February 17, 2025

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Strategies Adopted by Economies to Spur Economic Growth

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By Edwin Waithaka

Do Taxes Matter? 

Kenya is currently under pressure from the general public to drop its presumably harshstrategies to solve the economic challenges and induce economic growth. The country has been grappling with heavy public debt, a decline in tax revenues, increasing government spending and pending projects for some time now. 

Despite all these pressures, the government is still expected to induce economic growth and save the citizenry from the wrath of extreme inflation rates, increasing prices of goods and services, high taxes and dwindling incomes.

These challenges pose thought-provoking questions, such as: What are the strategies for economic growth? Do the traditional strategies still work? And why is it so hard to implement them? Why have some countries, like the United States of America, China, and Estonia, applied strategies that have been so successful, while countries like Colombia have performed dismally by applying ineffective tax structures? 

What is economic growth? According to the OECD, Economic growth is an increase in the production of economic goods and services in one period compared with a previous period in an economy. It can be measured in nominal or real terms. Traditionally, aggregate economic growth is measured in terms of gross national product (GNP) or gross domestic product (GDP), although alternative metrics are sometimes used. 

Often, but not necessarily, aggregate gains in production correlate with increased average marginal productivity. That leads to increased incomes, inspiring consumers to open their wallets and buy more, thereby driving a higher material quality of life and standard of living. In economics, growth is commonly modelled as a function of physical capital, human capital, labour force, and technology. Increasing the quantity or quality of the working-age population, the tools they have to work with, and the recipes available to combine labour, capital, and raw materials will lead to increased economic output. 

How, then, do Taxes Affect Economic Growth? Taxes affect economic growth, at least in the short term, through their impact on demand. A tax cut increases demand by raising personal disposable income and encouraging businesses to hire and invest. However, the size of the effect depends on the economy’s strength. If it operates close to capacity, the effect will likely be small. The impact will be more pronounced if it operates significantly below its potential.The Congressional Budget Office (CBO) estimates that the effect is three times larger in the latter case than in the former. The CBO also found that tax cuts are generally less effective in stimulating economic growth as government spending increases. That is because most spending boosts demand, while tax cuts boost savings and demand. One way to mitigate this effect is to target tax cuts to lower- and middle-income households, which are less likely to put the money into savings.

Economists also postulate that the structure of a country’s tax blend determines its economic performance. A well-structured tax blend is easy for taxpayers to comply with and can promote economic development while raising sufficient revenue for a government’s priorities.  On the other hand, poorly structured tax systems can be costly, distort economic decision-making, and harm domestic economies.

Over the past few decades, global marginal tax rates on corporate and individual income have declined significantly. Nations raise significant revenue from broad-based taxes such as payroll taxes and value-added taxes (VAT). A neutral tax blend seeks to raise the most revenue with the fewest economic distortions. It doesn’t favour consumption over saving, as with investment and wealth taxes. It also means few or no targeted tax breaks for specific activities carried out by businesses or individuals.

A tax blend that is competitive and neutral promotes sustainable economic growth and investment while raising sufficient revenue for government priorities. It is also important to appreciate the fact that there are many factors unrelated to taxes which affect a country’s economic performance. Nevertheless, taxes play an important role in the health of a country’s economy. Experts use an index to measure whether a country’s tax system is neutral and competitive. The Index looks at a country’s corporate taxes, individual income, consumption, and property taxes, and the treatment of profits earned overseas. As tax laws become more complex, they also become less neutral. The United States, the United Kingdom, and Chile are phasing out temporary improvements to their corporate tax bases.

The International Tax Competitiveness Index (ITCI) seeks to measure the extent to which a country’s tax system adheres to two important aspects of tax policy: competitiveness and neutrality. A competitive tax blend keeps marginal tax rates low. 

Corporate taxes are the most harmful to economic growth, with personal income taxes and consumption taxes being less toxic. Taxes on immovable property have the slightest impact on growth. According to the OECD, Estonia is currently the country with the best tax blend in the world; It has been leading for the last ten years. Firstly, it has a 20 per cent tax rate on corporate income that is only applied to distributed profits. Secondly, it has a flat 20 per cent tax on individual income that does not apply to personal dividend income. Thirdly, its property tax applies only to the value of land rather than to the value of real property or capital. Finally, it has a territorial tax system that exempts 100 per cent of foreign profits earned by domestic corporations from domestic taxation, with few restrictions. This is despite the fact that Estonia is landlocked and disadvantaged compared to many countries worldwide. Its economy is driven majorly by the service industry.  According to OECD findings, Colombia is the country with the least competitive tax blend. It has a net wealth tax, a financial transaction tax, and the highest corporate income tax rate of 35 per cent. Colombia’s VAT covers less than 40 per cent of final consumption, revealing policy and enforcement gaps.

Kenya ranks at the bottom of the OECD list. It has a 30 per cent tax rate on corporate income. A graduated tax on individual income, with the lowest band of 10% and the highest band of 35%, reintroduced capital gains tax after a long break. It made most goods and services that were exempted or zero-rated. The game is still there; The citizenry has given the government a thorough pass. Will Kenya rise to the occasion and score the most yearned-for goal? Only time will tell!

The debate on the best tax blend will not die soon, and it will be essential to focus on the many other factors affecting economic growth, such as culture, emotions, resources available, technological development, and more.

The writer is a financial accountant and tax practitioner at the University of Nairobi

e.waithaka@uonbi.ac.ke

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