Wawire, N. H. W.
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Several studies have been undertaken on the responsiveness of tax revenues to changes in GDP in Kenya. These studies have found a positive relationship between tax revenues and GDP. However, the studies omit some key determinants of tax revenues, such as the nature of the tax system and institutional, demographic and structural features of the economy. Due to this omission, the estimated income elasticities of tax revenues are unreliable for planning purposes, a situation that might be responsible for recurring budget deficits. The main objective of this study was to examine the composition of tax revenues and properly estimate income elasticities of various taxes. The study is important because its results can be used to design pro-growth tax policies and implement tax changes that are equity enhancing. The thesis uses Paul Samuelson's (1955) fundamental general equilibrium analysis of the public sector to derive its main results. In my framework, the demand function for the public good is derived from a constrained model of utility-maximization. In the same vein, tax revenues are taken as functions of household incomes, which paves the way for the estimation of Engel curves for public goods. The study finds that tax elasticities for total taxes, income taxes, and excise duties with respect to GDP are less than unity. Elasticities of excise duties with respect to the volume of imports and volume of trade are less than unity, as is the elasticity of import duty with respect to the volume of trade. On the other hand, growth elasticities for direct taxes and sales taxes are all greater than one. The elasticity of the direct tax revenue with respect to GDP is found to be unitary. The estimation results show that total GDP elasticities of tax revenues are less than the elesticities with respect to monetary GDP, suggesting the existence of an underground economy in Kenya over the period analyzed. The study shows that population growth has adverse effects on tax revenues. It is found that tax revenues respond with substantial lags to changes in tax determinants and that tax revenues are sensitive to unusual circumstances. The study concludes that Kenya's tax revenues are only moderately responsive to changes in their determinants. There is therefore the challenge of creating flexibility in the tax system so that tax revenues can increase rapidly as the economy grows.