Effects of Value Added Tax Reforms on Household Welfare and Collection Efficiency and the Determinants of its Compliance Gap in Kenya
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The study evaluated the Value Added Tax reform process in Kenya, and established its effect on welfare of households and collection efficiency of Value Added Tax. In addition, the study estimated the Value Added Tax gap in Kenya and evaluated its determinants. The study made use of the Quadratic Almost Ideal Demand System model to assess the effects of Value Added Tax reforms on household welfare, Value Added Tax efficiency was measured using the Collection-Efficiency model and Value Added Tax gap was estimated using the International Monetary Fund Revenue Administration- GAP model. Secondary data was used from the year 2015/16 Kenya Integrated Household Budget Survey, whereas data on value added tax revenue, final consumption, Gross Domestic Product, was obtained from Statistical Abstracts, Economic Surveys, Kenya Revenue Authority and World Bank Data base. The study found the VAT reforms in Kenya to have led to decline in welfare of households, since the uncompensated price elasticities for all the selected ten food items were found to be negative; tea leaves, sugar, beans, salad, white-bread, rice, cooking fat, spices, soda, maize, which was an indication that consumers would respond to increase in prices of the commodities by cutting down their expenditure on them. Further, coefficients of eight out of the ten food items exhibited positive expenditure elasticities; sugar, beans, salad, white-bread, rice, cooking fat, soda, and maize. The results demonstrated that households were under consuming these commodities and required either a reduction in their prices or income compensation to consume more, this was another pointer of decline in welfare of households as a result of VAT reforms in Kenya whose net effect was general increase in price levels. The tax reforms were found to have significantly improved VAT collection efficiency but also contributed to widening of VAT compliance gap in Kenya. The ARDL model run to estimate the determinants of VAT compliance gap obtained the following results; standard VAT rate (0.097), VAT reforms (0.150), number of VAT rates (-0.022), manufacture value added growth (0.032), population growth (-4.91), import as a percentage of GDP (0.066), final consumption as a percentage of GDP (-0.122), and export as a percentage of GDP (-0.087), all significant at one, five and ten percent levels. These results revealed that tax evasion and avoidance were quite rampant in Kenya and also laxity on the part of Kenya Revenue Authority to effectively collect VAT revenue. This study will be useful for future policy formulation in Kenya and in designing more effective tax reforms with consideration to welfare of households by the National Treasury, Kenya Revenue Authority and Scholars.