EFFECT OF TRADE TAXES ON TRADE DEFICIT IN KENYA

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1 EFFECT OF TRADE TAXES ON TRADE DEFICIT IN KENYA Kiganda Evans Ovamba Deparmen of Economics, Kaimosi Friends Universiy College, Kenya Ouma Denis Deparmen of Business adminisraion and Managemen Science, Kaimosi Friends Universiy College, Kenya Mobile: Address: C/O Kaimosi Friends Universiy College, P.O. Box , Kaimosi, Kenya Absrac Kenya has been recording rade deficis over years. However, sudies o esablish deerminans of rade defici in Kenya have fell shor of analyzing he effec of rade axes on rade defici. This makes he effec of rade axes on rade defici in Kenya unknown. Therefore, his sudy invesigaed he effec of rade axes on rade defici in Kenya wih he specific objecives of deermining he composiion of oal ax in Kenya and deermining he effec of rade axes on rade defici in Kenya. The sudy employed correlaion research design based on monhly ime series daa spanning 36 monhs from January 2015 o December Daa was obained from he Cenral Bank of Kenya. The Johansen co inegraion es was used o analyze he long run effec of rade axes on rade defici in Kenya while Granger causaliy es analyzed he direcion of causaliy beween rade axes and rade defici in Kenya. The findings indicaed ha VAT consiued he larges proporion of oal ax bu had no effec on rade defici while excise duy and impor duy had significan posiive and negaive effecs on rade defici in Kenya respecively. There was also unidirecional causaliy from rade defici o VAT, excise duy and impor duy in Kenya. The sudy recommended ha he governmen of Kenya should adop a fiscal policy geared owards reducing excise duy and increasing impor duy o increase expors and decrease impors ha will lead o a reducion in rade defici. Keywords Trade axes; Trade defici; Kenya Inroducion Background o he sudy Trade balance is he difference beween impors and expors. When impors overweigh expors hen we have a rade defici (Osoro, 2013). Trade deficis are linked o economic developmen due o impors of capial goods, raw maerials, inermediae producs among ohers. In Kenya we can associae deficis o low expor prices and low wages paid o workers, poor infrasrucure, high prices of inpus, poor healh and safey sandards, poor environmenal policies, and relaively high barriers o rade wih rade parner counries (Osoro, 2013). Kenya has been winessing worsening rade balance over ime (KIPPRA, 2016). The rade balance worsened by 18.7 per cen from a defici of KSh billion in 2013 o a defici of KSh 1,081.1 billion in Page 233

2 2014. This was as a resul of faser growh in impors (14.5 per cen) compared wih 7.0 per cen increase in oal expors (Republic of Kenya, 2014). Trade axes are associaed wih increased welfare coss o consumers and producers. Taxes on specific ypes of consumpion reduce rade if he good in quesion is an imporable, and hey promoe rade if he good is an exporable (Whalley, 2002). The design of ax srucures in boh developed and developing counries is influenced by many hings, including he ways in which axes affec boh he composiion and size of rade. While axes are used primarily o raise revenue, i is widely agreed ha hey should be as neural as possible in heir impac on resource allocaion in he economy, and hence no undermine inernaional compeiiveness and be as neural as possible in heir impacs on rade (Whalley, 2002). Impor and expor axes have a principal effec of rearding rade by reducing rade volumes on boh he impor and expor side and imposing economic coss hrough heir induced resource misallocaion effecs (Whalley, 2002). Several sudies have been conduced world over o esablish he deerminans of rade balance. In Kenya Osoro (2013) and Oguu (2014) analysed he deerminans of rade defici. However, heir sudies focused on he effec of Gross Domesic Produc (GDP), money supply, exchange rae, Foreign Direc Invesmen (FDI) and budge deficis on rade balance. This makes he effec of rade axes such as Value Added Tax (VAT), impor and expor duy on rade defici in Kenya unknown. Thus, his sudy invesigaed he effec of rade axes on rade defici in Kenya. Specific Objecives i. To deermine he composiion of oal ax in Kenya ii. To deermine he effec rade axes on rade defici in Kenya Research Quesions i. Wha is he composiion of oal ax in Kenya? ii. Wha is he effec of rade axes on rade defici in Kenya? Significance of he Sudy The Kenyan economy has been experiencing worsening rade balance which has led o he counry recording rade deficis over years. Despie he huge rade deficis characerized by high impors and low expors, sudies on he deerminans of rade deficis in Kenya like ha of Osoro (2013) and Oguu (2014) failed o analyze how rade axes affec rade defici in Kenya. This raised he need o invesigae he effec of rade axes on rade defici in Kenya. This bridges he knowledge gap of unknown effec of rade axes on rade defici in Kenya. The sudy findings inform policy makers he effec of rade axes on rade defici in Kenya hence appropriae in he formulaion of fiscal policy ha considers how he various axes affec rade defici wih an aim of argeing a reducion in worsening rade defici in Kenya. Scope of he Sudy The sudy covered 36 monhs from January 2015 o December Page 234

