The Constitution of Kenya in 2010 ushered in a decentralized system of governance comprising a national government and 47 county governments. This forms a two-tiered system of government in which the sovereign power of the people is exercised at the national and county levels.
The new system features significant administrative and political devolution, in addition to fiscal decentralization, in which county governments are granted responsibility for raising revenue, and budgeting for devolved functions.
The Constitution grants both the national and the county government powers to raise revenue, and revenue entitlements. Both governments are entitled to equitable share of revenue raised nationally. The counties are eligible to an equitable share of at least 15 per cent of most-recently audited revenue raised nationally, loans and grants, equalization fund based on half of one per cent of revenue raised nationally, and conditional and unconditional grants from the national government’s share of revenue. The Constitution also authorizes county governments’ funding sources to include local revenues in form of charges, taxes and fees (property rates; entertainment taxes; charges for services they provide and any other tax or licensing fee authorized by an Act of Parliament). The national government is given powers to impose income tax, value-added tax, customs duties and other duties on import and export goods, excise tax, licenses and borrowing. Additionally, an Act of Parliament may authorize the national government to impose any other tax or duty, except a tax specified in Article 209, clause (3)(a) or (b). Additionally, national governments may additionally impose charges for the services they provide.
Locally-generated revenue accounted for approximately 10 per cent of county governments’ total income from the onset of devolution to date (2013-2018). A general concern is the small and declining share of locally-generated revenue as a proportion of counties’ total resources, which implies that counties are heavily relying on transfers. The share of locally-generated revenue as a proportion of counties’ total available fund has been reducing from 11.7 per cent to 11.1 per cent, 10.2 per cent, 8.8 per cent and 8.4 per cent in 2013/14, 2014/15, 2015/16, 2017/18 financial years, respectively. One of the contributing factors to the small share is the fact that counties are not achieving the financial targets they have set. For instance, in the 2017/18 financial year, county governments were expected to generate own source revenue amounting to Ksh 49.22 billion. However, the 47 counties only managed to raise Ksh 32.49 billion, which was 66 per cent of the annual target. This shows that they missed their target by 34 per cent in the year under consideration. This was not the only financial year the counties missed the target but also in the previous years since devolution. In the financial years 2016/17, 2015/16, 2014/15and 2013/14 the counties missed their target by 43.6 per cent, 30.7 per cent, 32.8 per cent and 51.5 per cent, respectively, as shown in the table below.
Source of data: COB County Annual Reports
Assessing individual counties every year following devolution, only a few counties manage to hit the target. For instance, in 2017/18 financial year, only four of the 47 counties (Meru, Tana River, Migori and Machakos) met their local revenue collection targets. This is a slight improvement from the 2016/17 financial year where only two counties met the target. The figure below shows how counties performed with regard to achieving their own revenue target mark in 2017/18 financial year.
Source of data: COB County Annual Reports
The question is, how can counties enhance their own source revenue and even surpass their targets?
The private sector is a key contributor to tax revenues, a key stakeholder in economic development, principle job creator and therefore a major contributor to national income. However, the private sector in Kenya has not yet reached its potential due to various challenges. According to a study by a Kenya National Bureau of Statistics (KNBS), MSMEs, which are a key part of the private sector, face a number of challenges which include lack of collateral for credit, poor roads/transport, licenses, high taxes and other government regulations, local competition, lack of markets, foreign competition, lack of skilled manpower, lack of space, inaccessibility to electricity, poor access to water supply, interference from authorities, shortage of raw materials or stock, power interruption and poor security. A study done by the Kenya Institute for Public Policy Research and Analysis (KIPPRA) in 2019 on assessment of MSEs business environment also echoed some of these challenges and additionally found that corruption is also a major challenge.
According to the latest Ease of Doing Business Report 2019 published by the World Bank, Kenya has gone up 19 places to position 61 in the Ease of Doing Business Index. This has largely been because of initiatives aimed at the easing the business environment. Examples include the merging of all permits into a single unified business permit, which has strengthened access to credit. Minority investors are also better protected, and payment of taxes has been simplified. Resolving insolvency has been made easer whereby a debtor’s business is facilitated to continue during insolvency proceedings by providing for equal treatment of creditors in reorganization proceedings and granting creditors greater participation in the insolvency proceedings.
However, the same report shows that the country is still struggling with starting business, construction permits, and registering property which has remained a problematic process in Kenya. This has made Kenya’s business environment less friendly to investors compared to other African countries and some countries in the region. For instance, it costs 25 per cent of the income per capita to start a business in Kenya, which is almost ten times more expensive than in Cote d’voire and the process takes 23 days compared to just four days in Rwanda. To register a property, a business has to go through nine procedures compared to an average of seven in the East African Community region despite an online system to clear land rent rates aimed at easing property registration.
