‘Kinship tax’ puts the brakes on business

Kenyan study measures the impact of helping family

ANALYSIS | MUNIR SQUIRES | Imagine working hard to build your business, only to find that your success brings about a wave of requests for help that you can’t turn down. This is a reality for many in African communities, where sharing income is a deeply rooted tradition. In fact, 93% of Kenyans I surveyed in a study of entrepreneurs believed that success in business led to financial demands from friends and family.

Research has highlighted that resource sharing within African communities serves as a crucial social safety net. It helps in the pooling of risks for households and in providing partial insurance among members of the same ethnic group, particularly in regions with poor access to formal financial arrangements.

However, this tradition also brings a “kinship tax” – a pressure to share income that can distort economic incentives and hinder investment and productivity.

During my research, I encountered numerous entrepreneurs grappling with this dilemma. For instance, a female clothing vendor from Nairobi told me:

I sell second-hand clothes without anyone knowing, far from home. I hide from my friends because I believe not all friends will be happy with my success, and from family to create a picture that I have no money, for them to work hard for their own money. My previous business, a street-side restaurant, failed due to my in-laws using me for money, yet I wanted to expand it.

Her experience shows how far some entrepreneurs go to avoid financial pressures from their social circles.

My research as a development economist focuses on the economic impacts of kinship and associated cultural practices. To understand the impact of kinship taxation on entrepreneurs, I recently studied the strong pressure to share income faced by residents of Kenya’s Garissa County. I found that kinship taxation reduced productivity among the firms I studied by one-quarter. This was primarily because the most productive entrepreneurs faced the highest kinship tax rates. My study revealed that a third of entrepreneurs faced pressure to share income, which hindered their business expansion efforts.

This was the first study to use a direct measure of kinship taxation to study its effect on investment incentives for firm owners. A related 2021 study found that the pressure to share income reduced the work effort of factory workers in Côte d’Ivoire.

Studying economic decisions

Participants included 361 entrepreneurs from 20 villages in Garissa County, Kenya. They were selected from a larger pool of participants in a randomised cash transfer experiment aimed at increasing primary school enrolment. Since they owned small businesses, they were ideal subjects to study the impact of kinship taxation on investment decisions.

The paper showed how much each entrepreneur’s economic decisions were distorted by kinship taxation. This was done by asking entrepreneurs how much they would pay to keep some money secret from their family and friends. By putting real money on the line, the experiment distinguished between obligatory sharing and voluntary gifts or altruism, providing a clear picture of the economic impact of these social obligations on people’s investment decisions. About one in six entrepreneurs were willing to pay as much as 70% of their earnings to keep them secret, indicating significant pressure to share income.

The paper also examined how kinship taxation affected entrepreneurs’ investment in their firms. When entrepreneurs who faced kinship tax received large amounts of cash, they chose not to invest in their businesses, to avoid having to share more with their relatives. This was especially true for highly productive entrepreneurs who would otherwise benefit the most from investing in their businesses.

The study revealed that kinship taxation significantly reduced investment and productivity. Many entrepreneurs, especially the most productive, kept their businesses small to stay under the radar, fearing financial demands.

The cost of kinship

The experiment revealed that a third of entrepreneurs were willing to pay to hide income, which is what I use to measure kinship taxation.

Those with the highest entrepreneurial ability, estimated using education and cognitive ability, had the highest kinship tax rates. This was especially striking for male entrepreneurs. They were three times more likely to be heavily taxed by kinship obligations as they went from low to high entrepreneurial ability.

I found that when entrepreneurs received large sums of cash, those who weren’t heavily taxed by family obligations invested this extra money into their businesses. Those under heavy kinship tax pressure did not increase their business capital, even though they were among the most productive and would benefit from more investment. This effect was observed primarily among men. Women generally did not invest in their businesses, regardless of kinship tax pressure.

Social support and financial assistance

These findings highlight the economic cost of kinship taxation, which diverts resources from the most capable entrepreneurs, stifling overall productivity. Addressing this issue requires policy interventions that provide alternative social support systems and financial assistance, reducing the reliance on informal income sharing.

Kinship taxation may pose a significant barrier to investment and productivity in developing economies. Policies that provide formal financial support and insurance might empower entrepreneurs to invest more freely and improve their business outcomes.

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Munir Squires is the Assistant Professor, Vancouver School of Economics, University of British Columbia