3 Lieraure Review Deerminans of Trade Defici Oguu (2014) esablished he relaionship beween he real exchange rae and he rade balance in Kenya using annual ime series daa from 1963 o The sudy findings indicaed ha exchange rae had a posiive effec on rade defici in Kenya. Osoro (2013) invesigaed he major deerminans of rade balance using annual daa for he period He explored he long run and shor run deerminans of rade defici wih he resuls indicaing ha he coefficiens of rade defici are posiively correlaed wih budge deficis, FDI and exchange raes. Waliullah e al. (2010) examined he shor and long-run relaionship beween he rade defici, income, money supply, and real exchange rae in he case of Pakisan s economy. The esimaed resuls showed ha exchange rae depreciaion was posiively relaed o he rade defici in he long and shor run. The resuls also provided srong evidence ha money supply and income played a srong role in deermining he behavior of he rade defici. Kamaruddin (2014) esed he deerminans of rade defici in Malaysia using annual daa saring from year 1975 unil Four variables were used in his sudy, rade defici, he real effecive exchange rae, Gross Domesic Produc (GDP) and money supply. The resul showed ha he variables had a posiive effec on rade defici in Malaysia. Yoshimine and Norrbin (2011) examined he effec of ax rae on rade balance in OECD counries. The resuls indicaed ha he rade balance is adversely affeced by corporae rae ax where here was a posiive relaionship beween corporae ax and rade balance in OECD counries. Desai and Hines (2005) examined he effec of value-added axes (VATs) on inernaional rade. Evidence from 136 counries indicaed ha reliance on VATs is associaed wih fewer expors and impors. Counries using VATs have one-hird fewer expors han do counries no using VATs, and 10 percen greaer VAT revenue is associaed wih wo percen fewer expors. There was a significan posiive effec of VATs on rade defici. Summary of Lieraure Empirical lieraure review indicaes ha here are several deerminans of rade defici. These deerminans include exchange rae, GDP, FDI, budge deficis, axes among ohers. However, sudies conduced in Kenya only esablished exchange rae, GDP, FDI, budge deficis as rade defici deerminans. This makes he effec of rade axes on rade balance in Kenya unknown necessiaing a sudy o invesigae he effec of rade axes on rade defici in Kenya. Page 235

4 Theoreical Framework According o he naional income ideniy as specified by Keynes in his Keynesian heory of income deerminaion ha; Y 1 ( a bt I G X M ) (1.1) 1 b X M ( 1 b) Y a bt I G (1.2) X M (1.3) X M (1.4) X M (1.5) f ( Y, a, T, I, G) f ( T, ) f ( ID, ED, VAT, ) Based on he ransformaion of Keynesian model of income deerminaion and making ne expors (X-M) he subjec, his sudy hypohesized ha rade defici (a negaive difference beween expors and impors) a dependen variable is a funcion of rade axes (impor duy, excise duy and VAT) which are he independen variables and oher facors capured by he error erm such as governmen expendiure, invesmen, auonomous consumpion and naional income. Research Mehodology Research Design. A research design is he plan and srucure of he invesigaion used o obain evidence o answer research quesions and which sraegies are mos effecive for obaining i (Taylor & Wallace, 2007).The sudy employed correlaion research design. Gujarai (2004) argue ha correlaion research design is used in esablishing he effec of a variable on anoher. Daa Collecion This sudy involved monhly ime series daa o be obained from he Cenral Bank of Kenya Saisics. I consiued daa on rade defici and rade axes for he period January 2012 o December Daa Analysis and Model Specificaion Page 236

