How bid to formalise small businesses is doing more harm than good

Small business owners navigate the challenges of operating in Kenya’s informal economy. [File Courtesy]

Perhaps there is no language the government has not spoken to endear itself to small business owners.

If it is about translation, through its various agencies, the government has made efforts to explain its intentions to them, all in an effort to bring them into the tax bracket.

Like a suitor wooing a lover, there are times the government’s words fall on deaf ears, or are disregarded as lies, but there are incidents where they fulfil the mission.

But while the government says ‘they cannot sleep or eat’ without this lover in their bosom, Prof Hiroyuki Hino from Duke University argues that small businesses should, at the least, be left alone.

And the government should stop trying too hard to have them on the Kenya Revenue Authority (KRA) radar.

This is the argument Hino presented during the Beyond 2030 national conversation launch. He even referred to a study he published in 2024, together with two other colleagues, that supports his argument.

His understanding is that it is the informal nature of informal business that makes them thrive. Yet the government’s strategy has been strong-arming or hoodwinking them to be formalised.

Once formalised, they appear on the radar of the taxman, who will monitor their movement and demand the pound of flesh owed to them.

Hino said the government ought to embrace informal enterprises rather than dismissing them.

“The study shows that informal enterprises can grow faster, especially when owners’ informal characteristics are combined with the informal ways of doing business,” he said.

One of the strategies the government has used to have small businesses formalised is through funding. The argument has been that banks and other financing agencies, cannot extend lending to micro, small and medium enterprises (MSMEs), due to their informal nature.

Such arguments have given rise to products, among them the Credit Guarantee Scheme (CGS) managed by the government. Other more customised products, such as the ongoing World Bank-funded Nyota programme, also indirectly seek to attain some level of informality.

At a recent sit-down between Ecobank and business owners, this issue also came up.

“Some of the problems that make us say you are not bankable are: you have the entire business on your mind. So, how do you convince the bank to give you money if all the information is in your head? As bankers, we cannot read what is in your mind,” said Victor Mbaabu, director of commercial banking at Ecobank Kenya.

Professor Hino said small businesses have their own way of finding finance.

“They do not necessarily need subsidised government loans,” he said, citing microfinance institutions as one of the solutions to this problem.

In Kenya, there are about 7.4 million small businesses according to the Kenya National Bureau of Statistics (KNBS). This figure has, however, been argued to be higher.

The data also shows that MSMEs contribute close to 40 per cent to the country’s gross domestic product (GDP) and over 80 per cent of employment opportunities. These are 14.9 million jobs. For contrast, the formal sector hosts 3.3 million jobs.

The findings of the study being referenced by Hino are published in a paper titled 'Rethinking the Informal Economy in Africa: Findings of a Survey of Microbusinesses in Ghana, Kenya, and Nigeria'.

Considering that revenue is the main reason behind the government’s push to have small businesses formalised, the paper argues that it is incorrect to presume that low-income micro-entrepreneurs do not pay taxes.

It adds that in the three countries combined, nine out of 10 low-income micro-entrepreneurs pay tax in some form and of those who pay, two out of three do so always or usually.

“These ratios are somewhat lower in Nigeria than in Kenya or Ghana,” it says. “It is important to note that taxes paid are predominantly sales tax, while a business permit or levy is paid to tax collectors (and not at government offices).”

The paper was co-authored by Charles Piot, Nobuaki Hamaguchi, Lilly Brouwer and Jiahan Yin.

The paper argues that there should not be a blanket claim of non-registration, saying the picture of compliance with regulatory requirements is mixed.

It says a limited number of low-income micro-entrepreneurs register with federal or central governments.

“Hence the generally held assumption that low-income micro-enterprises are outside

government purview may be correct in so far as the orbit of the central or federal government is concerned,” it says.

Findings from the paper say almost 50 per cent of the self-employed individuals surveyed

are registered with regional or local agencies and about 40 per cent are registered for business licenses, public utilities and tax payments.

“For the three countries as a whole, only about 50 per cent of the micro-entrepreneurs in the survey are not registered with any government agencies,” the paper says.

It further details that government support for low-income business owners is not strong in any of the three countries, as generally assumed in the literature.

In Ghana, it says, only 15 per cent of low-income microenterprises receive support from the state and basically only for utilities and health services.

In Nigeria, about 40 per cent of low-income micro-entrepreneurs receive support from the state, mostly in security and health services, while nearly all of them consider government support not very or not at all helpful.

“However, the government is considered more helpful in Kenya,” it says. “There, 40 per cent receive support from the government for utilities, security and health services, and almost 50 per cent consider the support somewhat or very helpful.”