The Effect of Custom and Excise Duties On Economic Growth in Kenya

The responsibility shouldered by the government of any nation, particularly the developing nation is enormous; the need to fulfill these responsibilities largely depends on the amount of revenue generated by government through various means. Kenya relies heavily on tax revenue to fund government expenditure. The role of tax revenue in promoting economic growth may not be felt if the correct choice between different taxes is not made, this calls for proper examination of the relationship between the revenue generated from different types of taxes and economic growth. The fiscal crisis occasioned by the international oil shock in early 1970s, motivated the Kenyan government to shift the tax policy towards greater reliance on indirect taxes. Consequently, the level of revenue from custom and excise taxes has risen steadily in the period 1973-2010; however, this was coupled with a persistent decline in economic growth. Such significant increases in custom and excise tax revenue raise pertinent questions about the effect they have had upon economic growth. The purpose of the study was therefore to analyze the effect of custom and excise duties on economic growth in Kenya for the period 1973 to 2010, This study is motivated by two developments. First, by the inconsistency in existing empirics and secondly by the wide knowledge gap occasioned by the paucity of empirical literature on Kenya. Therefore, this study attempts to reconcile the different positions and also close the knowledge gap. The study adopted a correlation research design based on its ability determine the strength and direction of relationships between variables while the theoretical framework was anchored on endogenous growth model. The empirical results indicate that custom and excise duties are positively correlated with economic growth in Kenya. 1.0 INTRODUCTION The responsibility shouldered by the government of any nation, particularly the developing nation is enormous, Furthermore, the new constitutional dispensation in Kenya establishes a devolved system of government with its enormous resource requirements, the need to fulfill these responsibilities largely depends on the amount of revenue generated by government through various means therefore there is need to put measures that are geared towards enhancing the revenue base (Kago, 2014).A system of tax avails itself as a veritable tool that mobilizes a nation’s internal resources and it lends itself to creating an environment that is conducive for the promotion of economic growth (Ayuba, 2014). Muriithi and Moyi (2003) observe that a good tax system should be able to generate the needed revenue for government; redistribute income; and investment infrastructure that will provide the guarantee for business to strive and economic growth. Despite far reaching reforms implemented in taxation in Kenya, tax revenue collection has not yet reached a level where it can meet all the expenditure requirements of the government (Kago, 2014). The machinery and procedures for implementing a good tax system in developing countries are inadequate; hence tax evasion and avoidance of the self-employed individuals and organizations whose data base is not captured in the relevant tax authority’s data system (Fasoranti, 2013). A study by Parliament’s Budget Office (2012) says that Kenya’s large and rapidly expanding underground economy has expanded rapidly to become a mammoth Sh825 billion International Journal of Scientific and Research Publications, Volume 9, Issue 1, January 2019 531 ISSN 2250-3153 http://dx.doi.org/10.29322/IJSRP.9.01.2019.p8564 www.ijsrp.org industry that is denying the government at least Sh275 billion in uncollected revenues. The need for the government to generate adequate revenue from internal sources has therefore become a matter of extreme urgency and importance (Afuberoh&Okoye, 2014). The desire of any government to maximize revenue from taxes collected from tax payers cannot be over-emphasized. This is because the importance of a tax lies in its ability to generate revenue for the government, influence the consumption trends and regulate economy through its influence on vital aggregate economic variables (Fasoranti, 2013). Kenya relies heavily on tax revenue to fund government expenditure, both current and capital, the role of tax revenue in promoting economic growth may not be felt if the correct choice between different taxes is not made. This calls for proper examination of the relationship between the revenue generated from different types of taxes and economic growth. Tax revenue mobilization as a source of financing developmental activities in less developed economies has been a difficult issue primarily because of various forms of resistance, such as evasion, avoidance and other corrupt practices can easily be perpetuated within the direct taxes bracket (Akhor, 2016). The solution appears to be in broad-based indirect taxes like Custom and