Balancing The Tax Burden: Addressing Inequities Between Kenya’s Formal And Informal Sectors

By Jer­ameel Kevins Owuor Odhi­ambo

Worth Not­ing:

• To address this imbal­ance, a mul­ti­fac­eted approach is nec­es­sary, com­bin­ing leg­isla­tive reforms, admin­is­tra­tive improve­ments, and pub­lic edu­ca­tion ini­tia­tives. The first step in rec­ti­fy­ing this sit­u­a­tion is to con­duct a com­pre­hen­sive review of the cur­rent tax code.
• This review should aim to iden­ti­fy loop­holes that allow infor­mal sec­tor par­tic­i­pants to evade tax­es and pro­pose amend­ments to close these gaps. For instance, the Income Tax Act (Cap. 470) and the Val­ue Added Tax Act of 2013 could be amend­ed to include pro­vi­sions that specif­i­cal­ly tar­get infor­mal sec­tor activ­i­ties and bring them into the tax net.
• One poten­tial solu­tion is the imple­men­ta­tion of a pre­sump­tive tax sys­tem for small busi­ness­es and self-employed indi­vid­u­als in the infor­mal sec­tor.

Accord­ing to recent sta­tis­tics, approx­i­mate­ly 3 mil­lion Kenyans employed in the for­mal sec­tor bear a dis­pro­por­tion­ate tax bur­den com­pared to their coun­ter­parts in the infor­mal sec­tor. This stark dis­par­i­ty has led to a sig­nif­i­cant imbal­ance in the coun­try’s tax sys­tem, with for­mal sec­tor employ­ees con­tribut­ing a sub­stan­tial por­tion of the nation’s tax rev­enue while the infor­mal sec­tor, which com­pris­es a larg­er seg­ment of the work­force, con­tributes con­sid­er­ably less. This sit­u­a­tion has cre­at­ed a wide gap in tax con­tri­bu­tions and placed undue pres­sure on those in for­mal employ­ment.

The root of this issue lies in the struc­tur­al dif­fer­ences between the for­mal and infor­mal sec­tors in Kenya. The for­mal sec­tor, char­ac­ter­ized by reg­is­tered busi­ness­es, reg­u­lar employ­ment con­tracts, and stan­dard­ized wage sys­tems, is eas­i­ly track­able by tax author­i­ties. In con­trast, the infor­mal sec­tor, con­sist­ing of small-scale enter­pris­es, self-employ­ment, and unreg­is­tered busi­ness­es, often oper­ates out­side the purview of tax reg­u­la­tions. This dichoto­my has result­ed in a tax sys­tem that inad­ver­tent­ly penal­izes for­mal sec­tor employ­ees while allow­ing a sig­nif­i­cant por­tion of eco­nom­ic activ­i­ty to remain untaxed.

To address this imbal­ance, a mul­ti­fac­eted approach is nec­es­sary, com­bin­ing leg­isla­tive reforms, admin­is­tra­tive improve­ments, and pub­lic edu­ca­tion ini­tia­tives. The first step in rec­ti­fy­ing this sit­u­a­tion is to con­duct a com­pre­hen­sive review of the cur­rent tax code. This review should aim to iden­ti­fy loop­holes that allow infor­mal sec­tor par­tic­i­pants to evade tax­es and pro­pose amend­ments to close these gaps. For instance, the Income Tax Act (Cap. 470) and the Val­ue Added Tax Act of 2013 could be amend­ed to include pro­vi­sions that specif­i­cal­ly tar­get infor­mal sec­tor activ­i­ties and bring them into the tax net.

One poten­tial solu­tion is the imple­men­ta­tion of a pre­sump­tive tax sys­tem for small busi­ness­es and self-employed indi­vid­u­als in the infor­mal sec­tor. This sys­tem, which has been suc­cess­ful­ly employed in coun­tries like Ghana and Tan­za­nia, would allow tax author­i­ties to esti­mate the income of infor­mal sec­tor par­tic­i­pants based on cer­tain indi­ca­tors such as busi­ness type, loca­tion, and size. By sim­pli­fy­ing the tax cal­cu­la­tion process, this approach could encour­age com­pli­ance and bring more infor­mal sec­tor work­ers into the tax sys­tem.

Anoth­er crit­i­cal aspect of address­ing this issue is improv­ing the capac­i­ty and effi­cien­cy of the Kenya Rev­enue Author­i­ty (KRA). This would involve invest­ing in advanced tech­nol­o­gy for data col­lec­tion and analy­sis, enhanc­ing the skills of tax offi­cers, and imple­ment­ing more effec­tive enforce­ment mech­a­nisms. For exam­ple, the KRA could lever­age big data ana­lyt­ics to iden­ti­fy poten­tial tax evaders in the infor­mal sec­tor and con­duct tar­get­ed audits. Such mea­sures would not only increase tax col­lec­tion from the infor­mal sec­tor but also cre­ate a more equi­table tax envi­ron­ment.

