Taxing the Informal Sector Katherine Baer Fiscal Affairs Department International Monetary Fund.

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