Taxation

One of the ways that the Kenya Government can support farmers and consumers is through the zero-rating of inputs, and processed food, eliminating the additional cost that would result from such charges.

A decision by government to tax some agricultural inputs and processed foods has affected the agricultural sector negatively. Not only does it increase farm input prices and reduce affordability, but it also has the potential to increase food prices, a situation which hurts an already burdened population. An analysis of the potential effects on farm production costs and consumer prices of maize and maize meal can inform policy makers. This will ensure that any dire consequences are avoided, and more significantly, that Kenya continues to ensure food security for all its citizens.

BACKGROUND
Increased agricultural productivity is key to food security and poverty reduction. A major impediment, though, has been the low use of productivity enhancing inputs in the form of quality inputs, due to limited capital to finance such expenditures, and in some cases, low returns to inputs used. A candid discussion with growers reveal that most farmers who do not use quality inputs are constrained by the high cost of the inputs relative to price of the output. To ensure increased food supply and low food prices for consumers, governments must be frugal in their interventions by making agricultural inputs and food affordable, particularly for smallholder farmers and consumers in the low income categories respectively. One of the ways that the Kenya Government can support farmers and consumers is through the zero-rating of inputs, and processed food, eliminating the additional cost that would result from such charges.

Imposing Tax on agricultural inputs would effectively lead to higher input prices. Higher input prices will have two possible effects. First, farmers at the margin will not be able to meet the additional cost, and will either reduce the acreage under cultivation or use less inputs per given crop area. Either possibility will result in lower farm output and hence reduced national supply. Secondly, households that can afford to meet the increased cost of input, will ultimately face a higher cost per unit of output, a cost they will likely pass on to consumers in form of high output prices. Thus the real implications of imposing tax on inputs will go beyond the increase in input prices and reduced affordability to affect consumers through its effects on food prices. This multiplicity of effects is likely to have significant implications on food insecurity and poverty, particularly among poor and vulnerable consumers.

POTENTIAL EFFECTS OF IMPOSING 16% VAT

Farm Level Effects

Increased costs of Inputs
Using data collected randomly on maize production costs, the cost of maize production per acre range from about KES 30,000 to KES 33,000 with VAT it will raise to Ksh.35,000/=, which translates to a unit cost per bag of KES 1,837 to KES 2,109. The results show that the cost of producing a bag of maize increased by between 5% and 7% depending on the scale of production when comparing production costs of taxed and untaxed.

Reduction in input use and maize yields
As discussed above, the immediate effect of taxation on inputs will be an increase on inputs prices. The increase in will lead to the following scenarios, farmers will reduce the input application rate and maintain the area under maize compared to previous season, resulting in lower yields and increased cost of production; ii) farmers will reduce the area under maize and maintain the same input application rate, leading to a decline in production and supply of maize in the market and the consequent higher maize grain prices; and iii) farmers will maintain the same area under production and input application rate but transfer the costs to the consumer, implying that the price of maize grain will increase.

Decline in national demand of Inputs
Growth in agricultural productivity is largely a function of the use of improved agricultural technologies. With the increase in the price, the demand will decline.

Consumer Level Effects
Increase in price of maize grain As discussed earlier, cost of maize production will increase. The effect this would have is on the wholesale and retail prices of maize grain in the Nairobi market. According to the Ministry of Agriculture, Marketing Information Bureau, the average wholesale maize grain price in Nairobi avereage KES 1980 per 90 kg bag, while the average retail price avereage KES 2250 (Kenya National Bureau of Statistics). Assuming that the mark-ups (margins) of producers, wholesalers and retailers remain the same after the increase in production cost, the new wholesale and retail maize prices in Nairobi would increase by 5%. The new wholesale and retail prices would be KES 2079 and KES 2363 respectively.

Increase in the price of sifted maize meal
The increase in the cost of maize grain implies that millers’ costs of purchasing grain will rise. Assuming miller and trader/ retailer margins are maintained, the average price of sifted maize meal would increase by 5% from KES 58 to KES 60 per kilogramme. When 16% VAT is reduced on the sifted maize meal, price would increase to KES 50 per kg. This implies that the consumer will pay around 22% more for a kilogramme of sifted maize meal because of the effects of VAT.

Estimated price elasticity of sifted maize meal in the urban areas of Nairobi as -1.85. Based on this elasticity, imposing tax will lead to a decline in demand for sifted maize meal of 30%. For poor households that mainly rely on maize meal for food, a decline in demand basically implies that these households will have to adopt various coping mechanisms as a result of the increase in the price of sifted maize meal. These could include skipping meals, taking smaller portions of food, and diversifying to less preferred foods, among others.

POLICY IMPLICATIONS

Subjecting farm inputs to taxation increases the cost of agricultural production, and therefore increases the cost of producing food commodities. This in turn raises prices of food commodities; consumers will ultimately bear this tax burden. In addition taxation on inputs raising food prices by 5%, taxation on processed food commodities result in a further increase in prices of 16%.

By having a negative impact on the cost of food production and prices of food commodities, taxation on inputs and food commodities affect domestic food supply and its affordability, hence food security.

Given the government objective of ensuring food availability for all it citizens, parliament must seriously consider the implications of any policy move that would further increase prices of food commodities. An increase in food prices will exacerbate the food security situation of poor households whose expenditure on food constitutes about 60% of their income.