The National Treasury should not succumb to pressure to increase Value Added Tax (VAT) beyond the current 16 per cent rate, the Kenya Institute for Public Policy Research and Analysis (KIPPRA) has cautioned.
A new research warns that any further hike could end up eroding rather than increasing government revenue.
KIPPRA says Kenya is already operating close to the revenue-maximising VAT rate, meaning higher taxes risk depressing consumption, encouraging tax evasion and weakening compliance instead of boosting collections.
The findings come as the government continues to grapple with widening fiscal deficits and mounting pressure to mobilise more domestic revenue while easing additional borrowing.
Using data covering the period between 1990 and 2023, KIPPRA estimated that while the theoretical optimal VAT rate in a perfect economy would be 10.25 per cent, Kenya’s economic realities, including GDP growth, tax administration and technological improvements, push the optimal revenue-generating rate to about 16.3 per cent.
That leaves the current 16 per cent VAT rate almost exactly at the point where revenue collection is maximised.
“Kenya’s current VAT rate of 16 per cent falls within this range, suggesting it may be approaching the prohibitive threshold where further increases could reduce revenue,” the report says.
The paper challenges the long-held assumption that increasing tax rates automatically translates into higher government revenue.
Instead, it argues that VAT follows the so-called Laffer Curve, where tax collections initially rise as rates increase but eventually begin to decline once taxation becomes excessive because consumers cut spending, businesses under-report sales or shift into the informal economy.
KIPPRA’s simulation found that once VAT rises beyond 16.3 per cent, revenue elasticity turns negative as higher tax rates discourage economic activity, reduce compliance and increase incentives for tax avoidance.
The country has undertaken numerous VAT reforms over the past three decades, including changes in tax rates, expansion of the tax base and adoption of digital tax administration systems such as Electronic Tax Registers (ETR), iTax and the Electronic Tax Invoice Management System (eTIMS).
Despite those reforms, VAT performance has weakened relative to total tax collections.
According to the study, VAT accounted for an average of 45 per cent of total tax revenue during the 1990s but that share has steadily declined to about 26 per cent in recent years as exemptions and zero-rated products narrowed the tax base.
The report argues that Treasury’s focus should now shift from raising tax rates to improving efficiency within the tax system.
Instead of increasing VAT, policymakers should broaden the tax base by reducing exemptions, formalising more businesses operating in the informal economy and strengthening tax compliance through technology and enforcement.
The researchers also recommend rationalising tax incentives to ensure they stimulate investment without unnecessarily eroding the VAT base.
“Policymakers can focus on addressing inefficiencies in VAT administration, enhancing compliance and leveraging technology to increase VAT’s share of total revenue,” the report says.
The study identifies digital tax administration as one of the strongest contributors to improved VAT performance.
Its econometric analysis found that technology-driven reforms—including ETR, iTax and eTIMS, have had statistically significant positive effects on VAT collections by improving transaction reporting, reducing fraud and enhancing compliance.
The findings suggest that investments in tax technology may generate stronger revenue gains than further increases in statutory tax rates.
KIPPRA also cautions that Kenya continues to lose considerable revenue through a large informal economy and extensive VAT exemptions.
The study notes that while economic output has continued to expand, growth has not translated proportionately into VAT collections, pointing to persistent leakages within the tax system.
It argues that reducing exemptions and bringing more businesses into the formal economy would expand the tax base without imposing additional tax burdens on compliant taxpayers.
The report further shows Kenya’s VAT rate is broadly in line with regional peers, but its efficiency still trails some neighbouring countries.
While VAT contributes about 23.6 per cent of Kenya’s total tax revenue, the share is higher in Rwanda and Uganda, suggesting there remains room to improve compliance and tax administration rather than increasing rates.
