Determinants of value added tax revenue in Kenya

Abstract. Past studies that have been undertaken on the responsiveness of Value Added Tax revenues to changes in GDP in Kenya have found a positive relationship. However, the studies omit key determinants of tax revenues, such as the nature of the tax system, institutional, demographic and structural features of the economy. Due to this omission, the estimated income elasticities are unreliable for planning purposes, a situation that might be responsible for the recurring budget deficits. The specific objectives of thepaperare to establish the determinants of Value Added Tax revenue and assess yields responseto changes in bases and reforms. The paper uses Paul Samuelson's (1955) the paper are fundamental general equilibrium analysis of the public sector to derive its main results. The estimation results show that GDP elasticity is less than the elasticities with respect to monetary GDP, suggesting the existence of an underground economy. It is also found that tax yields respond with substantial lags to changes in its determinants and revenues are sensitive to reforms and unusual circumstances. The study concludes that Kenya’s Value Added Tax revenue is very responsive to changes in its determinants especially international trade. There is the challenge of creating a stable Value Added Tax system.Keywords. Tax revenue, Elasticity, Tax system, Underground economy, Unusual circumstances.JEL. H25, H24, H27