Abstract

Kenya has continued to experience increasing budget deficits. This is despite implementing various tax reforms. To finance the deficit, the Kenyan government should either raise more tax revenue or resort to borrowing. Domestic borrowing crowds out investment while external debt specifically non-concessional loans are tied to some unpopular conditions. The government has an option of considering non-concessional loans but this comes with a price of high interest rates and short payment periods. This means raising more tax with minimum burden is the best option. This study therefore seeks to investigate the responsiveness of Kenya’s tax system to GDP and Discretionary tax measures for the period between 1970 and 2018. Variables used in the study are integrated of order one. Johansen cointegration test reveals presence long run relationship thus informing the study to consider Vector Error Correction Model (VECM). The results reveal that Kenya’s tax system is inelastic but buoyant. This implies that the Kenyan tax system is unresponsive to GDP but responsive to discretionary tax measures. The finding of inelastic tax system has implications for the fiscal policy. The fiscal policy’s managers should target reducing or eliminating the tax exemptions, which might be eroding the effective tax base.

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