Discussion Paper No. 06 of 2001 on Beer Taxation in Kenya: an Assessment

Abstract

In Kenya, excise taxes on beer contribute a significant share of government revenue. The government is therefore interested in establishing the optimal excise tax rates for the different types of beer-lager and stout. The optimal tax rate means that the government maximizes revenue from beer taxation. This paper attempts to show the revenue-maximizing tax rate in the beer subsector in Kenya. The study uses two methodological approaches to derive the price elasticity necessary in computing the revenue-maximizing tax rate. The first methodology is the partial-adjustment model. While this model has been found to provide satisfactory estimates of demand elasticity, it does not take into account persistence in consumer behaviour. The second approach takes into account persistence in consumer behaviour and hypothesizes that consumers have a strong memory. The study underpins the importance of a time horizon in evaluating the revenue-maximizing tax rates and confirms the argument that the short-run price elasticity is not appropriate for making policy choices. In addition, the study demonstrates that the assumption about the shape of the demand curve has important implications for the revenue-maximizing tax rate. The conclusion from the study is that there is need to carefully evaluate beer taxation in the country. The study results suggest that lowering the taxes on beer is likely to increase the level of production with subsequent increase in tax revenue.