Taxing Kenya’s M-Pesa Picks the Pockets of the Poor

Kenya has instituted a new tax that affects users of M-Pesa -- a widely popular phone-based money transfer service used by more than half of Kenya’s adult population. The new 10 percent excise duty on fees charged for money transfer services applies to mobile phone providers, banks, and other money transfer agencies. Operated by Safaricom, the largest mobile network operator in Kenya, M-Pesa accounts for the largest share of users of money transfer services. Users of M-Pesa products will therefore bear most of the impact of the tax.M-Pesa services are used by companies and individuals of all income levels. But because of the low cost of the transfer service, it is the poor that benefits the most from this product;  low-income workers in urban areas who rely on M-Pesa to transfer money to their families in the countryside. Is the burden on the poor created by taxing M-Pesa justifiable? The Kenyan government could look to Latin America’s past experience with taxing financial service products to gain further insight .M-Pesa’s success lies in the product’s adequacy for the evolving social-economic characteristics of Kenya – a country that is urbanizing faster than others in Africa. With an under-developed pension system, most families support older relatives by sending money home. M-Pesa greatly facilitated and significantly reduced the cost of these transfers.The benefits of M-Pesa have been highlighted in a number of CGD papers and blogs. For example, a case study on Kenya produced under my direction assessed recent innovations for improving financial inclusion in the country. It found that M-Pesa meets most of the ten Principles for Expanding Financial Access identified by a CGD Task Force. Several posts by CGD senior fellow David Roodman and CGD non-resident fellow Jenny Aker underscore the benefits that M-Pesa has delivered to Kenya’s poor population. Some of their blogs can be found here and here.Thus, a tax on M-Pesa is a tax on the poor. Does it matter that the tax is levied on the fees charged by providing M-Pesa services? Does it mean that the tax will be paid by the providers rather than the customers? The answer to both questions is no.Because there is a real need by the people in Kenya to use this product, this product can be characterized as what economists call highly price-inelastic; meaning the demand for the product will not change significantly in the presence of price increases (within a certain range, of course), at least in the short-term. This gives a strong incentive to the service providers to transfer most of the tax to the customers. While a small price increase can be easily absorbed by the upper-middle and high-income classes, the tax will impose a burden on the emerging urban middle class and their poor families in rural zones.The taxing of financial service products by governments facing difficulties to meet their financing needs is not a new trend. The imposition of the so-called financial transaction tax (FTT) in a number of Latin American countries during the 1990s provides ample examples of this practice. The FTT was typically introduced as a bank’s debit tax; that is, a tax on withdrawals from bank’s accounts. The FTT shares two important commonalities with Kenya’s tax on money transfer services. In both cases, the tax base is quite large, which gives governments the opportunity to collect a substantial amount of revenue. Second, the design of the tax is simple and the tax collection is straightforward since it’s done electronically and on real time.These Latin American experiences demonstrate why governments outside the region would want to employ similar types of taxes, but they also reveal shortcomings.  For example, in a number of countries, the FTT contributed to financial disintermediation over time as efforts to avoid paying the tax resulted in an increased holding of cash and a reduction in the usage of bank deposits. While corporations and rich individuals avoided the tax by shifting their banking businesses abroad, the middle class and the poor turned to the informal financial sector.The Kenyan government could learn from these lessons as it considers the desirability to maintain the tax on money transfer services. In the short-term, this tax would bring additional fiscal revenue to the government. But at what cost? The tax may discourage the country’s poorest from using an effective, secure, and cheap money transfer system that provides social and economic gains.