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Constitution of Kenya Review Commission |
By Julius Kipngetich,Lecturer,Department of Management Science Faculty of Commerce, university of Nairobi.
12-09-2001
Introduction
In Kenya's economy today, total taxation is 24% of GDP and is considered on the high side by world standards. The Government is the biggest employer either directly or indirectly through parastatals. The Government borrows heavily from the domestic market, taking on average sh.8 billion per week. A very large proportion of our taxes go to support Government's recurrent budget - mainly salaries and debt repayments.
Beyond the budgetary function, public policy influences the course of economic activity through monetary, regulatory and other devices. Public enterprises play an important role, though most of them are poorly managed and have become avenues for corruption. The modern capitalist economy is thus a thoroughly mixed system in which public and private sector forces interact in an integral fashion.
Need for Public Sector
In a supposedly private enterprise economy, questions are asked why a substantial part of the economy is subject to some form of government direction rather than left to the "invisible hand" of market forces. The prevalence of government may reflect the presence of political and social ideologies which depart from the premise of consumer choice and decentralized decision making. Public policy is needed to guide, correct and supplement the economy in certain respects. The following are some of the reasons for need for governments to intervene in economies:
* The claim that the market mechanism leads to efficient resource use is based on the condition of competitive factor and product markets. Thus there must not be any obstacles to free entry and consumers and producers must have full market knowledge. Government regulation or other measures may be needed to secure these conditions
* They may also be needed where competition is inefficient due to decreasing cost
* The contractual arrangements and exchanges needed for market operation cannot exist without the protection and enforcement of a governmentally provided legal structure
* The production or consumption characteristics of certain goods are such that they cannot be provided for through the market. Problems of 'externalities' arise which lead to market failure and required correction by the public sector, either by way of budgetary provisions, subsidy or tax penalty.
* Social values may require adjustments in the distribution of income and wealth which results from the market system and from the transmission of property rights through inheritance
* The market system does not necessarily bring high employment, price level stability and the socially desired rate of economic growth. Public policy is needed to secure these objectives.
* Public and private points of view on the rate of discount used in the valuation of future consumption may differ
Although particular tax or expenditure measures affect the economy in may ways and may be designed to serve a variety of purposes; several distinct policy objectives include:
* The provision of social goods or the process by which total resource use is divided between private and social goods and by which the mix of social goods is chosen. This provision may be termed the allocation function of budget policy. Regulatory policies are considered part of the allocation function.
* Adjustment of the distribution of income and wealth to ensure conformance with what society considers a 'fair' or 'just' state of distribution. This is thus the distribution function of government.
* The use of budget policy as a means of maintaining high employment, reasonable degree of price level stability and an appropriate rate of economic growth, with allowances for effects on trade and on the balance of payments. This is the stabilisation function.
While these policy objectives differ, any one tax or expenditure measure is likely to affect more than one objective. The problem is how to design budget policy so that the pursuit of one goal does not void that of another.
Government Policy Instruments to Manage the Economy
The Allocation Function
The market mechanism is well suited for the provision of private goods. The assumption is that consumption of goods and services is based on exclusion unless you pay and is rivalrous. The government must step in where the market cannot deal with a particular situation.
The political process must enter the picture as a substitute for the market mechanism. Voting by ballot must be resorted to in place of voting by dollar bids. Since voters know that they will be subject to the voting decision, they will find it in their interest to vote such that the outcome will fall closer to their own preferences. Decision making by voting becomes a substitute for preference revelation through the market, and the collection of cost shares thus decided upon must be implemented via the tax system if we say that social goods are provided publicly, it means that they are financed through the budget and made available free of charge. How they are produced does matter. When looking at the public sector in the national accounts, the cost of such provision through salaries of public employees, and purchases from private firms. Public production of private goods should be severely limited.
The Distribution Function
This is the major point of controversy in any budgetary debate as it plays a key role in determining tax and transfer policies. In the absence of policy instruments, the distribution of income and wealth depends on the distribution of factor endowments e.g. personal earnings abilities and the ownership of accumulated and inherited wealth. Distributional attention appears to be shifting from the traditional concern with relative income positions, with the overall state of equality, and with excessive income at the top scale to adequacy of income at the lower end. Thus the current discussion emphasize on prevention of poverty, setting what is considered a tolerable cut-off line or floor at the lower end rather than putting a ceiling at the top, as was once a major concern.
Among various fiscal devices, redistribution is implemented most directly by:
* A tax-transfer scheme, combining progressive taxation of high income with a subsidy to low income households
* Progressive taxes used to finance public services which particularly benefits low income households
* A combination of taxes on goods purchased largely by high income consumers with subsidies to other goods which are used chiefly by low income consumers
The Stabilisation Function
This does not come automatically but requires policy guidance. Without it, the economy tends to be subject to substantial fluctuations and with growing international interdependence, forces of instability may be transmitted from one country to another, which further complicates the problem.
The overall level of employment and prices in the economy depends upon the level of aggregate demand, relative to potential or capacity output valued at prevailing prices. The level of demand is a function of the spending decisions of millions of consumers. These decisions in turn depend on upon many factors, such as past and present income, wealth position, credit availability and expectations. In any one period, the level of expenditures may be insufficient to secure full employment of labour and other resources. Expansionary measures to raise aggregate demand are then needed. Expenditures, also, may exceed the available output under conditions of high employment and thus may cause inflation. In such situations, restrictive measures are needed to reduce demand.
Policy measures available to deal with these problems involve both monetary and fiscal measures.
