Hiccups in State's push to formalise and tax small businesses

The government’s aggressive strategy to net micro, small and medium enterprises (MSMEs) into the tax bracket has been criticised, with some experts pointing out huge gaps in the plan. They say it does not reflect the strength of the country’s economy.

These gaps are being noted, even as the government prides itself in creating more than 250,000 jobs as a result of the affordable housing programme, which is largely informal.

There are plans to create more jobs in other sectors such as leather and leather products.

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This was one of the issues recommended by small business owners among them landlords during the Kenya Revenue Authority (KRA) Tax Summit held in Nairobi late last year.

While most of the jobs being created by the government seem to be in the informal sector, it raises questions since the MSME sector has always been a difficult one to net revenue from.

According to the Budget Policy Statement 2025, at least 164,000 jobs have been created so far in the affordable housing programme. This number, however, according to President Ruto is 250,000.

In the dairy sector, the government plans to create 500,000 jobs while in the leather sector, the plan is to create 100,000 jobs from the current 17,000. Most of these jobs are being created in the MSMEs sector - synonymous with the country’s informal part of the economy.  

At the Fifth Diamond Trust Bank (DTB) Economic and Sustainability Forum, experts chimed in on the government’s endeavour to formalise the MSMEs sector and bring it into the tax bracket.

Their thoughts were that either, there was nothing to formalise or the government’s strategy was upside down.

 Institute of Economic Affairs (IEA) Chief Executive Kwame Owino said while jobs should not be categorised as formal or informal, how the latter operates reflects the exact scenario of how Kenyans live.

“For instance, most Kenyans draw their sustenance from small farms. And the way they work is that they work for themselves. I don’t know what it is you are going to tell them to formalise because you want to give them an ETR machine to place in a hut,” said Kwame. Issuance of electronic tax register (ETR) machines is one of the strategies that KRA is using to get a view of how much MSMEs make to tax them.

The government has even gone ahead and said it will consider payment termination platforms offered by telcos such as pay bill and till numbers to have this segment of the economy pay their fair share.

This was to be effective December 25, 2024. However, it is yet to be implemented.

“Combined, all our telcos’ digital touchpoints are two million. This is 10 times the ETR machines we have at KRA,” said Senior Advisor to President Ruto’s Council of Economic Affairs Moses Kuria at the KRA Tax Summit in October 2024.

The 2025 Budget Policy Statement recognises some of the challenges in this sector, among them accessing finance, inadequate infrastructure, regulatory and compliance constraints and limited market access.

“To address these challenges and transform the MSME economy, the government initiated a number of reforms including the establishment and strengthening of the Financial Inclusion Fund, popularly known as Hustler Fund to provide access to affordable credit; capacity building and linkage to markets, and strengthening of the capacity of MSMEs to venture into economic activities in building and construction value chains and ring-fencing certain components of low-cost housing projects for MSMEs,” reads the Budget Policy Statement report in part.

Informal sector

Mr Owino opined that such directives targeting the informal sector speak volumes about how the government is not in touch with the realities of how the economy operates.

“We have this pressure on the back of KRA to widen the tax base, to what? I am not persuaded that there is a lot of money sitting out there outside that some people hide,” he said.

“We have a problem taking a tax mandate run by Sweden and impose it on a country in which most people still rely on agricultural farms.”

According to the Kenya National Bureau of Statistics (KNBS) 2024 Economic Survey Report, employment in the modern and informal sectors excluding small-scale farming and pastoralist activities, went from 19.1 million in 2022 to 20 million.

 The report says the total new jobs generated in the economy were 848,200 in 2023. ​“The informal sector created 720,900 new jobs and accounted for 85.0 per cent of all the new jobs created in 2023,” the report says.

Jubilee Holdings Ltd chief executive Dr Julius Kipngetich said aggregation is the best bet to deal with the informal sector - referencing the tea sector.

He said when he was on the board of Kenya Tea Development Agency (KTDA), he witnessed how smallholder farmers benefited from aggregation as they made 76 per cent of their tea auction prices.

“Just imagine a smallholder farmer in Kericho who earns 76 per cent of the auction price and all that headache (of how and where to sell their tea) is covered by a set of expertise like KTDA,” he said.

As a result, KTDA, he said, is one of the most sought-after entities for insurers due to how organised the farmers are. “Every informal smallholder group must be aggregated by an efficient entity such as KTDA,” he said.

Executive Director of Bajeti Hub Dr Abraham Rugo said the lack of incentive for banks to extend money to the private sector, largely made up of MSMEs puts pressure on the formal economy.

“If there is no incentive for banks and financial institutions to lend to MSMEs, who do not have the kind of collateral of assurance that the government has, it means the net effect is that the space in which you want to collect tax is limited,” he said.

“And that is what has ended up being, that you are basically punishing the formal employment which is the case right now.”

KRA, in its ninth Strategic Plan, has its eyes set on MSMEs with Commissioner General Humphrey Wattanga indicating that the entity wants to approach the sector with a corporate look.

“We are taking a bit of a corporate approach looking at our taxpayers as our clients to understand their context. We are engaging with Eastleigh Business Community, Nyamakima, and avocado farmers - seeking to develop solutions that speak directly to these specific value chains,” said Wattanga during an interview in November 2024.

Mr Owino pointed out that the informal economy exists as it does partly due to the poverty levels of the country. He referenced that an individual in the village in a day will engage in three or four jobs from ploughing their land to selling at the market in the evenings.

“The fact that we have a big informal sector is in large part that those incomes are too small to start formalisation. They can’t have an office. The office is their home,” he noted.

“Otherwise, you will forever be stuck with the three million like you and I who are very lucky people with a track record, monthly income, bank accounts which can be tracked and revenues drawn. We are probably chasing a mirage.”