Reducing income tax by 5 per cent can greatly boost the economy

 In the 2024/25 financial year, Kenya Revenue Authority collected Sh560 billion from salaried workers through PAYE tax. [Courtesy]

Over the last few months, there has been considerable debate on the impact of tax reliefs for workers. The discussion has largely centered on two perspectives: A fiscal stability standpoint, which emphasises the importance of government revenue and a growth-oriented perspective, which highlights how tax reliefs can boost consumption and stimulate economic expansion.

In Kenya, there has been a steady trend toward scaling up income taxation rather than production taxation, even though the latter is a more sustainable source of revenue. The resulting cumulative tax burden on payslips has not only reduced disposable income but also limited purchasing power, constraining workers’ participation in the economy from both a consumption and a production standpoint.

Over the past five years, Kenyan workers have effectively lost about 12 per cent of real wages, leaving many struggling to contribute meaningfully to economic activity. Unlocking this potential through tax relief can yield disproportionately large benefits for both households and the broader economy.

In the 2024/25 financial year, Kenya Revenue Authority collected Sh560 billion from salaried workers through Pay-As-You-Earn (PAYE) tax. A 5 per cent reduction in tax rates across all income tax bands would return approximately Sh28.1 billion to salaried workers, boosting their spending and investments, including in small businesses and productive sectors of the economy such as manufacturing and agriculture.

According to the International Monetary Fund and the World Bank, a developing country such as Kenya has a fiscal multiplier that triggers a chain reaction of income of about 1.5. Consequently, the Sh28.1 billion released to workers would translate into roughly Sh42 billion in GDP output, or about 0.26 per cent of GDP. The effect would be realised through strong spending, repeated rounds of consumption, and minimal saving, given the current economic conditions. The strongest impact would be felt in the informal markets, the services sector, and local trade.

An additional Sh28 billion flowing into salary-financed Micro, Small, and Medium Enterprises (MSMEs) would mean restocking goods, paying rent and utilities, funding transportation logistics, re-engaging wage or casual labour, and enhancing access to basic services.

For MSMEs, a Sh1 billion injection typically creates an estimated 1,300 direct jobs and 3,000–10,000 indirect jobs. The Sh28 billion would therefore create a minimum of 36,000 jobs annually, transforming livelihoods and stimulating economic activity.

Unlocking Sh28 billion for salaried workers would also create headroom for salary-backed loans in the banking sector, further stimulating economic activity. This would provide an opportunity for the government to collect more consumption taxes in the form of VAT and excise duties, partially offsetting the foregone PAYE revenue.

Based on an effective tax-to-GDP ratio, averaging about 15 per cent over the past three years, the Sh42 billion GDP boost would translate to Sh6.3 billion in additional tax revenue for the government. This implies that close to one-quarter of the revenue foregone through the PAYE reform would return to the government within a year through VAT, excise, PAYE, and other related taxes, with full recovery expected within two to three years due to enhanced economic activity.

Kenyans’ saving behaviour further underscores the potential impact of the stimulus. The national savings rate ranges from 12–16 per cent of GDP, compared with Africa’s 17 per cent and high-growth countries such as Singapore, which save over 40 per cent of income. This means that Kenyans typically spend Sh84 – 88  out of every 100 shillings earned. A PAYE reduction would therefore immediately translate into higher consumption, with rapid circulation in the economy.

Providing a 5 per cent tax cut across PAYE bands should not be viewed as a hit to government revenue. Instead, it would be a strategic, automatic stimulus to economic activity, with direct implications for job creation, livelihood enhancement, and a shift in government revenue sources from income tax to consumption-based taxes.