1 MOBILIZING LOCAL REVENUE FROM THE BUSINESS SECTOR Roy Kelly Duke University Innovations in Local Revenue Mobilization World Bank Workshop Sponsored by the Tax Policy and Administration and Decentralization Thematic Groups, World Bank Institute and Lincoln Institute of Land Policy June 2003

2 Business Taxation or Regulation? Legal issues Standard evaluation criteria –Revenue Adequacy –Efficiency –Equity –Administrative Feasibility –Political Acceptability If taxation: Maximize revenues fairly and efficiently within administrative and political constraints If regulation: Fees should be limited to costs of administration/enforcement (except to offset negative externalities)

3 Rationale for Local Business Taxation Benefit Principle: local businesses should pay for the general benefits they receive—not captured by direct user charges. Benefit taxes can be both efficient and equitable. Entitlement Principle: local communities are entitled to a share of the proceeds from economic activities. Caution from the economists: Firms can pass on the tax burden to suppliers and consumers, and possibly ‘export’ a portion of the tax. This affects the ultimate incidence of a tax on businesses and resulting efficiency and equity positions.

4 Rationale for Local Business Licensing Market Failures provide justification for government intervention—often exercised through regulatory controls such as licensing. Public health: licensing of food & alcohol trade, slaughter slabs, meat processing, etc. Public safety: entertainment & casinos, street trading, industries liable to cause pollution, etc. Public welfare: zoning—licensing for location, limiting excessive competition and quality control (e.g., taxis, certain traders, …)

5 Business Taxation/Revenue Experience Wide Variety –Ad Valorem on income, turnover/sales, property value –Unit Rates on type, size, location (presumptive) Local Examples (see Bird, 2003, Devas/Kelly, 2001): –North America (corporate income, VAT, property) –Europe (business capital/profits in Germany, business capital/payroll in France) –Latin America and Asia (turnover w/ flat fee for small businesses in Brazil, Venezuela and the Philippines, Octroi in South Asia) –Francophone Africa (business capital/payroll/turnover) –Anglophone Africa (licensing)

6 FIRST PRIORITY: Business Permits NOT Property Rates WHY? Businesses have a “culture of paying” thus compliance should be quite high. Businesses have “ability to pay” Businesses are spread throughout all LA(s) All LA(s) have access to some economic base of businesses. Businesses license revenue administration is quite simple and can serve as catalyst for improving all local revenue administration

7 The Critical Obstacle Although policy can be fine tuned, the primary obstacle to successful local revenue mobilization is: Weak Administration Problems: Lack of citizen credibility Lack of political will Revenue base information: lacking, incomplete, or dated Misclassification Low collections Enforcement: virtually non-existent

8 Analytical Model for Revenue Mobilization = * * * * Rev Base: Unknown Revenue Base TR: Tax Rate / Fee Structure Revenues $$$ Rev Base TR CR CR: Coverage Ratio VR VR: Valuation / Classification Ratio CLR CLR: Collection / Enforcement Ratio Policy VariablesAdministrative Variables

9 Reform Environment In Kenya Kenya Local Government Reform Programme Improve Service Delivery Participatory Governance Poverty Alleviation Primary Focus and Accomplishments: Intergovernmental Fiscal Transfers - Local Authorities Transfer Fund (LATF) Revenue Mobilization and Financial Management - Single Business Permit, local authority integrated financial operations management system (LAIFOMS) Participatory Service Delivery Planning - Local Authority Service Delivery Action Plan (LASDAP)

10 Decentralization Policy, Constitution Review, Local Government Act Review, public sector management and sectoral reforms, capacity development, econ recovery plan  Local Authority Transfer Fund (LATF) Participatory Local Authority Service Delivery Action Plan (LASDAP) Single Business Permit Pilot IFMS (PRSP, 9 th Development Plan) Devolution of functions to local governments Capacity of local governments Conceptualization Phase Consolidation Phase Take-Off Phase Early 1990sLate 1990s2002 onwards2004 onwards? Series of GOK studies, Omamo Commission, KLGRP secretariat, … Local Government Reform Programme (KLGRP) Phasing and Future Scenario

11 Comprehensive and Integrated Reform 1998: Central Government abolished central level trade licensing Local Government Act changed to allow Single Business Permit Ministry of Local Government SBP Circular Issued containing the 2-year phase-in strategy, classification/tariff schedules and administrative procedures Local Authorities Transfer Fund (LATF) Act enacted LA(s) adopted the SBP in 1999 Local Authority Services Charge (LASC) phased out LATF monies (Ksh 1 billion) released to all local authorities Integrated Financial Operations Management System (IFOMS) initiated in 2 pilot sites LA(s) adopted the SBP in 2000 LASC phased out by 1/2000 LATF’s SBP requirement LATF monies increased to Ksh 2.3 billion for FY

