Kenya is proposing to review its income tax structure and scrap tax exemptions to seal revenue leakages and help narrow its widening budget deficit.

The measures are part of the reforms the Treasury has lined up in the next few months to enable it to finance a projected Ksh291.5 billion ($3.4 billion) deficit in the next financial year, which begins in July.

The deficit will also see the government turn to the domestic market to raise at least Ksh190.8 billion ($2.24 billion), Treasury says in the 2014 Budget Policy Statement that details spending plans for the next fiscal year.

Henry Rotich, the Treasury Cabinet Secretary, told The EastAfrican that the government would review the existing income tax bands, institute new measures to reform tax administration to eliminate leakages and expand the tax base.

Three proposed laws — the Excise Management Bill, the Extractive Industry Tax (Income Tax Amendments) Bill and the Tax Procedure Bill — are set to be tabled in parliament before the end of 2014.

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In the course of the next fiscal year, a review and modernisation of the income tax law is to commence, to be completed in 2015.

“We want to clean up the current structures that we have in excise tax and tighten our regimes to properly capture the extractive industry given the oil and gas finds,” said Mr Rotich.

The Treasury is reported to be working on a new structure that could see the existing tax bands widened to reflect the current income trends and cost of living levels.

The Kenya Revenue Authority taxes all incomes above Ksh12,196 ($143), a threshold that was last reviewed nine years ago. Workers who earn above Ksh38,893 ($447) are charged a maximum tax rate of 30 per cent, the same rate as companies.

“We are looking at the bands to ensure that our taxes are progressive in that the richer you are, the higher the tax you pay,” said Mr Rotich, without giving details on expected changes in the tax bands.

Any changes in the bands would have far-reaching implications for household incomes. In 2010, then Finance Permanent Secretary Joseph Kinyua said the government would raise the minimum taxable income. This would have put more money in the pockets of millions of Kenyans whose earnings have failed to keep up with inflation.

According to the Economic Survey 2013, wages per employee grew by 4.7 per cent in 2012, well below the average inflation rate of 10 per cent, indicating that their earnings were eroded by the cost of living. Income tax accounts for about 40 per cent of KRA’s total tax collection.

The tax reforms are expected to usher in an era of belt-tightening for the public sector as well as businesses. Removing tax exemptions would free up more revenue to fund public spending, although it could reduce Kenya’s attractiveness as an investment destination as well increase the cost of living if companies pass the cost to consumers.

Two weeks ago, Tanzania said it would audit all tax exemptions issued over the past five years, with a report expected next month detailing how much was granted and why. Rwanda and Uganda too are considering reviewing exemptions.

READ: Tanzania starts review of all tax exemptions for past five years

Kenya is hoping to collect more revenue to fund its surging budget, with overall spending expected to reach Ksh1.54 trillion ($18.1 billion) in the next financial year. Data shows that, at the end of last year, cumulative revenues amounted to Ksh406 billion ($4.8 billion) against a target of Ksh489.2 billion ($5.8 billion).

With a deficit of Ksh291.5 billion ($3.4 billion), Treasury plans to resort to domestic borrowing, seeking at least 70 per cent of this amount or Ksh190.8 billion ($2.24 billion) from local markets, while the balance will be sourced through external financing. This will see the government lengthen the maturity structure of its debt to ease pressure on refinancing of the loans.

“While we had achieved a ratio of 85:15 in favour of long-term bonds, the appetite for short-term Treasury bills increased recently due to rising inflation expectations. Going forward, the government will gradually unwind short-term debt and replace this with long-term debt in conformity of the policy target ratio of 75:25,” said the Budget Policy Statement.

Whereas the government has in the past had a bigger fiscal space to adjust its debt strategy, a series of macro and policy factors have narrowed it, making it harder for it to take on more debt.

The country’s debt-to-GDP ratio, at 52 per cent, is well above the 50 per cent threshold that the IMF recommends for countries in Kenya’s economic position.

Secondly, the high interest rates on domestic borrowing, coupled with the expected maturity of a quarter of the country’s domestic debt, has exposed it to both rollover as well as refinancing risk, creating challenges for policy makers.

The government had proposed to borrow from the international market through a sovereign bond, expected this month, but the tapering off of quantitative easing by the US government has raised the expected yield on the bond.

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The government projects it will pay anything from 7.6 to 8.1 per cent. Kenya hopes to raise $1.5 billion-$2 billion through the sovereign bond. Rwanda, which sold its bond last year, is paying 6.8 per cent.

By Mwaura Kimani and Peterson Thiong’o