The Trade off between Direct and Indirect Taxes in Kenya. An Empirical Analysis

Abstract

The Trade off between Direct and Indirect Taxes in Kenya. An Empirical Analysis Omondi Benard Owino Abstract The correct selection of the composition and level of government taxes has become of crucial importance for the purpose of achieving a broad-based stable path of economic growth across countries. Since 1973 there has been a gradual shift from direct to indirect taxation in Kenya aimed at creating a sustainable tax system that could generate adequate revenue for economic growth. The level of revenue from indirect taxes has risen steadily in the period 1973-2010; however, this was coupled with a dwindling economic growth. It has been recently questioned whether alterations in the existing tax mix could promote economic growth. This study therefore attempted to establish the relationship between direct and indirect tax on economic growth. The motivation for this study was primarily premised on the paucity of empirical literature on the dynamics of the trade- off between direct and indirect tax and economic growth in developing economies, and the inconsistency of empirics on the issue in the developed economies. Three approaches were used to accomplish the study objectives namely regression analysis, Cointegration test and Error correction modeling. The regression analysis reported a negative relationship between direct tax and economic growth and a positive relationship between indirect taxes and economic growth. On the other hand, causality runs from tax revenue to economic growth. The empirical results indicate that direct taxes have a negative relationship with economic growth while indirect taxes are positively correlated with economic growth in Kenya supporting the predictions of the endogenous growth models. Thus according to this result among many other, the global transition from direct taxation to indirect taxation has empirical justification in Kenya. It therefore recommended that the government should rely more on indirect tax than direct tax due to its growth prospect and its less distortionary nature. Full Text: PDF DOI: 10.15640/jeds.v6n4a16