Kenya’s labour market is showing worrying signs of strain with data indicating that pay as you earn (PAYE) taxes grew at the slowest pace since COVID pandemic by 1.1% to KES 560.5 bn in June 2025 from KES 554.7 bn in June 2024. Despite this growth, this reflects a sharp reversal from the double-digit expansion over recent years and reflects the weak expansion posted in the pandemic period when there were mass layoffs and pay cuts. At the same time, employers are increasingly favouring casual and short-term contracts over permanent hires, a strategy that reduces tax obligations but erodes worker stability. This trend threatens long-term economic growth by shrinking the formal tax base, reducing pension contributions, and creating a workforce with little job security or upward mobility.
The root cause of this problem lies in Kenya’s high cost of formal employment. Between statutory deductions, employer contributions, and compliance costs, adding a new permanent staff member has become an expensive gamble, especially in an economy grappling with currency depreciation, high energy prices, and tight credit conditions. For small and medium-sized enterprises (SMEs), which account for over 80% of Kenya’s jobs, the payroll tax structure is particularly burdensome. As a result, companies are turning to flexible labour arrangements, leaving many workers without benefits or career growth prospects.
On the other hand, the costs of informality are severe. A workforce that relies on casual contracts is harder to train and retain, lowering productivity and innovation in the long run. The government also loses valuable tax revenue, forcing heavier reliance on indirect taxation, which disproportionately affects low-income households. To reverse this, Kenya needs to implement strategies which will help in fostering formal job creation without compromising revenue needs. First, introducing incentives on payroll taxes. Businesses that create opportunities for groups such as the youth may be awarded incentives. For instance, South Africa’s Employment Tax Incentive, which subsidizes wages for first-time workers, has been successful in lowering unemployment rates while broadening the tax base. Kenya could adopt a similar model, focusing on SMEs and high-employment sectors like manufacturing and agriculture.
Second, linking tax relief to worker training or benefits could ensure that tax breaks create more quality jobs. Employers who offer pension plans, medical insurance, or structured training could qualify for greater deductions, ensuring that reforms drive inclusive growth. Third, simplified tax compliance. Reducing the administrative burden of payroll reporting is critical. A single, streamlined platform that consolidates PAYE, NSSF, and NHIF contributions would cut costs for employers and increase compliance rates.
Kenya has an opportunity to re-imagine its tax and employment system. By shifting incentives from casualization to commitment, the country can create a virtuous cycle of higher productivity, broader tax compliance, and stronger economic resilience. Payroll tax reform is not simply a fiscal adjustment; it is a strategic investment in Kenya’s workforce and future prosperity.
