Kenya’s informal sector, often referred to as the “Jua Kali” sector, plays a vital role in the country’s socio-economic climate. This sector encompasses millions of self-employed individuals, small traders, and micro-enterprises, who contribute significantly to Kenya’s GDP and make up a significant majority of the labour force. However, despite its crucial role, the informal sector largely remains outside the formal tax system, presenting a major challenge to revenue collection and national development.

Incorporating the informal sector into the tax system is not only crucial for broadening the tax base but also for promoting economic fairness. The existence of a sizeable underground economy points to an opportunity for increased revenue collection, which is essential for the government to meet its resource mobilisation goals. However, this effort is not without its challenges.

Historically, the informal sector has evaded formal taxation due to its structure. Small, mobile businesses with limited record-keeping, cash-based transactions, and a general mistrust of government authorities have made tax compliance difficult. There is also the issue of high compliance costs for these smaller entities, which discourages them from engaging with formal tax systems.

This, therefore, informs the need to design strategies and policy interventions to enable KRA to tap this sector into the tax bracket. 

The Kenya Revenue Authority (KRA) has pledged its commitment to address challenges faced by the informal sector in a bid to incentivise and onboard the sector players into the tax net.

Overcoming barriers to tax compliance

Several obstacles hinder the integration of the informal sector into the formal tax system. One significant barrier is the nature of informal businesses, many of which are small, mobile, and often operate without proper records. This makes it easy for these businesses to remain outside the tax net. Additionally, there is widespread mistrust between informal sector operators and tax authorities, with many perceiving the government’s tax collection efforts as punitive or high-handed.

Furthermore, many informal businesses lack the skills and resources needed to navigate Kenya’s tax system, particularly with the introduction of online tax services. Limited access to technology, low levels of education, and inadequate communication from the government about tax obligations have created a knowledge gap that prevents many informal businesses from complying.

There is also the issue of corruption, with some informal sector operators opting to pay bribes to avoid taxes altogether. This contributes to the broader problem of tax evasion and undermines efforts to formalise the sector.

Policy recommendations for expanding the tax base

• Offering tailored tax regimes that better align with the unique characteristics of the informal sector.
• Having a harmonised system between KRA and county governments would ensure that businesses can fulfil their tax obligations at the point of registration, reducing opportunities for evasion and bringing more players into the formal economy.
• Establishing a strong enforcement presence is crucial to demonstrating the consequences of non-compliance. However, enforcement must be balanced with efforts to encourage voluntary compliance through education, incentives, and support.
• Incentivising bookkeeping among small businesses is another avenue for enhancing tax compliance. Offering lower tax rates or other incentives to businesses that meet certain record-keeping standards could encourage better financial practices and increase transparency.
• There needs to be increased investments in capacity-building initiatives for the informal sector, such as business counselling, training, and reducing registration costs. 

Conclusion

Incorporating the informal sector into Kenya’s e-tax system is both a challenge and an opportunity. While the sector’s complexity and historical mistrust of tax authorities have made compliance difficult, the potential for revenue growth is immense. By simplifying tax processes, building trust, offering incentives, and improving enforcement, KRA can bring more of the informal sector into the tax fold. In doing so, the government will not only increase its revenue base but also foster a more inclusive and equitable economic environment for all Kenyans.