How ignoring the informal sector is costing Kenya billions in untapped tax revenue

The rejection of the Finance Bill 2024 by Kenya’s Gen Z was more than a protest. It was a clarion call for change. The events that unfolded in Nepal recently calls for even more urgent reflection on our tax laws.

Young Kenyans sent a powerful message that tinkering with tax rates on an excel sheet to balance revenue targets with projected expenditure without a well thought out and structured national tax policy is no longer acceptable. The country cannot continue to patch fiscal gaps by piling new taxes on a narrow group of already compliant taxpayers. Instead, Kenya must confront the deeper structural problem; a narrow tax base that excludes the majority of workers and enterprises.

Kenya’s tax-to-GDP ratio stood at about 16.8 per cent in 2022, slightly above the African average, but slipped to around 14.1 per cent in the fiscal year 2023/2024. This decline is largely explained by the size of the informal sector which accounts for 84 per cent of non-agricultural employment, about 17 million people. Most of these workers and small enterprises operate outside the tax system.

As a result, less than 20 per cent of working-age Kenyans pay direct income taxes, while the rest of the population is either lightly taxed through consumption levies or not taxed at all. This imbalance has left the government dependent on a narrow base of salaried employees, formal businesses and excisable goods, while vast pools of economic activity remain untapped. There are many examples of untaxed businesses and individuals.

One glaring example is public transport. While cargo transport operators pay corporate tax, fuel levies, and excise duties, some passenger transport operators of matatu, minibuses, and long-distance individual bus operators remain largely outside the tax net. And now in cities like Mombasa, tuk tuks and motorcycle riders have taken over passenger road transport because of a failed national transport policy, while in cities like Nairobi, Kisumu, Eldoret and Nakuru, thousands of matatu collect fares in cash, leaving no digital record.

Some middle-distance individual passenger and Sacco-affiliated operators running lucrative routes also generate substantial turnover but remit little tax beyond licences, advance tax and basic permits. Most drivers and conductors earn about Sh1,000 per day translating to over Sh30,000 per month on average, yet few pay PAYE because they are informally employed. But an intern or any low paid support staff working in any government entity earning Sh30,000 per month on average pays all taxes including PAYE, SHA and affordable housing levy.

A conservative analysis suggests that Nairobi alone losses between Sh1.1 billion and Sh3.8 billion annually in potential income tax on profits from passenger transport services, PAYE tax revenue from drivers, conductors and other players in the supply chain simply because they are deemed to be in the informal sector. Expanding this nationwide, the untaxed income in passenger transport is staggering.

The solution is to mandate digital fare collection in all major cities and long-distance routes. Passenger operators should be required to register as limited liability companies, making PAYE mandatory for drivers, conductors and other supporting staff. Integrating fare data with KRA’s systems would create an auditable trail, ensuring that compliance is automated rather than voluntary. This would bring fairness to a sector where millions of shillings change hands daily but remain invisible to the tax system.

A similar imbalance exists in the rental and hospitality sector. Formal hotels and lodges pay corporate tax, VAT, and remit PAYE yet thousands of properties listed on Airbnb and other short-term rental platforms operate untaxed. This gives them an unfair competitive advantage over compliant operators. The government should launch a national property mapping initiative, working with counties and utility providers, to capture all short-term rentals and all landlords.

At the same time, ride-hailing companies and individual taxi operators process millions in fare everyday but very few of these are captured by the tax system. In Singapore and the United Kingdom where most of our policymakers frequent, the taxi industry is taxed the same manner as any other business. These jurisdictions have adopted cashless payment systems, which not only enhance efficiency but also provide a reliable audit trail, making tax administration and compliance much easier.

But locally, most drivers operate as individuals, receiving payments directly in cash or via mobile money, with no structured withholding. The core challenge is that KRA cannot effectively map or monitor these digital transactions under its current structure, which is focused on revenue collection rather than sectoral mapping and policy design. To close this gap, Kenya should require digital platforms to share transaction data with KRA and to withhold taxes at source.

Other sectors also remain untapped. Informal trade and markets employ millions of Kenyans, often under county licences that are not integrated with national tax systems. Small holder agriculture contributes significantly to the economy, yet commercial surpluses are rarely taxed, with only large agribusiness structures captured.

Micro-manufacturing like carpentry workshops and steel fabricators, the so-called Jua Kali, operate outside formal structures while cross-border traders often bypass customs, undercutting compliant importers. All of these represent opportunities for formalisation and revenue mobilisation, if approached with incentives rather than punishment.