Excise Duty that has the potential of diversifying the revenue portfolio for the country to promote fiscal sustainability and economic growth (Azaiki&Shagari, 2007). The performance of Kenya’s economy during the first decade of independence in 1963 was impressive because the growth of real GDP averaged 6.6% per year over the period 1963 –1972. Kenya experienced its first major fiscal crisis occasioned by the international oil shock in early 1970s and this motivated the government to shift the tax policy towards greater reliance on indirect taxes as opposed to direct taxes. The aim was to create a sustainable tax system that could generate adequate revenue for economic growth. Consequently, the level of revenue from custom and excise taxes has risen steadily in the period 1973-2010; however, this was coupled with a persistent decline in economic growth (table 1.1). Such significant increases in indirect tax revenue raise pertinent questions about the effect they have had upon economic growth. Table 1.1.Tax structure in Kenya as a percentage of GDP and GDP growth rate from 1963-2010 Type of tax 1963/4-1972/3 1973/4-1982/3 1982/3-1992/3 1992/3-2002/3 2002/3-2010/1 Excise duty 2.1 2.0 2.1 4.0 3.2 Custom duty 4.2 4.4 3.6 4.0 1.7 GDP growth rate (%) 6.6 5.2 4.2 2.3 4.3 Source: Karingi and Wanjala (2005), Amanja and Morrissey(2005),Economic surveys. This research looks at the effects of custom and excise duties on economic growth for Kenya, a developing country. An enormous amount of studies have been carried out in Kenya on the effects of taxes. However, the researches often look at sector specific taxes (Okello 2001, Kiringai et al 2001, Kiringai et al 2002, Bouet and Roy 2012). The empirical studies on the effect of custom and excise duties on economic growth in Kenya are relatively few. Some empirical studies have been conducted to examine the effect of custom and excise duties on economic growth in both developed and developing countries, but one common feature of these empirical studies is lack of consensus among the scholars, Most studies have therefore reached substantially different conclusions on the relative impact of custom and excise duties on economic growth. This study is motivated by two developments. First, by the inconsistency in existing empirics and secondly by the wide knowledge gap occasioned by the paucity of empirical literature on Kenya. Therefore, this study attempts to reconcile the different positions and also close the knowledge gap. 2.0 REVIEW OF THEORITICAL AND EMPIRICAL STUDIES In examining the effects of tax policy on economic growth, there are two lines of thinking: according to the exogenous growth models (Solow, 1956), tax policy has no impact on economic growth in the long run, assuming that key factors of production such as labour and technological progress are determined outside the model; on the contrary, endogenous growth theorists (starting with Barro, 1990; King and Rebelo, 1990; and Lucas, 1990), who believe that economic expansion is determined within the system, argue that tax policy does have an impact on economic growth and welfare over time. The theoretical foundation of the study revolves around endogenous growth model’s proposition that government spending and tax policies can have a longterm or permanent growth effects. The endogenous growth theory advocates the stimulation of level and growth rate of per capita output through the economic policies such as tax policies. Economic growth is generated by three production International Journal of Scientific and Research Publications, Volume 9, Issue 1, January 2019 532 ISSN 2250-3153 http://dx.doi.org/10.29322/IJSRP.9.01.2019.p8564 www.ijsrp.org factors: labour, capital and technological progress, which are related to each other through a production function. Taxes could alter the economic decisions regarding these factors, and thus affect economic growth (Zipfel and Heinrichs, 2012). Barro (1990) constitutes one of the first attempts at endogenizing the relationship between growth and fiscal policies. He distinguishes four categories of public finances: productive vs. non-productive expenditures and distortionary vs. non-distortionary taxation. Taxation is nondistortionary if it does not affect the investment decision, and hence economic growth. This is, above all, the case for customs duties, excise duties and value added tax. Otherwise taxes, such as direct income and profit taxation are considered distortionary. 2.1 Kenya’s tax structure The tax system in Kenya refers to the range of taxes over which the government has exclusive or shared jurisdiction. The tax system also covers the machinery put in place by government for the administration and collection of such taxes. Different types, forms and classes of taxes exist, but the most common classification in Kenya is direct and indirect taxes. In Kenya, the government can emphasize on any one of the tax forms depending on the objective it wants to pursue. The direct tax is a levy on personal income