12 Licensing Environment In Kenya Established System (Pre-Independence) Evolved into a Complex System: Multiple level of licenses (central and local) Multiple licensing agencies Multiple licenses for one business (based on activities) Illogical & inconsistent tariff structures and categories across LA(s) and business activity Poor Administration (incomplete registers, misclassifications, no billing, poor collection, ineffective enforcement, lack of taxpayer service) Ineffective regulatory requirements Low level of local revenues, with little scope for increase High Economic, Administrative and Compliance Costs with low revenue yield and regulatory impact

13 Business Profile in Kenya (2000) Over 300,000 reported businesses by LA(s) Activity Type Nation Counties (as % of Nation) Traders 56% 50% Informal sector 15% 42% Lodging/catering 12% 56% Agricultural 5% 63% Industry/workshop 5%33% Education 2%40% Others 5%20% TOTAL 100% 48%

14 License Reform In Kenya: Objective Rationalize the policy and administrative procedures in order to: Deregulate business sector to encourage greater economic growth and employment Provide more buoyant revenues for local authorities Improve horizontal and vertical equity Reduce administrative and compliance costs

15 What is the Single Business Permit? A Single Business Permit is “a permit that allows the conduct of a business or trade, including a profession or occupation, within the area of a local authority.” (LGA, Cap 265, Section 2) A comprehensive definition: Improves the revenue base, equity, efficiency and administration. Provides the necessary information for local planning, regulation, finance and service delivery.

16 SBP decoupled from Regulatory Functions There are no prerequisites for granting or renewing a license--such as a pre-approval or inspection by such offices as the health department or planning department. All businesses must comply with current regulations on health and safety, with inspections to be conducted on an ongoing basis, coupled with own enforcement provisions (e.g., closure) LA may cancel an existing business permit where “upon receipt of a written report from an inspector appointed under this Act or any other written law, it finds that the business or trade to which it relates endangers the health and safety of the persons residing in the neighborhood.” (Cap 265, Section 163 A (5)).

17 How does the Single Business Permit work? Each LA has discretion to choose one column (1-16) from the SBP Fee Schedule issued by the MoLG. Councils are responsible and accountable for the choice of fee schedule. Fee Schedules are “pre-approved” by the Minister. Fee schedules are progressive, based on presumptive turnover/income, differentiated by business type and size. Each business only pays one SBP fee.

18 SBP Requirements Each tariff schedule (ie, each column) must be used in its entirety. Council must Gazette its fee schedule. Each business should be registered, classified and recorded in a business register. Each business is to pay for only one permit in accordance with its SBP classification. Note: Although other licenses should not be charged, businesses can be required to pay other fees and charges such as user charges for garbage collection, advertising, etc.

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21 Buoyant Revenues for LA(s) A simplified fee structure and administration strengthens ability to register, assess, collect and enforce against non-compliance A progressive fee structure allows for buoyant revenue enhancement A comprehensive business register creates a broad revenue base

22 Improve Horizontal & Vertical Equity Fee structure simplified to assist proper classification Fee structure differentiated by business type and size Larger businesses pay more than smaller businesses Relative fee structure consistent across LA(s), although absolute fee levels are determined by LA

23 Reduce Administrative & Compliance Costs Fee Structure and Administrative Procedures were simplified to –Make it easier (cheaper) for Businesses and Professions to be Registered, Classified, Assessed and Pay a Single Business Permit –Make it easier (cheaper) for Local Authorities to Register, Classify, Assess and Collect a Single Business Permit through a “One Stop Shop” (OSS)

24 SBP Experience in Kenya Widely appreciated by the business sector and LA(s)—higher revenues, lower compliance costs. (Abuodha and Bowles, 2000) Initial revenues went up percent. SBP accounts for 15 percent of total own source revenues. Largest source of revenues in counties (27%) and small towns (22%). National level consultative forum (KAM, KNCCI): only 13 LA(s) identified as problematic.

25 Source: LATF Database 2002

26 SBP Implementation Issues Slight policy adjustments made for (new categories—mega traders & communications, reduction for large industry) Traveling wholesaler issue (e.g., bread) Professionals Level of fee schedule (court cases) Multiple licensing or intentional misclassification Need for more effective dialogue between LA and business community Need for improved collection/enforcement Continual need for improved administration (registries, classification, collection— LAIFOMS )

27 General Lessons from Kenya Keep policy and administration simple. Make LA(s) accountable for rate discretion but with central guidance and oversight. Delink regulatory controls from licensing revenues Involve business community stakeholders Refine policy but focus must be on improved administration

28 Way Forward Improve Consultation : Organize consultative forums with councilors, staff and business community (linked to participatory governance activities) Improve Implementation : Local authorities and business community partnership –Create a comprehensive business registry ensuring complete coverage and accurate classification –Consult on selection of the business fee schedule –Improve collection and enforcement Improve Monitoring : Regularly monitor progress on the implementation of Single Business Permit and take corrective measures on noted irregularities.