5 The sudy will employ Vecor Auoregressive (VAR) echniques of co inegraion and Granger causaliy o deermine he effec of rade axes on rade defici in Kenya. The model of analysis was based on he funcional relaionship (1.5) such ha; TD 0 1ID 2ED 3VAT (3.1) Where TD ID Trade defici Impor duy ED Excise duy VAT Value added Tax Error erm,, Coefficiens 0 1 2, Resuls 3 Descripive Saisics Table 4.1 es resuls indicaed ha all he variables of excise duy (ED), impor duy (ID), value added ax (VAT), oal ax (TTAX) and rade balance (TB) were normally disribued given he Jarque-Bera saisics for each of he variables was greaer han I was also noed ha he mean, minimum and maximum values are negaive implying ha Kenya has been experiencing a rade defici over years. The firs objecive of his sudy was o deermine he composiion of oal ax in Kenya. Table 4.1 es resuls indicaed ha excise duy, impor duy and value added ax on average consiued 12.4%, 9% and 27.8% of oal ax in Kenya. This implied ha VAT comprises he larges proporion of rade axes colleced in Kenya. Table 4.1: Descripive saisics ED ID VAT TTAX TB Mean Median Maximum Minimum Sd. Dev Skewness Kurosis Page 237

6 Jarque-Bera Probabiliy Sum Sum Dev. Sq. 3.04E E E E E+09 Observaion s Auhor (2017) Saionariy Tess Table 4.2 saionariy es resuls based on uni roo analysis indicaed ha excise duy alhough inegraed a level for he model wih inercep, i was inegraed of order one for he models wih inercep and rend and wihou inercep and rend. Impor duy was inegraed of order one, VAT alhough inegraed a level for he model wih inercep, i was inegraed of order one for he models wih inercep and rend and wihou inercep and rend. Trade balance alhough inegraed a level for he models wih inercep and wih inercep and rend i was inegraed of order one for he model wihou inercep and rend. Table 4.2: Uni roo es resuls Variable ADF - PP- Coeff ADF P- PP P- Inference Coeff value value Level Inercep * * I(0) None ED I & T s diff Inercep None * * I & T * * ID Level Inercep None I & T s diff Inercep * * Page 238

7 VAT None * * I & T * * I(1) Level Inercep * I(0) * None I & T s diff Inercep None * * I & T * * TB Level Inercep * * I(0) None I & T * * I(0) Auhor (2017) Co inegraion 1 s diff Inercep None * * I & T Table 4.3 es resuls based on Johansen co inegraion es indicae 4 co inegraion equaion based on boh race es and maximum eigenvalue es. This implied ha rade axes in Kenya have a long run relaionship wih rade defici. Unresriced Co inegraion Rank Tes (Trace) Table 4.3: Johansen co inegraion resuls Hypohesized Trace 0.05 No. of CE(s) Eigenvalue Saisic Criical Value Prob.** None * A mos 1 * A mos 2 * Page 239

8 A mos 3 * Trace es indicaes 4 co inegraing eqn(s) a he 0.05 level * denoes rejecion of he hypohesis a he 0.05 level **MacKinnon-Haug-Michelis (1999) p-values Unresriced Co inegraion Rank Tes (Maximum Eigenvalue) Hypohesized Max-Eigen 0.05 No. of CE(s) Eigenvalue Saisic Criical Value Prob.** None * A mos 1 * A mos 2 * A mos 3 * Max-eigenvalue es indicaes 4 co inegraing eqn(s) a he 0.05 level * denoes rejecion of he hypohesis a he 0.05 level **MacKinnon-Haug-Michelis (1999) p-values Auhor (2017) The second objecive of he sudy was o deermine he effec of rade axes on rade defici in Kenya. Normalized co inegraion coefficien resuls in Table 4.4 indicaed ha he long run relaionship beween rade axes and rade defici in Kenya can be represened as; TD 1.67 ID 1.85 ED 0.01VAT 0 (4.1) [3.3837] [ ] [0.0219] TD (4.2) 1.85 ED [4.1513] 1.67 [ ] ID 0.01 VAT [ ] Model (4.2) implied ha excise duy and impor duy have a significan posiive and negaive effec on rade defici in Kenya a 5% level of significance while VAT had no significan effec on rade defici in Kenya. Thus a percenage increase in excise duy increases rade defici in Kenya by 1.85% while a percenage increase in impor duy decreases rade defici in Kenya by 1.67%. This may be aribued o he fac ha increased excise duy increases he price of locally manufacured goods making Kenyan producs uncompeiive in he inernaional marke which discourages expors while increase in impor duy makes local producs cheaper as compared o goods from foreign marke hus discouraging impors. These findings conform o he findings of Yoshimine and Norrbin (2011) who examined he effec of ax rae on rade balance in OECD counries and esablished ha rade balance is adversely affeced by corporae rae. Table 4.4: Normalized co inegraion coefficiens Page 240

