Direct taxes — income, corporate, capital

Direct taxes are levied on income, profits, or wealth — paid directly to the tax authority by the person or entity whose income is being taxed. They contrast with indirect taxes (VAT, excise, customs) which are paid via the seller. Direct taxes are the workhorses of redistribution because the base — income — is the variable we usually want to redistribute on.

Personal income tax (PAYE)

Personal income tax in most modern systems is a progressive marginal-rate schedule applied to taxable income — gross income less allowable deductions (personal relief, pension contributions, insurance premiums, mortgage interest). Kenya's 2025 PAYE schedule:

Annual taxable income (KES)        Marginal rate
0 – 288,000                           10%
288,001 – 388,000                     25%
388,001 – 6,000,000                   30%
6,000,001 – 9,600,000                 32.5%
Over 9,600,000                        35%

Personal relief: KES 28,800/year (a flat tax credit that effectively
zero-rates the first KES 288,000 for everyone).

Marginal vs average tax rate

A common confusion: 'I'm in the 30% bracket so I pay 30% of my income in tax.' Wrong. The marginal rate applies only to income above the bracket threshold. The average tax rate — total tax paid divided by total income — is always lower than the top marginal rate (unless your entire income is in the highest bracket).

Example: Kenya PAYE on KES 1,200,000 gross / KES 1,100,000 taxable (after relief etc.)

• 10% on first 288,000      = 28,800
• 25% on next 100,000       = 25,000  (288,001 to 388,000)
• 30% on next 712,000       = 213,600 (388,001 to 1,100,000)
• Total tax                 = 267,400

Marginal rate at this income = 30%
Average rate                 = 267,400 / 1,200,000 = 22.3%

Corporate income tax (CIT)

Corporate income tax is levied on corporate profits — revenue less allowable expenses, interest, depreciation, and prior-year loss carryforwards. The Kenya CIT rate is 30% for resident companies; 37.5% for branches of non-resident companies. Most African economies sit in the 25-35% range, broadly aligned with the global mean.

• Base — taxable profit, NOT revenue. The deductions allowed (depreciation rates, interest deduction limits, R&D credits) shape the effective tax rate significantly
• Effective tax rate vs statutory rate — the rate companies actually pay is usually lower than the headline statutory rate, sometimes by 5-10 percentage points, because of legal deductions, credits, and (for multinationals) profit shifting
• Double taxation — corporate profits are taxed once at the corporate level (CIT) and again when distributed as dividends (withholding tax). Many systems offer partial credit (imputation systems, qualified dividend rates) to mitigate this. Kenya: 5% withholding on resident dividends, 15% on non-resident

Base erosion and profit shifting (BEPS)

Multinational corporations have strong incentives to shift reported profits to low-tax jurisdictions and report losses or low margins in high-tax jurisdictions. Mechanisms:

• Transfer mispricing — Kenyan subsidiary buys inputs from a Mauritius parent at inflated prices, reducing Kenyan profit and inflating Mauritius profit (Mauritius has historically had low effective rates on foreign-source income)
• Interest stripping — high-debt low-equity capitalisation, with interest paid to a foreign affiliate. Interest is deductible in the high-tax jurisdiction, reducing the tax base; the interest income lands in the low-tax jurisdiction. Most BEPS-compliant economies now cap deductible interest at 30% of EBITDA
• Treaty shopping — routing investment through a third country with a favourable double-tax treaty. Kenya-Mauritius treaty disputes have featured here; the treaty was renegotiated in 2019 to limit shopping
• Intangible-asset placement — locating patents, brand IP, and customer-data in low-tax jurisdictions, then charging royalties to operating subsidiaries in higher-tax countries

Capital gains tax (CGT)

Capital gains — the difference between sale price and acquisition cost for an asset — are taxed in most modern systems. Kenya CGT was 5% from 2015-2022, raised to 15% in the 2022 Finance Act. The rate sits well below the top PAYE marginal rate (35%), which creates the classic distortion: high earners can shift labour income into capital income (through founder shares, carried interest, performance-based equity grants) and pay 15% instead of 35%. This is the policy debate behind US 'carried interest' and 'Buffett rule' arguments, replayed in African contexts.

Evaluating progressivity: Kakwani and Suits indices

Two standard measures of how progressive a tax system is, using the Lorenz/Gini framework:

• Kakwani index = Concentration coefficient of tax payments − Gini of pre-tax income. Positive values indicate progressivity; negative regressivity. Bounded between -2 and +1
• Suits index = a related construct based on a Lorenz curve of tax shares against income shares. Bounded between -1 and +1

For Kenya (KIPPRA estimates 2020): the income-tax system Kakwani index is approximately +0.21 (progressive); the VAT system is approximately -0.05 (mildly regressive in budget-share terms); the overall tax system is mildly progressive at around +0.06 once all taxes are combined and weighted by revenue share.