Implications of Tax Reforms on Tax Potential in Kenya: An Econometric Analysis

Abstract

Taxation serves as a crucial financial foundation for economic and social development, yet inefficient systems can impede compliance and efficiency. Kenya have implemented various tax reforms to increase revenue for public finance. However, despite the numerous tax reforms implemented, Kenya has continued to experience increasing budget deficit. This research therefore aims to examine the impact of tax

reforms on tax potential in Kenya. The research examines the influence indirect tax reforms, direct tax reforms, and tax rate reforms has on tax potential in Kenya. The study utilized autoregressive distributed lag (ARDL) modeling to examine the short term and long-term effects of tax reforms on tax potential in Kenya using annual secondary data spanning 52 years (1970–2022). The findings indicated that Kenya’s tax structure is not elastic or buoyant. A positive connection was established between indirect tax reforms and tax potential in the long term. A positive relationship between direct tax reforms and tax potential was also established in the long run. Further, tax rate reforms was found to be insignificant in influencing tax potential in Kenya. The study also incorporated manufacturing as a share of gross domestic product and inflation as control variables. The results indicated a strong and positive correlation between manufacturing input and the potential for taxation over the long term. The findings offer valuable insights for policymakers in Kenya seeking to enhance tax revenue mobilization strategies. The positive relationship between indirect tax reforms and direct tax reforms, tax system being neither buoyant nor elastic emphasized the importance of creating and executing additional reforms, with particular emphasis on investing in those that enhance the tax system’s resilience and connect it more directly to economic growth.