9 Normalized co inegraing coefficiens (sandard error in parenheses) TB ID ED VAT ( ) ( ) ( ) [ ] [ ] [ ] Auhor (2017) Causaliy The Granger causaliy es resuls in Table 4.5 indicaed ha here exised unidirecional causaliy running from impor duy and excise duy o rade defici and a unidirecional causaliy running from rade defici o VAT a 5% level of significance in Kenya. Table 4.5: Pair wise Granger causaliy ess Null Hypohesis: Obs F-Saisic Prob. ID does no Granger Cause TB * TB does no Granger Cause ID ED does no Granger Cause TB * TB does no Granger Cause ED VAT does no Granger Cause TB TB does no Granger Cause VAT * Auhor (2017) Conclusions and Recommendaions Conclusions The sudy concluded ha; i. Value added ax (VAT) comprised he larges proporion of rade axes ii. iii. Excise duy had a significan posiive effec on rade defici in Kenya in he long run Impor duy had a significan negaive effec on rade defici in Kenya in he long run Recommendaions The sudy recommended ha; i. The governmen of Kenya o adop a fiscal policy geared owards reducing excise duy. This will encourage expors as he locally manufacured producs will be less expensive improving inernaional compeiiveness and hence decrease in rade defici. Page 241

10 ii. The governmen hrough is fiscal policy o arge increasing impor duy. This will discourage imporers hence decreasing impors ha will decrease rade defici. References Cenral Bank of Kenya. (2015). Moneary policy saemen: June Nairobi: Cenral Bank of Kenya. Desai, M. A., & Hines, J. R. (2005). Value-Added Taxes and Inernaional Trade: The Evidence. Michigan: Michigan Universiy. Gujarai, D. N. (2004). Basic economerics (4h ed.). McGraw- Hill Companies: Unied Kingdom. Kamaruddin, A. A. (2014). Deerminans of Malaysian Trade Balance:An ARLD and FMOLS Approach. Inernaional Conference on Posgraduae Research (pp. 7-15). Kuala Lumpur, Malaysia: ICPR. KIPPRA. (2016). Kenya economic repor 2015: Empowering youh hrough decen and producive employmen. Nairobi: KIPPRA. Oguu, G. O. (2014). Effecs of real exchange rae on rade balance in Kenya. Hague: Inernaional Insiue of Social Sudies. Osoro, K. (2013). Kenya's Foreign Trade Balance: An Emperical Invesigaion. European Scienific Journal, 9 (19), Republic of Kenya. (2014). Kenya Economic Survey 2014 Highlighs. Nairobi: Kenya Naional Bureau of Saisics. Taylor, P. C., & Wallace, J. C. (2007). Qualiaive Research in Pos Modern Times: Conemporary Qualiaive Research. Neherlands: Springer. Waliullah, W., Kakar, M. K., Kakar, R., & Khan, W. (2010). The Deerminans of Pakisan s Trade Balance: An ARDL Coinegraion Approach. The Lahore Journal of Economics,15 (1), Whalley, J. (2002). Taxes on Trade. Onario: Universiy of Wesern Onario.Yoshimine, K., & Norrbin, S. c. (2011). The effec of he corporae ax rae on he rade balance. Applied Economics Leers, 14 (5), Page 242