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Taxing the Informal Sector
Katherine Baer
Fiscal Affairs Department
International Monetary Fund
Profile of a taxpayer in the informal sector
Owners often lack business skills and knowledge of tax obligations
Often do not register for tax purposes Often have poor record keeping and
systems Easily fall into debt and return filing
problems Often cash based and prone to evasion
Some of the costs of informality Lack of access to licenses/permits that may facilitate
business activity, lack of access to bank credit Dispersion of business activity No possibility of carrying out publicity Required to pay bribes to corrupt officials to avoid penalties
and sanctions Cannot sell to formal sector, or deduct tax paid on inputs
purchased from formal sector Barriers to growth of the business
Result: affects overall productivity…..
Other costs
Prevents government from obtaining revenue needed to satisfy budgetary needs
Increased tax burden for other taxpayers May inhibit growth of small business
sector, employment in that sector
Aspects of tax system that can discourage small businesses from joining formal
economy
High tax rates Complex tax system Overly complex procedures (high
compliance costs) Dicretionary application of tax laws (audit) Low risk of being detected
How to promote formality? Simplify tax system and modernize
administrative procedures Differentiate taxpayer universe by segments
that reflect different risks to revenue, and design a strategy that targets each group according to their service needs (large, medium and small taxpayers)
Build competence in the tax system with training and strong HR systems
Improve integrity of the tax system
Basic steps to improving the tax compliance of small taxpayers
Ensure proper registration of small taxpayers
Use basic cross-checking to locate small businesses
The main characteristics of the small taxpayers and implications
for tax administration
Highest % of taxpayers, lowest % of revenue Lack of knowledge about tax obligations Tax administration needs a simple regime, or else:
– Tax administration will be unable to pay sufficient attention to large and medium taxpayers
Structure of Tax Collection: 2000(excludes tax collected through customs)
Type of taxpayer Argentina Peru LargeTaxpayers (%) 0.04 0.12Tax collection (%) 50.90 65.97
Medium size Taxpayers (%) 4.35 0.81Tax collection (%) 33.60 18.85
Small Taxpayers (%) 95.62 99.07Tax collection (%) 15.40 15.18
Concentration of tax collection in selected countries: 1999
Country Medium/small % of total % of revenuetaxpayers
Argentina 3,657,670 99.9 50.9Benin 99,288 98.5 8.0Bulgaria 841,158 99.9 48.6Ecuador 776,100 99.5 20.7Hungary 1,229,631 99.9 57.9Kenya 59,400 99.6 39.0Mexico 7,279,412 99.8 14.9Peru 242,550 99.1 35.1Philippines 415,667 99.8 64.0
Need realistic goals in setting up simplified regime
Identify main sources of underground activity and incorporate them into the tax system
Be sufficiently dissuasive without incurring too many costs
Motivate registered taxpayers to comply Dissuade taxpayers who do not belong in
regime from registering as small taxpayers Reduce costs of administration
Simplified Tax Regimes: Options
Single tax or special regimes for existing taxes
Voluntary or obligatory Minimum fees which are easily payable Can have additional requirements such as:
simplified book-keeping or return filing requirements
Simplified regimes should define:
Type of taxpayer that can join Thresholds, excluded activities Taxes covered by simplified regime Methods of joining, classification and re-
classification Administrative requirements: book-keeping,
filing, payment, penalties for noncompliance
Reasons for using presumptive methods for taxing small
businesses:
Because it may be the only way to tax small businesses
Because it is a way to overcome tax administration weaknesses
Because of administrative ease for tax administration and taxpayer
There are several ways in which presumptive taxation may be levied
Estimate of taxpayer income Use of of taxpayer’s assets to estimate
profits Use of gross receipts Use of external indicators of income Best to use systems that are based on fact,
not judgement, using little tax administration effort for assessment
If information on turnover is not available, the tax administration
must devise methods to determine it
In manufacturing--purchases In restaurants, theaters, and barber shops--
number of tables, seats, and employees In transportation--amount of cargo space
Argentina: Monotributo Natural persons, sole proprietors,
professionals Turnover, energy consumption, area of
business activity, etc. Substitutes: Income tax, VAT, SS Voluntary registration Purchase and sales invoices required, but no
VAT credit granted No accounting requirements, no returns,
includes pension and medical benefits.
Bolivia: RTS, STI, RAU
Natural persons and sole proprietors Varies by regime: activity, assets, annual
turnover, area of business activity, etc. Replaces CIT, VAT, PIT and transactions tax Voluntary registration Purchase invoices required, no sales invoices No formal book-keeping requirements
Peru: RUSNatural persons and sole proprietorsGross income, one establishment, number of
workers, area of business activityReplaces: Income tax and VATVoluntary registrationPurchase and sales invoices required, but no
VAT credit grantedNo return filing, monthly payments, no book-
keeping requirements
Accounting basis and tax invoices
Make a cash accounting basis available for smaller taxpayers to simplify record keeping
Require/encourage taxpayers to keep income and expenditure cashbooks
Emphasize that claims for VAT paid can only be made if a tax invoice is held
Provide simplified tax invoices for small value transactions
Return filing and payment
Some return filing should be requiredPayment in single installmentsForm of payment: with payment form
to the bank, automatic bank debit, electronic funds transfer, etc.
Payment periodicity varies: monthly, bi-monthly, quarterly, annually
Importance of taxpayer education
Prepare clear explanatory material that tells taxpayers what they have to do, when they have to do it, and how to do it.
Use simple language in explanatory material Establish a Taxpayer Services counter in all
tax offices to answer questions from taxpayers
Conduct seminars and advisory visits for new taxpayers.
Compliance control
Should be systematic and timely
Based on presumptive methods to categorize taxpayers or remove from simplified regime
Permanent audit program required to ensure large and medium size taxpayers are not hiding in this regime
Penalties for noncompliance…
Sufficiently high
Objective
Easily and immediately applicable
In order to encourage voluntary compiance…
Type of penalties applied
Temporary closure of business
Seizure of goods