By CPA Linet Mutegi
It Is Time to Tax the Informal Sector Formally If the Government Is to Increase Its Tax Base
Long before he became the famous British Prime Minister, Winston Churchill was a Member of Parliament, where he said, “Taxes are an evil — a necessary evil but still an evil — and the fewer we have of them, the better” (The International Churchill Society (ICS), 2024). Taxes are a part of the social contract between the government and the people, where everybody gives up something in exchange for security and rule of law promised by the state. Globally, 61 per cent of the world’s workers are in informal employment and 89% sub-Saharan Africa (International Labour Organization, 2018). In line with the ILO (2015:4), the informal economy entails all economic activities undertaken by economic units that, in law or practice, are not wholly covered or are insufficiently covered by formal arrangements (ATAF-ICTD (2024). Unlike the informal sector, there exists well defined laws and frameworks that sufficiently stipulate and regulate taxation in the formal sector.
Why tax the informal sector?
The untapped potential and future of taxing informal economies has become increasingly pivotal in tax and development conversations in Africa. As African governments today grapple with diminishing revenue owing to the increasing financial needs that result from the growing populations and reduction in foreign aid disbursements, it is crucial that there’s diversification of taxation income. With informal economies being responsible for over 75% of the labour force in Africa, it is time to tax the informal sector formally if the government is to increase its tax base.
Diminishing government revenue has also been brought about by base erosion and profit shifting (BEPS) which entails tax avoidance by multinational companies (MNCs) who take advantage of existing tax loopholes to declare their profits in lower-tax base jurisdictions where they do not operate from. Research by Global Financial Integrity shows that, tax and illicit capital flight from Africa is greater than the aid received with the amount lost ranging from $50 billion to $80 billion per annum (Oguttu, 2015). How then, can governments effectively tax informal economies so as to achieve equity and wealth redistribution among other goals?
The Kenyan context of tax and informality
In Kenya, the body taxed with the collection of taxes, the Kenya Revenue Authority (KRA) continues to heavily rely on its key tax heads which are Pay as You Earn (PAYE) taxes, corporation taxes and non-oil taxes. Similarly, the Kenyan government has continuously targeted the formal sector in its drive to raise revenue, thus depicting a major focus on formal taxes and a minor focus on the informal sector. The most notable effort made by KRA to tax the informal sector was the introduction of turn-over tax (TOT) which required mama mboga[1] kiosk owners and roadside traders to maintain records dating back seven years. TOT was aimed at businesses whose yearly turnover was less than Sh5 million. Critics criticized the tax as impossible to administer as small-scale traders do not keep records with some comparing it poll tax which was introduced and administered by the colonial government. Further, experts argued that SMEs were already burdened by taxes and bribes demanded by local authorities. Through its Commissioner for Domestic Taxes, KRA insisted that Kenya was simply heeding calls by economists that governments get informal sector enterprises into paying taxes and that turnover tax was reintroduced to “bring the informal sector into the tax bracket and ensure equitable distribution of the tax burden” (Jalio, 2020).
Introduction of TOT is an affirmative action which was aimed at incorporating the SME sector into national taxation system, however, the performance of TOT has not been satisfactory. According to KRA, the total revenue collected from the TOT system is Kshs. 221 million against a target of Kshs. 645 million which is far from attaining the set target of creating an additional Kshs 2,400 million per year. On TOT recruitment, the performance has on average been below 50% (Kimaru, & Jagongo, 2014).
After the failure of TOT, the finance Bill 2018 introduced a Presumptive Tax Regime effective of 1 January 2019 to collect revenue from the informal sector. Businesses with an annual turnover of less than Shs. 5 million were required to pay for this tax before they are issued trade permits or business license by the county governments. Today, to tax the informal sector in Kenya, the increasing use of mobile money services in Kenya’s informal sector has been deemed to be a potential entry point to taxing small-scale businesses that usually fly under the radar of local tax authorities.
