Abstract

High taxation leads to increase in the tax revenue. Taxation, on the other hand reduces the purchasing power of the people and adversely affects their ability and willingness to work, save and invest. With the continued increase in demand for more resources and consequently desire to increase the rates of some taxes or imposing new taxes, the government has to keep in view the capacity of the people as a whole to pay taxes in framing its tax policy accordingly. The paper
provides a longer period analysis of Kenya’s trend of taxable capacity and tax effort indices between 1975 and 2015 to enable inform on long-term tax policy direction in Kenya. The paper also provides a trend and comparative analysis of taxable capacity and tax to GDP ratio which informs on the tax effort indices and has established if Kenya’s taxable capacity is close or far from its tax effort indices. The findings obtained show that the coefficients of GDP per capita, the
share of export in GDP are positive and significant. On the other hand, the share of import in GDP is negative and insignificant. The coefficient of share of agriculture in GDP is positive but insignificant. Measures to enable commercialize agricultural activities will reduce informality in the sector and hence more tax revenue realized. The share of export in GDP has been growing and this trend requires to be maintained. This is by putting in place measures to encourage more exports and to protect domestic production against imports. Taxable capacity in Kenya shows an upward trend which is not stable and has registered higher peaks and lower peaks in different years. The gap between actual and predicted taxes was large in favour of predicted values, between 1975 and 2015. The gap between the taxable capacity and tax to GDP ratio was narrow from 1975 to 1988 but there after the gap has widened. As this gap widens, Kenyan’s economy continue being dominated by the service sector though the sector does not play a significant role to actual tax collection in Kenya. This could be a worrying trend to the Kenyan economy. The Kenyan Government needs to develop tax measures targeting the service sector practitioners besides boosting other sectors of the economy. The tax effort indices are on a downward and unstable trend from 1975 to 2015. Kenya Government requires to invest in long term tax measures to enable stabilize the taxable capacity and tax effort trends. Kenya’s tax effort indices for the 1975 to 2015 is below 1. This shows that Kenya has no optimal taxation system and that the country has a substantial scope or potential to raise more tax revenue. Given that actual taxes are below the taxable capacity, Kenya is expected to spend more effort to increase tax revenues.