Pub­lic edu­ca­tion and aware­ness cam­paigns play a cru­cial role in fos­ter­ing a cul­ture of tax com­pli­ance. Many infor­mal sec­tor par­tic­i­pants may be unaware of their tax oblig­a­tions or the ben­e­fits of for­mal­iz­ing their busi­ness­es. By launch­ing com­pre­hen­sive out­reach pro­grams, the gov­ern­ment can edu­cate cit­i­zens about the impor­tance of pay­ing tax­es and the advan­tages of oper­at­ing with­in the for­mal sec­tor. These pro­grams should empha­size how tax rev­enues con­tribute to pub­lic ser­vices and infra­struc­ture devel­op­ment, there­by cre­at­ing a sense of civic duty among all Kenyans.

Incen­tiviz­ing for­mal­iza­tion is anoth­er key strat­e­gy in bal­anc­ing the tax bur­den. The gov­ern­ment could offer ben­e­fits such as access to cred­it facil­i­ties, social secu­ri­ty pro­grams, and busi­ness devel­op­ment ser­vices to infor­mal sec­tor par­tic­i­pants who reg­is­ter their busi­ness­es and com­ply with tax reg­u­la­tions. This approach has been suc­cess­ful in coun­tries like Brazil, where the “Sim­ples Nacional” pro­gram pro­vid­ed tax incen­tives and sim­pli­fied pro­ce­dures for small busi­ness­es, lead­ing to increased for­mal­iza­tion and tax com­pli­ance.

It is essen­tial to rec­og­nize that the infor­mal sec­tor often com­pris­es low-income earn­ers who may strug­gle to meet tax oblig­a­tions. To address this, the gov­ern­ment should con­sid­er imple­ment­ing a pro­gres­sive tax sys­tem that takes into account the abil­i­ty to pay. This could involve intro­duc­ing tax brack­ets with low­er rates for low-income earn­ers and grad­u­al­ly increas­ing rates for high­er income lev­els. Such a sys­tem would ensure that the tax bur­den is dis­trib­uted more equi­tably across all sec­tors of the econ­o­my.

Col­lab­o­ra­tion between var­i­ous gov­ern­ment agen­cies is cru­cial in tack­ling this issue. The KRA should work close­ly with oth­er bod­ies such as the Reg­is­trar of Com­pa­nies, local author­i­ties, and finan­cial insti­tu­tions to share infor­ma­tion and cre­ate a more com­pre­hen­sive data­base of eco­nom­ic activ­i­ties. This inter-agency coop­er­a­tion would enhance the gov­ern­men­t’s abil­i­ty to iden­ti­fy and tax infor­mal sec­tor par­tic­i­pants effec­tive­ly.

The role of tech­nol­o­gy in for­mal­iz­ing the infor­mal sec­tor can­not be over­stat­ed. The gov­ern­ment should explore inno­v­a­tive solu­tions such as mobile-based tax pay­ment sys­tems, dig­i­tal iden­ti­fi­ca­tion for busi­ness­es, and blockchain tech­nol­o­gy for trans­par­ent record-keep­ing. These tech­no­log­i­cal advance­ments can sim­pli­fy tax com­pli­ance process­es, reduce cor­rup­tion, and make it eas­i­er for infor­mal sec­tor par­tic­i­pants to meet their tax oblig­a­tions.

While imple­ment­ing these mea­sures, it is cru­cial to main­tain a bal­ance between increas­ing tax com­pli­ance and avoid­ing over­ly bur­den­some reg­u­la­tions that might sti­fle eco­nom­ic growth. The gov­ern­ment should con­duct reg­u­lar impact assess­ments to ensure that tax poli­cies do not dis­in­cen­tivize entre­pre­neur­ship or dri­ve busi­ness­es fur­ther into infor­mal­i­ty. This bal­anced approach would help cre­ate a more equi­table tax sys­tem with­out ham­per­ing eco­nom­ic devel­op­ment.

In con­clu­sion, address­ing the dis­par­i­ty in tax con­tri­bu­tions between Kenya’s for­mal and infor­mal sec­tors requires a com­pre­hen­sive, long-term strat­e­gy. By com­bin­ing leg­isla­tive reforms, admin­is­tra­tive improve­ments, pub­lic edu­ca­tion, incen­tives for for­mal­iza­tion, and tech­no­log­i­cal solu­tions, Kenya can work towards a more equi­table tax sys­tem. This bal­anced approach would not only alle­vi­ate the bur­den on for­mal sec­tor employ­ees but also fos­ter eco­nom­ic growth, increase gov­ern­ment rev­enues, and pro­mote a cul­ture of tax com­pli­ance across all sec­tors of the econ­o­my. Ulti­mate­ly, these efforts would con­tribute to a more pros­per­ous and equi­table Kenya for all its cit­i­zens.

The writer is a lawyer and legal researcher