Gov't plan to exempt Kenyans earning below Sh45,000 from PAYE tax [Explainer]

In a move that could positively impact millions of Kenyan workers, the government plans to raise the zero tax rate threshold from Sh24,000 to Sh45,000 per month over the next three years.

This means that the government intends to increase the amount of money that Kenyans can earn each month without having to pay income tax, increasing disposable income for many workers.

The Current Situation

As of now, employees earning Sh24,000 or less per month are exempt from paying income tax.

However, only a fraction of the working population benefits from this threshold, with those in the formal payroll sector contributing significantly to the country’s tax revenues.

Personal Income Tax Breakdown

• PAYE: In 2023, employees on the PAYE (Pay As You Earn) system contributed a total of Sh495 billion in taxes. This group comprises only 15.69% of the tax-paying population.
• Informal Sector: The remaining 85% of the economy, including self-employed professionals and those in the informal sector, contributed only Sh15 billion in taxes in 2023. The government's challenge is ensuring these groups also contribute their fair share.

David Ndii, Chairperson of the President's Council of Economic Advisors, has been vocal about this issue, challenging the notion that individuals in the informal sector don’t earn enough to be taxed.

He prefers to refer to this group as the MSME economy, highlighting the significant, though often invisible, economic activity taking place in this space.

Road map to lowering tax rates

David Ndii on Wednesday while speaking at the 2024 NCBA Economic Forum, stressed the importance of a fairer tax system, one that would ensure people in all sectors of the economy contribute to the national coffers, not just those in formal employment.

The government aims to close the existing tax gap, where formal employees bear most of the burden, while a large segment of self-employed professionals and informal sector workers are under-taxed.

According to Ndii, the goal is not just to relieve pressure on lower-income earners but to bring about a fairer system that aligns tax contributions with the realities of today’s economy.

Watch David Ndii explaining the plan to raise income threshold for PAYE tax exemption below:

Most of Kenya's economic activities happen in the informal sector

Acknowledging the growth of Kenya’s digital and financial ecosystems, he pointed out that the current tax system doesn’t capture all income generated in the informal and MSME sectors, which is where most of the country’s economic activity is happening.

For example, consider the financial services sector: banks have outsourced many of their operations to mobile banking agents.

While bank tellers are officially employed and pay taxes, mobile banking agents, who perform similar duties, often don’t pay taxes because they’re not on formal payrolls. This disparity, Ndii argues, is unsustainable.

The government’s larger goal is to make tax collection more transparent and efficient through the use of technology.

Using AI for tax assessment

Ndii envisions a system where 90% of taxes are assessed automatically using algorithms and AI.

This would eliminate the need for manual assessments, reducing human discretion and improving fairness.

In the coming years, he anticipates that taxpayers would simply receive their tax returns based on their digital transaction data, with the option to dispute or accept the calculated tax liability.

With the increasing digitisation of financial transactions, this system could become a reality, making tax compliance easier and more equitable for all sectors of the economy.

READ: 6 ways Kenyan banks are using AI to serve customers

Potential Impact on Taxpayers

While some might resist the changes, especially those in the informal sector who fear increased scrutiny, Ndii emphasised that the goal is to relieve the burden on salaried workers who currently shoulder most of the tax load.

"So, there will be a lot of squealing, as expected, but we really hope that those who have been carrying a disproportionate share of taxes will step forward and recognise this as a positive development. The purpose isn't just to fund the essential needs of our economy, but also to ease the tax burden," Ndii said.

The introduction of the new tax brackets could lead to increased tax relief for middle- and lower-income workers.

By narrowing the income tax yield gap and ensuring that all sectors contribute fairly, the government hopes to create a more balanced and sustainable tax system that benefits all Kenyans.

The proposed increase in the zero tax rate threshold from Sh24,000 to Sh45,000 represents a crucial step toward achieving a more equitable tax system.