Many European countries enacted Value Added Tax (VAT) in the 1960s and 1970s. Other countries followed in the 1980s and thereafter. In some countries, it is known as goods and services tax (GST). VAT is an indirect tax; this means that the tax is paid to the revenue authority by the seller of the goods but it is actually paid by the buyer to the seller as part of the price. Contrary to income tax, which taxes more on high earners, VAT applies equally to every purchase. It is paid by the person who consumes taxable goods and taxable services.
To mitigate the effects of COVID-19, the President proposed various measures. Key among these measures was that the rate of VAT be reduced from 16% to 14%. The cabinet Secretary (CS) for National Treasury is by law given the powers to vary the VAT rate either upwards or downwards by rate not exceeding 25%. The effective date was published as 1st April, 2020.
The tax is collected at designated points by VAT registered persons who act as agents of the Government. VAT is a consumption tax since it is ultimately borne by the final consumer and is charged as a percentage of the price. It is a tax on personal spending and not a charge on businesses.
Imposing a VAT rate of 14% implies that the seller must add 14% to the sales price of the item. Depending on the price elasticity of the goods and services, the VAT tax system can change the consumers’ buying decisions.
Reducing the VAT rate decreases the retail price of goods and services, although the expected price decrease is not directly proportional to the VAT rate reduction. Reducing the VAT rate slightly increases the consumption of the affected goods. At the same time, reducing the VAT rate decreases revenues in the government budget. Following the reduction of the rate from 16% to 14%, the price of an item worth Kshs 200, for example, will drop by Kshs 20. Consequently, the consumer’s demand for this item will increase. Consumers often switch their demand towards the good with the lower tax rate because the price is lower than before.
In conclusion, it is expected that following the reduction of the VAT rate, the price of items and services will ultimately go down. The reduction is a welcome measure to reduce the cost of living since reduced prices will increase savings for the consumers.
By Rhoda Wambui
Tax Education, Kenya Revenue Authority.