The Finance Act 2023 proposed an increase on excise duty tax on mobile money services from 12 to 15 per cent, resulting in increased fees for customers utilizing the services. Studies found an overall anti-tax sentiment, partly stirred by the political opposition in Kenya, which contributed to tax avoidance and evasion by citizens through adoption of fiscal workarounds. Further, participants were deeply frustrated with the political class while at the same time reinvigorating their view of taxation as based on a ‘social contract’ between tax-compliant citizens and a government that provides essential services. Fiscal workarounds are based on the ideology that citizens do not simply accept or reject taxes but rather redefine, revise and resist the taxes. Small scale business owners opted to shun digital mobile payments while other small-scale employers opted to remove employees from the formal and official payroll while employing more interns and casual staff in order to avoid paying any taxes. Interestingly, participants did not have a negative perception of taxes, rather, they viewed them as a key driver of a developed and democratic state (Magale, & Schmidt, 2024).
Studies conducted by Oxfam on the impact of taxes on small scale traders in the formal and informal sector of Kenya found that payment of cess twice a week to the market management, worker salaries, suppliers as well as security fees put a strain on their income. Additionally, they used their hard-earned profits to pay for informal services such as garbage collection, water and security services. Some traders had to reduce the variety of goods or products that they sold as they could no longer afford purchasing the raw materials due to increased taxation. Traders were of the opinion that they deserved better decent stalls, toilets, access to water and electricity as a social benefit of paying taxes to the local government officials.
Recommendations
Prevailing taxation rules and strategies go against the principle of equity in taxation because of the disproportionate burden placed on the lower-income earners in both the formal and informal sectors. There is need to prioritize and address the informal sector using well researched and evidence-driven data which is currently scanty. Further, the government ought to fulfil its social contract role before over-burdening small scale traders with more and heftier taxes, this will restore trust among citizens and the government.
Secondly, the Kenyan government can learn from other African countries who have adopted measures to improve their informal sector taxation, the Ghanaian government, for instance, has proposed the scrapping of what the finance minister deemed as ‘nuisance’ taxes as part of its 2025 fiscal policy in an effort to ease the tax burden being bore by firms and households. These taxes include the 10% withholding tax on lottery winnings and the 1.5% withholding tax on unprocessed gold winnings by small-scale miners. Ghana hopes to increase tax compliance as well as improve the welfare of its citizens through the abolishment.
Lastly, hasty generalization and generalist strategies of taxing the informal economy should be replaced with targeted and well-evidenced strategies. This will ensure that new taxes are embraced and complied with due to their social benefit specificity to the targeted population.
References
ATAF-ICTD (2024, November). Taxing Informal economies: practices, challenges & ways forward. https://www.ictd.ac/publication/taxing-informal-economies-practices-challenges-ways-forward/
International Labour Organization (2018). Women and men in the informal economy: A statistical picture. Third Edition. Geneva.
Jalio, T. (2020). Turnover tax is more a business killer than tax evasion healer. The Star. https://www.the-star.co.ke/sasa/2020-03-13-turnover-tax-is-more-a-business-killer-than-tax-evasion-healer
Kimaru, T., & Jagongo, A. (2014). Adoption of Turnover Tax in Kenya: A Snapshot of Small and Medium Enterprises in Gikomba Market, Nairobi Kenya. International Journal of Social Sciences and Entrepreneurship, 3(1), 18-30.
Magale, E., & Schmidt, M. (2024). Tax Awareness and Fiscal Workarounds in Contemporary Kenya: Reactions Towards New Taxation Laws, and the Need to Renew the Social Contract. The Institute of Development Studies and Partner Organisations.
Oguttu, A. W. (2015). Tax base erosion and profit shifting in Africa-part 1: what should Africa’s response be to the OECD BEPS Action Plan?. Comparative and International Law Journal of Southern Africa, 48(3), 516-553.
Oxfam (2024). The impact of tax on women small-scale tradershttps://cng-cdn.oxfam.org/kenya.oxfam.org/s3fs-public/Case%20studies%20for%20impact%20of%20tax%20on%20women%20small%20scale%20traders.pdf
Piotrowska, M. (2021). International Journal of African Studies.
The International Churchill Society (ICS), 2024. https://winstonchurchill.org/events/2024-international-churchill-conference/
Tax and informality in Kenya; Milestones, challenges and lessons
The author is an adjunct – faculty of Accounting and Finance at KCA University
Email: mukamimutegil@gmail.com
[1] Mama mboga (Swahili). literally: Vegetable Lady, refers to female hawker. She works as a small-scale fruit and vegetable seller, who often vend their merchandises in wooden stalls at the corner of the streets (Piotrowska, 2021).
