Kenya Can Increase Tax Revenue Without Raising VAT, KIPPRA Study Finds

Kenya does not need to increase its Value Added Tax (VAT) rate to generate higher government revenue, according to a new study by the Kenya Institute for Public Policy Research and Analysis (KIPPRA), which argues that improving tax administration, expanding compliance and leveraging digital tax systems would be far more effective than imposing higher tax rates.

The findings come at a time when Kenya continues to debate its tax policy following a series of Finance Bills aimed at increasing government revenue while addressing public concerns over the rising cost of living. According to the study, future tax reforms should place greater emphasis on strengthening tax administration and broadening the tax base instead of increasing VAT rates.

In its discussion paper titled Prospects and Optimal Level for VAT in Kenya, KIPPRA concludes that Kenya's current VAT rate of 16 per cent is already close to the level that maximises tax revenue under existing economic conditions. The researchers warn that raising the rate beyond this threshold could have the opposite effect by discouraging consumer spending, reducing the taxable base and encouraging tax evasion.

“The findings from the regression analysis provide strong evidence for the existence of the Laffer curve,” the report states, explaining that VAT revenue rises as tax rates increase up to a certain point, after which further tax increases begin to reduce overall government collections.

Using data covering the period from 1990 to 2023, the researchers estimate that the optimal VAT rate in a theoretical economy without structural inefficiencies would be 10.25 per cent.

However, after incorporating Kenya's economic realities, including GDP growth patterns and improvements in tax administration driven by technology, the optimal VAT rate increases to 16.3 per cent, almost identical to the country's current rate of 16 per cent.

“Kenya’s current VAT rate of 16 per cent is well positioned within the optimal range identified by the analysis,” the report says, cautioning that rates exceeding this level could discourage economic activity, reduce tax compliance and ultimately lower government revenue.

The study disputes the long-held assumption that increasing VAT automatically results in higher tax collections. Instead, it argues that taxation has an optimal point beyond which higher rates become counterproductive because businesses and consumers alter their behaviour by reducing spending, shifting transactions into the informal economy or avoiding taxes altogether.

Rather than advocating for higher VAT rates, KIPPRA recommends a comprehensive approach to reforming Kenya's tax system.

“Policy recommendations emphasize on a wholesome rather than piece-meal approach to reforming VAT policy to enhance fiscal sustainability in Kenya,” the report says. It recommends expanding the VAT base, eliminating unnecessary exemptions, formalising informal businesses and strengthening tax compliance as key measures for increasing government revenue.

The study also highlights the growing importance of technology in improving tax collection by the Kenya Revenue Authority (KRA). According to the researchers, digital tax platforms such as Electronic Tax Registers (ETR), iTax and the Tax Invoice Management System (TIMS) have significantly improved VAT compliance and strengthened revenue collection over time.

“Policy interventions and technology-driven systems significantly enhance collections,” the researchers say, noting that digital tax administration contributes more to increased VAT revenue than changes in tax rates alone.

Beyond tax administration, the report identifies several structural challenges that continue to limit Kenya's VAT performance. These include the country's large informal economy, which was estimated to account for approximately 84 per cent of total economic output in 2024, widespread VAT exemptions, invoice fraud and weak tax compliance, all of which reduce the country's revenue potential.

The researchers further observe that although VAT remains one of Kenya's most significant sources of tax revenue, its contribution has steadily declined over the years. Between 1990 and 2022, VAT generated an average of about one-third of the country's total tax revenue.

However, its share has fallen from approximately 45 per cent during the 1990s to around 26 per cent in recent years, largely due to increasing exemptions and the expansion of zero-rated goods, which have narrowed the taxable base.

According to the study, the findings could shape future Finance Bill proposals and influence Kenya's broader tax policy by encouraging the government to prioritise more effective tax collection instead of raising VAT rates. For households and businesses already struggling with the high cost of living, the report presents an alternative strategy for increasing government revenue without placing additional VAT burdens on consumers.

Ultimately, KIPPRA concludes that Kenya's long-term fiscal sustainability will depend less on increasing VAT rates and more on improving tax compliance, broadening the tax base and making better use of technology to ensure that existing taxes are collected more efficiently.

By fLEXI tEAM