* Monetary instruments - if left to its own devices, the banking system will not generate precisely that money supply which is compatible with economic stability but will accentuate prevailing tendencies to fluctuation. The money supply must be controlled by the central banking system and be adjusted to the needs of the economy in terms of both short-
turn stability and long-range growth.
* Monetary policy - cash ratio, treasury bills, discount rates, interest rates, exchange rates etc - is thus an indispensable component of stabilization policy. Expanding money supply will tend to increase liquidity, reduce interest rates, and thereby increase the level of demand, with monetary restriction working on the opposite direction.
* Fiscal Instruments - raising public expenditures will be expansionary as demand is increased, initially in the public sector and transmitted to the private market. Tax reduction, similarly, may be expansionary as taxpayers are left with a higher level of income and may be expected to spend more. Expansionary effects of deficit finance, if matched by a tight monetary policy will call for an increase in the rate of interest.
Fiscal Institutions
Whereas a unitary government need not have its taxing and spending powers specified in the Constitution, a federation by necessity must have them so specified. Fiscal arrangements of taxing and spending powers are all at the very core of the contract between the constituent governments which combine to form the federation. Even though the Central Government necessarily must have fiscal powers, the composing units retain a sovereign right to conduct fiscal transactions of their own.
The USA Experience on Public Finance
The fiscal powers of the Federal Government were laid down in a series of specific constitutional provisions which came to be further defined by judicial interpretations given to certain other provisions not exclusively aimed at fiscal matters. The major provisions are:
* Taxing powers and expenditure functions - the general enabling statute for federal taxing powers is contained in Article 1 Section 8 of the Constitution which provides that the "Congress shall have power to levy and collect taxes, duties, customs and excise, to pay the debts and provide for the common defense and general welfare of the United States".
* Uniformity Rule - also covered in Article 1, Section 8, it states that all taxes shall be uniform throughout the U.S. This means that there is equal treatment of tax payers in equal position independent of their place of residence.
* Apportionment Rule - this is covered under the 16th Amendment which states 'Congress shall have power to levy and collect taxes on incomes, from whatever source derived, without apportionment among the several States and without regard to census or enumeration. This cleared the way for uniform and nationwide income tax.
* Export taxes - Article 1, Section 9 of the Constitution also prohibits the levying of export taxes. It is interesting to note in connection with the potential use of tax policy to affect the balance of payments that there is no corresponding prohibition of export subsidies. Whereas the Federal Government had to be granted basic taxing powers by the constitution, the states did not need this provision. Taxing powers of the states is vested in their sovereign rights as constituent members of the federation and retained by them under the residual power doctrine. The constitution however, imposes certain restrictions on the taxing power of the states, partly through specific provisions and partly again through judicial application of other clauses of the constitution to tax matters. The following four limitations are important:
o In Article 1, Section 10 of the Constitution, the states are prohibited specifically from imposing taxes not only on exports but on imports as well. This was to place the regulation of foreign commerce exclusively under the authority of the federal government.
o The immunity doctrine forbids federal taxation of state and local instrumentalities and also applies in reverse. States may not tax the instrumentalities of the federal government. Salaries paid by the federal government are subject to state income tax though.
o The 14th Amendment holds that a state must not deny to any person within its jurisdiction the equal protection of the laws. This clause has been interpreted as a prohibition against arbitrary classification and sets some limits on the extent to which states may discriminate among various categories of taxpayers.
o The 14th Amendment has also been interpreted as granting the taxpayer the right of appeal against arbitrary acts of state or local tax administration, similar to its application at the federal level.
Right to Education and School Finance
The bulk of the funds for public elementary and secondary education come from the local property tax. Since the property tax base varies among school districts, children in low base districts may be disadvantaged. The California Supreme Court in Serrano v. Priest held that the right to an education in public schools is a fundamental interest which cannot be conditioned on wealth.
Budgetary Process
The central instrument of expenditure policy is the budget. The four steps involved in the budget cycle are
* Formulation of the President's budget by the executive branch
* Appraisal of the President's budget by Congress and budget legislation
* Execution of this legislation by the executive branch
* Auditing by the General Accounting Office - the independent audit office reporting directly to congress
Proposals Regarding Public Taxation and Expenditure
* Sharing of Revenue
* National Taxes
o Income tax, VAT, customs and excise, court fees and levies –
* Provincial Taxes
o Rates on property, land taxes o Special consumption taxes
* District/Municipal Taxes
o Cess, tolls, fees, licenses
o Special consumption taxes
* Creation in the constitution a Monetary and Fiscal Commission to oversee the Central Bank and Ministry of Finance policies
* Education
* Provincial and District government matter
* National government grants to subsidize education
* Commitment to universal primary education up to Standard 8
* Establishment of national secondary schools funded by the national
* government
* Universities will be national matter
* Commitment to affirmative action
* Research to be funded by the National Government
* All schools and colleges to be run by Community Management Boards
* Health
* Provincial matter for District and Provincial hospitals
* Referral hospitals to be run by the national government
* directly to Congress.
* Disease control a national government matter
* Commitment to universal basic health care
* Labour
* Constitution to protect the interest of minorities, children and disabled
* Constitution to clearly delineate employee/employer relationship
* Provinces to establish appropriate labour contracts e.g. working hours
* Prohibition of double taxation
* Infrastructure
* Aviation, railways, postal, telecommunications, highways, radio,
* television to fall under the control of the national government
* Water and energy to be shared between the national, provincial and local
* governments
* Science and Technology
* National government to protect intellectual property rights
* Research to be a national issue in collaboration with university research institutes and international institutions.