Kenya State Think Tank Warns Raising VAT Risks Driving Firms to Informal Sector
Kenya · ECONOMY
Key Facts
—The warning: KIPPRA advised the National Treasury against raising value-added tax above the current 16 percent, arguing it would reduce consumption and push firms into the informal economy.
—The threshold: KIPPRA modelling found that once VAT exceeds 16.3 percent, revenue elasticity turns negative, meaning higher rates start reducing total collections.
—The business risk: Forcing VAT obligations onto small businesses with turnover below KSh 5 million could push many to shut down or move outside the formal system, according to one business report.
—The informal economy: The World Bank says informality remains a major reason Kenya’s tax system has limited coverage, because many workers have irregular incomes and are difficult to track.
—The compliance gap: One survey found 94.3 percent of micro, small and medium enterprises in the informal economy did not pay taxes, and about eight in ten informal enterprises pay no tax at all.
—The alternative: KIPPRA urged the government to broaden the tax base, cut exemptions and improve compliance rather than raise the value-added tax rate.
The Kenya Institute for Public Policy Research and Analysis has warned the National Treasury that any Kenya VAT rise above the current 16 percent would backfire, reducing total revenue and accelerating the flight of firms into the informal economy.
KIPPRA draws a red line at 16.3 percent
KIPPRA, the state-backed policy research institute, told the Treasury in late July 2026 that Kenya is already near its revenue-maximising value-added tax rate. Its modelling indicates that once VAT crosses 16.3 percent, the relationship between the tax rate and collections turns negative.
The logic follows the Laffer Curve: tax revenue rises with the rate up to a point, then falls when the rate becomes too high. Consumers cut purchases, businesses under-report sales, and economic activity shifts into channels the tax authority cannot easily reach.
“Raise VAT at your own peril,” the think tank cautioned, according to The Star newspaper. The warning lands at a sensitive moment, as the Treasury searches for revenue to service debt and fund spending under an International Monetary Fund-backed consolidation programme.
Why a Kenya VAT rise threatens small business
For small traders, the danger is not only the statutory rate but the compliance burden that comes with it. Invoicing, filing, digital systems and remitting tax can be expensive relative to margins, especially for enterprises with turnover below KSh 5 million.
One business report warns that forcing VAT obligations onto these micro-enterprises could push many to shut down or move outside the formal system entirely. In that environment, a higher VAT acts as a tax on formalisation rather than a reliable revenue tool.
The World Bank has long flagged informality as the central constraint on Kenya’s tax coverage. Many workers have irregular incomes and operate with low record-keeping, making them difficult to track for tax purposes.
The informal economy already dominates
Kenya’s informal sector is large enough that VAT changes reshape how firms behave, not just how much the state collects. About eight in ten informal enterprises do not pay tax, and one survey found that 94.3 percent of micro, small and medium enterprises in the informal economy paid no taxes at all.
When taxes are perceived as too heavy or compliance too costly, small firms respond by staying small, fragmenting operations, under-reporting sales, or going cash-only. KIPPRA’s advice to broaden the base and cut exemptions rather than raise VAT is consistent with that broader pattern.
The state has tried for years to convert informality into stable tax revenue. Turnover Tax was introduced in 2007, cut in 2020, and then proposals were made to alter it again under subsequent Finance Bills, Deloitte notes. The history shows how difficult it is to net informal actors.
The money and power tradeoff behind the VAT debate
This debate sits inside Kenya’s broader fiscal and political economy. Revenue pressure, debt service, inflation and IMF-backed consolidation all constrain the government’s room to manoeuvre. When the state leans on VAT, it shifts the burden toward consumption.
That burden is politically visible and regressive in a country where many households live close to subsistence. The Treasury wants more predictable revenue to service debt and fund spending, while small-business interests want lower compliance costs and protection from margin squeeze.
Middle-class consumers absorb higher prices if VAT is passed through, and informal-sector actors can more easily evade or exit the tax net, weakening the intended gains. KIPPRA’s intervention effectively tells the Treasury that a rate hike would hurt all four groups without delivering the revenue it seeks.
What a Kenya VAT rise means for investors and lenders
Kenya’s tax strategy matters to external partners because the country is a key IMF, World Bank and donor-facing economy in East Africa. Revenue mobilisation is a central part of its macro-stability narrative, and VAT policy affects debt sustainability and investor confidence.
Across the continent, governments under fiscal pressure often reach first for consumption taxes because they are easier to collect than income taxes in informal economies. But that can deepen resistance if citizens already feel overtaxed while elites and exemptions remain protected.
For Kenya, the optics of VAT are especially sensitive: the state is trying to tax a mass of small, hard-to-measure actors while continuing to negotiate with powerful creditors and domestic commercial interests. How Nairobi navigates this will shape its policy space with lenders and rating agencies, a dynamic explored in our pillar Africa: The New Scramble.
What to watch next
The Treasury has not yet signalled whether it will accept KIPPRA’s advice or press ahead with a rate increase. The next Finance Bill will be the vehicle to watch, as it will reveal whether the government prioritises base-broadening reforms or a simpler but riskier rate hike.
KIPPRA’s own recent policy work pushes the government toward reducing exemptions and formalising more businesses rather than raising rates. The think tank’s public warning suggests it sees a real risk that the Treasury is leaning the other way.
For investors and businesses operating in Kenya, the direction of travel matters. A VAT rise that pushes more activity into the informal economy would narrow the tax base further, making future fiscal adjustments harder and potentially raising the risk premium on Kenyan assets.
Frequently Asked Questions
What is Kenya’s current VAT rate?
Kenya’s current value-added tax rate is 16 percent, and KIPPRA has warned the Treasury not to raise it above that level.
Why does KIPPRA say a VAT rise would reduce revenue?
KIPPRA modelling shows that once VAT exceeds 16.3 percent, revenue elasticity turns negative, meaning higher rates reduce consumption and compliance enough to lower total collections.
How would a higher VAT affect small businesses in Kenya?
A higher VAT, especially if applied to firms with turnover below KSh 5 million, could push many small businesses to shut down or move into the informal economy where they are harder to tax.
Connected Coverage
For more on how fiscal policy choices intersect with great-power competition and investor sentiment across the continent, read our pillar Africa: The New Scramble.
Sources
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