Capturing the informal sector

The KRA customs offices in Mombasa.Photo Elkana Jacob
The KRA customs offices in Mombasa.Photo Elkana Jacob

Stemming from last week’s piece, it was noted that one of the major driving forces behind introduction of the presumptive tax regime is the concerted effort by the taxman to tax the informal economy, today we shall focus on the informal economy and options through which it can be captured in the tax net, thereby increasing revenue collections and generally improving tax compliance as a whole.

The informal economy is defined as comprising economic activities that are not regulated by laws relating to taxation, labour and the environment. In Kenya, statistics show it captures 83.4% of total employment and contributes upwards of 30% (approx.) to the country’s GDP. The sector employs an overwhelming portion of the Kenyan citizenry and contributes a substantial portion of GDP. However, despite its significant role, taxation of the informal sector has largely remained elusive. KRA hopes to reverse this through the introduction of the PTR.

Two notable options for taxing the informal sector have been advanced by academic circles: Through registration and formalization or through indirect taxation. Under that, businesses in the sector would be incentivized to formalise and thereafter taxed through traditional means. Taxation of the informal economy through indirect taxation proposes the levying of tax on goods or services in the informal sector as the manner through which the informal sector may be taxed.

Both options have proved futile in the Kenyan context. While the informal economy shoulders the tax burden through indirect taxes, this has not translated to substantial increases in tax revenues from the informal sector – a challenge that is perhaps exuberated by the difficulties in accurately tracking businesses operating in the informal sector.

Under the PTR, challenges affecting accountability bypassed by tying taxation to businesses’ business licence as opposed to their revenue. This serves to reduce administrative burdens on both sides of the table. It is expected that the reduced administrative burden will result in increased compliance from the informal sector. While the jury may still be out on PTR, it remains a viable solution for taxation.