When you tax inputs, you kill production; eventually, there will be no taxable output
By Ephraim Njega
National Social Security Fund (NSSF) and National Health Insurance Fund contributions have been increased significantly and the government is proposing to impose a 3% National Housing Development Fund Levy (NHDF). Public service workers have also been contributing to a pension scheme, unlike in the past when the government fully funded their pension.
In Kenya, there is more reliance on a socialist system where able relatives help the struggling ones. This is often referred to as black tax. The community also steps in with fundraisers whenever a disaster strikes. We have developed a social security system built on the weak foundation of generosity and charity. With society becoming more individualistic, the trend is not sustainable.
In a system where the weak depends on the strong, the sick on the healthy, and the old on the young, numerous dependency layers are bound to be created. Such dependency appears necessary and beneficial in the short run. In the end, it just promotes and perpetuates poverty.
Ideally, we should have more institutionalised social security systems through insurance, pension schemes, and government-financed safety nets. This, however, can only work in a country with a formalised economy characterised by high employment levels. How can the weak depend on the strong when nearly everyone is struggling?
Running on a charity and generosity-dependent social security system is not sustainable. It reaches a breaking point where fatigue sets in, and the weak are left to their own devices. The ever-weakening economy threatens to leave nearly everyone in dire need of help. Who then will provide the help?
Social security funds not a panacea
According to the Economic Survey Report, only three million Kenyans are employed formally. This represents 16% of the 19.1 million working Kenyans. An overwhelming 84% of Kenyans are employed in the informal sector.
It is hard, if not impossible, for the government to collect social security deductions from the informal sector. The poorly performing economy has worsened things even when people make voluntary contributions. A recent NHIF report revealed that over 80% of the voluntary contributors have defaulted on the monthly contribution.
In view of such difficulties, the State is only left with the formally employed workers to target. Given their few numbers, there is no way they can meet all the social security needs the government comes up with. The stiff resistance the NHDF proposal has met clearly indicates that the squeeze on the formally employed can’t be tightened further.
The history of social security funds has not been covered in glory. They have been beset by endless governance challenges and endemic plunder. Why increase the rates and set up more Funds before addressing these challenges? Will the workers get benefits commensurate to their contribution? Or will these deductions end up as just another form of taxation?
The levying of all these deductions increases the country’s labor cost. This is worsening our competitiveness challenges. It is likely to worsen the unemployment situation. Employers can’t keep up with all these demands regarding matching contributions. At some point, they will have to lay off workers. The government is also shooting itself in the foot. It is currently struggling to pay salaries. These increased deductions mean the government, as the single largest employer, will have to part with more money. The mounting wage bill is not sustainable. Soon the government will also be overwhelmed and have to let go of workers.
Rethinking the affordable housing project
Given our large informal economy, the obsession with social security funds doesn’t make sense. The government’s focus should be on formalising the economy. The informal economy is characterized by low incomes, short income cycles, and income insecurity.
Many workers in the informal economy are more concerned with daily survival than long-term financial security. Ideas such as NHDF make little sense to such people. The real Hustlers are troubled by where next month’s rent will come from. House ownership is not an immediate priority to them.
Looking around, you will notice that much construction has occurred in the last ten years. What we have now is not a shortage of housing but affordable housing. Affordable housing is about the cost of housing, not ownership. The lack of affordable housing creates an obsession with home ownership.
Considering the country, 61% of Kenyans live in their own homes. This number stood at 87% in rural areas as per the 2019 census. The opposite is true in urban areas, where 79% are renters. No affordable housing project can turn all these people in urban areas into homeowners. Lowering rents is a more practical and achievable objective.
Higher urban home ownership can only be achieved in a formalised economy with high incomes. As a low-tier middle-income country, promoting urban home ownership is a pipe dream.
The government can lower rents by decongesting Nairobi through satellite cities, investing in low-cost building technologies, improving connectivity through rapid transport systems, and investing in fast internet to encourage people to work from anywhere. Additionally, it can lower taxes on construction materials, impose tariffs on idle land, and providing developers with affordable serviced land. The government should also invest in paving roads in urban areas that are already fast developing.
Most importantly, it should build houses for renting at affordable rates as opposed to building houses for sale. Building and selling houses can’t lower rents since the owners of such houses will let them at market rates defeating the whole purpose of the affordable housing project. The only beneficiaries will be the private developers accessing free government land.
There is no need to set up NHDF. The government can build affordable housing for low-income segments through annual budgetary provisions. Housing is just as critical as road infrastructure. It should be budgeted for. Given that the houses will generate rental income, the affordable housing project will eventually be self-financing.
Why the clamour to raise statutory deductions?
This obsession with raising statutory deductions and creating more funds raises many questions about the real intentions. With the tightening fiscal space, opportunities to plunder public resources are diminishing. Creating Funds with weak governance structures and dubious objectives increases the funds available for looting. It could also be a way of introducing taxes through the backdoor.
Some people would like to compare us with Scandinavian countries with high taxes. However, such countries have proper accountability systems; every tax coin is accounted for. People happily part with their income because there are commensurate benefits. What is the point of making heavy deductions on workers’ salaries in a country where public services face extinction? Education, security, transport, and healthcare should be public goods. But in this country, they are all being privatised.
Collecting taxes without delivering services amounts to robbery. It is like milking a cow you are not feeding. Even a cow for slaughter must be fed and fattened first.
The Lafer Curve illustrates the concept of taxation capacity. When tax rates are raised incessantly, like we have been doing in recent years, it reaches a point where higher tax rates result in lower tax revenues. The taxation capacity gets exhausted, and raising tax rates yields nothing extra.
Higher taxes on incomes result in reduced demand which can eventually kill the economy. It would be more sensible to tax consumption. Consumption taxes also reach more Kenyans, hence the tax burden’s better distribution, especially in a largely informal economy.
Imposing excessive deductions on the few formally employed workers can’t solve any of the intended problems. Most of the NHIF and NSSF contributors and beneficiaries are formally employed. Where does that leave the over 84% who are informally engaged?
Way forward
The government should work extra hard to increase the size of the formal economy. Imagine if we could just double the number of formally employed workers to six million. This would significantly lower the dependency burden in the country. The government would also collect more tax revenues to help fund its social security programmes, such as Inua Jamii.
Formalisation of the economy is the only sustainable solution to the country’s social security challenges. All these shortcuts and patchwork we are trying will fail just as they have in the past. The Funds will be crippled by graft and benefit only a few corrupt people. Heavy resistance by workers will also ensure some of these proposed Funds are dead on arrival.
In the meantime, the government should implement a tax code that targets wealth and consumption before income and investment. It should completely eradicate taxes on inputs. When you tax inputs, you kill production; eventually, there will be no taxable output.
If we need to establish more Funds, we need a “Sinking Fund” to drive down our public debt levels. We also need a Sovereign Wealth Fund which can balance the needs of the current and future generations.
Writer is a business and development consultant. He is also an experienced analyst, with an MBA Degree from the University of Nairobi.
