For national governments around the world, effective budgeting depends on accurate revenue forecasts.
Revenue forecasts are estimates of what governments will collect from various sources, such as income taxes, value-added taxes, corporate taxes, and excises, which together determine the funds available to allocate to various public programs. If revenues are significantly overestimated in the budgetary process, the results can be unexpected borrowing, high debt-service costs, and cutbacks in these important governmental services.
Under Kenya’s newly decentralized government structure, accurate revenue forecasting has become more important than ever.
Kenya’s new constitution, approved in 2010, decentralized the country’s government structure and created 47 county governments, each responsible for a broad range of programs and services. Counties’ execution of these programs depends heavily on funds from the national government.
If these funds aren’t transferred as planned, most counties are unable to perform their assigned budgetary responsibilities because they cannot generate significant revenues on their own. Of the 47 counties, only 3 (Mombasa, Nairobi, and Narok) currently raise own-source revenue in amounts equal to or greater than 20 percent of their available resources.
Unfortunately, Kenya’s National Treasury has a track record of significantly overestimating revenues in the national budget. These overly optimistic revenue forecasts (and the lack of transparency around such estimates) has led to excessive debt and a fragile fiscal environment, a record that has not gone unnoticed by the International Monetary Fund (IMF). In fall 2018, the IMF emphasized the “importance of realistic revenue projections to increase fiscal transparency and to avoid ad hoc cuts in public investments and other high priority expenditures.”
Putting Kenya’s revenue forecast challenges in perspective
This pattern of revenue overestimation existed before Kenya’s new constitution came into operational effect in 2013, but it has not improved in the five years since. As illustrated in the figure below, over this period, the National Treasury in Kenya has overestimated revenue each year by 5 percent a year on average, with a high of 8 percent in Kenyan fiscal year 2016–17.
A 5 percent overestimation in fiscal year 2014–15 revenue equates to 21 percent of the total revenue shared with the counties in that year. In recognition of the fact that forecasting is inherently an imprecise activity, it may be useful to compare Kenya’s experience with the revenue forecasts made by the US Congressional Budget Office (CBO) for each forthcoming fiscal year in the United States.
While the forecasting errors of the CBO, without regard to sign, are of the same order of magnitude as those in Kenya, CBO’s overestimation of revenue in some years tends to be offset by underestimates in others, resulting in a much smaller average estimation error of 1.1 percent over the comparable forecast horizon forecasts (PDF) . This suggests the opportunity exists in Kenya for developing forecasting tools that have the potential to significantly improve revenue forecasting on average.
Because counties depend so heavily on the transfer of national revenue under decentralization, they and the locally elected officials responsible for county budget planning and execution are left vulnerable if the national government fails to raise and transfer the revenues it has forecasted in the national budget.
Before Kenya’s new constitution, the national government and national politicians were responsible for providing public services such as county health care, agricultural service, and waste management. Under decentralization, the responsibility for providing such services has shifted from the national government to the counties, and locally elected county officials are now held accountable for delivering those services.
Accordingly, continuing overestimation of national revenue has added needless stress on the new intergovernmental fiscal system, which is already under pressure, as public officials at all levels have had to learn new roles and responsibilities. County governors and other local officials are forced to operate in an uncertain environment as they attempt to prepare and execute their budgets and provide needed public services while being unsure of when and whether the resources to do so will be made available.
Better tools can improve revenue forecasts and overall government efficiency
In these circumstances, the Urban Institute can make a significant contribution. Urban’s Center on International Development and Governance, together with the Urban-Brookings Tax Policy Center, has partnered with the Institute of Economic Affairs, a Kenyan research organization, to work under a grant from the Hewlett Foundation to develop tools and models to help Kenya improve its revenue forecasting.
The project seeks to develop tools for more accurate revenue forecasting while increasing transparency in the revenue forecasting process, thereby strengthening budgetary planning and execution at national and local levels and helping counties in particular receive the resources they need in a timely manner.