Global studies have also pointed out that the environment in Kenya is not conducive for businesses to thrive. Kenya’s business environment and investment climate is still uncompetitive, according to World Economic Forum competitive report. Also, in their assessment of the ‘Most Problematic Factors of Doing Business’ in the last 10 years, corruption has been the top problem for Kenya. Other problematic factors in doing business, which are pointed out, include difficulty in accessing financing, high tax rates, inadequate supply of infrastructure, inflation, crime and theft, inefficient government bureaucracy, stringent tax regulations, policy instability, insufficient capacity to innovate, poor work ethic in national labour force, foreign currency regulations, inadequately educated workforce, government instability, restrictive labour regulations and poor public health.
The legal and regulatory system also has an impact on the business environment. For instance, small enterprises in all counties are now required to pay 15 per cent of the business permit fee or license as presumptive tax at the time of payment for business permit fee or trade license. This may escalate the cost of doing business and discourage investment. Most counties have also not enacted trade licensing legislation that should underpin the single business permit; some have focused on amending single business fee schedules to enhance collections, thereby impacting on cost of doing business.
Counties have also hampered businesses by imposing extra fees and charges for goods that pass through their jurisdiction. They have developed laws that tax goods moving in and out of their regions, thus increasing the cost of doing business across counties. They have increased their tax rates, leading to a possible laffer curve effect which may be the reason behind declined county revenues. Simply, laffer curve is a relationship between an increasing tax rate and a government’s total revenues. The relationship suggests that revenues decline beyond a peak tax rate. This may be explained by the fact that reducing tax rates influences government revenue in two ways. In the short-run, tax cuts translate directly to less revenue in government. However, in the longer-term, the opposite is what happens; lower tax rates put money into the hands of taxpayers, who then invest in it. More business activities are established and eventually these businesses hire more employees who then invest from their additional income. This leads to more revenues as a larger tax base is generated. Finally, this replaces any revenue lost from the tax cut. In short, tax rates influence savings, investment, and innovation, which have an impact in the economy in terms of employment and government revenue. To avoid a laffer curve in taxation, counties need to determine the optimal tax rate to avoid overtaxing the taxpayers which may be the reason behind the declining county own revenues.
The recent rise in fuel prices led to increase in tax on petroleum goods. Increase in the cost of fuel negatively impacts transport costs and prices of raw materials, and also disrupts flow of customers, among others. This increases the cost of doing business. Moreover, amendments to the Banking Act 2015 capped the rate of interest chargeable by banks, and this has had a significant effect on doing business. It has tightened credit and liquidity in the country, especially for SMEs, which is a major constraint to businesses. According to a recent analysis by the Central Bank of Kenya 2018, SMEs have borne the greatest impact of interest rate capping because commercial banks have continued to turn their backs on them and shifted to lending to government and large corporates. Whereas demand for credit immediately increased following the capping of lending rates, credit to the private sector has continued to decline. According to the FinAccess Survey 2015, the share of MSMEs lending by commercial banks was at 23.4 per cent in 2015. However, a survey conducted by the Kenya Bankers Association (KBA) in 2016 shows that the average MSMEs loans has reduced to 17 per cent.
Counties have a role to play in improving the business environment in Kenya. There is need for counties to come up with the right policies and interventions that support private sector participation by creating an enabling environment for the private sector to thrive. There is need for policy instruments and interventions that will help complement, coordinate and collaborate with the private sector rather than compete against it. There is also need to make the regulatory environment more conducive to operate a business. Counties need to come up with laws that are in harmony with existing policy documents around licenses, fees and charges and determine the optimal rate of taxation to avoid a laffer curve effect.
Good governance also contributes to improvement of business environment, as it minimizes persistence of bad policy and enhances policy implementation. Additionally, better and more infrastructure is an important goal for creating a good environment for the private sector. Counties need to develop and maintain infrastructure that can attract investors. This includes good housing, electricity, roads, airports, public transport, water, sanitation, waste management, telecommunications, hospitals, and schools.
Moreover, a comprehensive workplace security is essential for businesses to thrive. Security of business and individuals is among the most significant components of a favourable investment climate. Insecurity imposes high operational costs to businesses. For example, businesses take preventive security measures such as installation of surveillance cameras and hiring of private security guards, which ends up increasing the cost of operations. In addition, profitability is affected by loss resulting from insecurity in terms of reduction in business working hours when businesses close earlier due to security issues.
Opportunity
KIPPRA in line with its mandate of developing capacities for policy formulation, implementation and evaluation within national and county governments has launched a programme ‘Creating an Enabling Environment for Private Sector (CEEP)’ that focusses on strengthening the capacities for county government officers in articulating key priorities to provide an enabling environment to grow the private sector.
Florine Mwiti, Young Professional, Governance Department, KIPPRA
