Raising taxes to increase revenue is similar to making a fat man skinny by tightening his belt

The reason advanced by the Parliamentary Budget and Appropriations Committee for raising these taxes, is to fund the KES 3.6 trillion budget. In other words, this was an admission that there is a budget deficit.

A budget deficit occurs when government spending is greater than tax revenues. It is caused by certain unanticipated events such as the Covid19 pandemic that has had huge economic ramifications, expanding welfare programs, tax evasions, corruption or demographic pressure of an aging or fast-growing population.

Budget deficits lead to accumulation of public sector debt. When the deficit is unsustainable, it leads to higher interest payments, and in a worst-case scenario, a loss of confidence in the government by the global money market. To correct a budget deficit, a government can do three things; one, cut government spending; two, raise taxes; and three, promote economic growth.

The government has chosen option two. But this is very lazy thinking because any law, habit or action that is undertaken gives birth not only to an effect, that is immediate and seen, but to a series of effects, that unfold in succession, but are not instantly seen.

And as surely as night follows day, when the immediate effect is favorable, the ultimate consequences are fatal, and the converse is also true. In other words, the sweeter the first fruit of an action, the more bitter are the consequences. An obvious example is prodigality. Kindly ask your Sunday School teacher to elucidate further.

It is impossible to ring-fence any tax increase. Humans are praxeological beings. They rank their needs according to their available means. For example, if you had only one litre of water and had to choose between cooking, brushing your teeth or watering your lawn, you would use it on the need that you rank the highest. I bet that would be cooking.

The same principle applies when Kenyans are compelled to pay higher prices for fuel without a commensurate increase in their income. They may opt to walk to work, which leads to fewer people using personal cars or public transportation. This leads to fewer trips by the vehicles, leading to fewer litres of fuel purchased, leading to lower revenues generated by the fuel entrepreneur and matatu owner, leading to both of them downsizing and job losses.

Equally an increase in the cost of gas means more people will opt for cheaper unhealthier and environmentally unfriendly alternatives. This will lead to pollution and poor health, leading to a loss in productivity and forest cover, and an increase of more people seeking health care services, leading to an increase in the strain on the health services, leading to increased negative externalities, which leads to the need to increase the health budget, while already we are in a budget deficit.

It has been forecasted that with the increased tax on airtime, the government will collect KES 8 billion from the 62 million mobile phone subscribers. However, an increase in air time costs will lead to more people spending less time communicating or transacting on their phones because rationale human beings are creatures of incentives and disincentives. If you encourage something, people will do more of it; and if you discourage something, people will do less of it.

The latter will lead a loss in revenue by the telcos, and a slump in the e-commerce sector, which will eventually lead to downsizing and job losses. So isn’t it a fallacy to think that the KES 8 billion will be realized through increased taxes on air time?

When revenues of entrepreneurs and industries decrease, this leads to job losses and zero incomes. Subsequently, people are unable to purchase other goods and services, leading to lower production in all other sectors, which also leads to further job losses. This eventually leads to lower taxes collected, and ultimately budget deficits, that the said increase in taxes is meant to cure. Allow me to illustrate this using the Laffer Curve.

In economics, the Laffer Curve theory explains this relationship between tax rates and the tax revenue. It illustrates that the more an activity is taxed, the less of it is generated. The converse also holds true. This means that lower taxes boost economic growth and underpins what is called the supply-side economics.

Let us conceptualize this on a graph and plot the revenue along the x-axis, the tax rate along the y-axis, and the point at which they intersect is zero. If the tax rate is 0% no tax revenue is generated because nobody is paying taxes. Likewise, if the tax rate is 100%, the tax revenue is still zero because nobody is willing to work and have all their income taxed leaving them with nothing. When taxes increase from zero, it boosts government revenue immediately.

And the more the taxes go higher along the y-axis, the more the revenue that is collected along the x-axis. However, as the tax increase continues, the payoff in additional revenue begins diminishing as the tax base reduces causing the curve to boomerang backwards to zero.

The Laffer Curve theory has two effects; one is arithmetic and the other is economic. Proponents of demand-side economics only focus on the arithmetic because they view this effect as static. It means that when tax rates are lowered, the tax revenue will also be lowered by the amount of the decrease in the rate, and vice versa for increasing the tax rate. So, hypothetically if the tax rate is 1%, the revenue may be KES10,000, and 2% would generate KES20,000. This decreases the after-tax income with every tax increment.

Similarly, if the tax rate is 0.5%, the revenue generated would decrease to KES5,000.

Demand-side economists however, ignore the economic effect that recognizes the positive impact that lower tax rates have on work, output and employment. When people are taxed less, it incentivizes them to work, spend, save and invest more. This increases their income and spending on other goods and services thus stimulating economic growth. Entrepreneurs who are taxed less are able to re-invest into expansion of their enterprises or invest in new enterprises thus hiring more workers, and producing more goods and services.

The net effect is a boost to economic growth, which in turn generates a larger tax base and eventually a higher tax revenue for the government. Conversely, raising taxes has the opposite effect.

In economic-speak, the fundamental economic principle is that of demand and supply. The law of demand states that, ceteris paribus, the higher the price of a good, the lower the quantity demanded and vice versa, save for inelastic goods. Tax rates also follow the universal principle of demand and supply. The more costly a product or service is, the less of it that will be demanded by the consumers and produced by suppliers.

In keeping with this economic principle, the proponents of increases in the sin tax postulate that it is meant to reduce consumption of harmful goods such as tobacco and alcohol, and correct the negative externalities arising from the consumption of these products. They concede that the decrease in consumption is motivated by economics, and not health. It is therefore quite baffling that these same advisors cannot, or are unwilling, to apply the same principle on the tax increases on fuel, gas and air time.