Taxation and Formalization

1. Taxation and Formalization Richard M. Bird University of Toronto April 2, 2013

2. Tax is usually seen as a barrier to formalizationtry

3. Taxation as Barrier to Formalization • Costs of registration • Costs of compliance • The cost of simply having to pay taxes • The costs of being known to authorities • Obvious - all those other regulations • Hidden - corruption, harrassment

4. Why all these costs? • Some are inevitable e.g. paying some tax but others are unnecessary and arise from such factors as • Unduly complex procedures • Unduly complex design • Inadequate provision of information and assistance to taxpayers • Inadequate training of staff (incompetence, bad attitudes, corruption)

5. Taxation is also sometimes seen as strangling business growth

6. Taxation as Growth-Deterrent? • And so it often does, for the reasons just mentioned e.g. • Poor policy – upper ‘threshold’ of simplified systems • Poor administration – no incentive to know much about those in such systems • Complexity of ‘normal’ system, etc • As well as, of course the reduced availability of internal funding because of taxes + compliance costs

7. Still, better taxation of the informal sector may be the right road for both business and government. Although perhaps the way ahead may seem like a rather dark and narrow tunnel, getting to the other end may be worth the effort

8. For example, taxes may perhaps sometimes stimulate growth • By increasing access to credit markets • By spurring more efficient use of resources (tax pressure) + perhaps access to some incentives (e.g. to reduce costs of investment or employment or exporting etc.) • By improving (one can hope!) accounting and hence business understanding • Though, admittedly, all these are a bit tentative and relatively little explored

9. A clearer case can be made that a broader base for national taxation a more responsible national government • Which is worse? • No taxation, no representation (anarchy or perhaps resource-funded dictatorship) • Taxation without representation (exploitative authoritarianism) • Representation without taxation (irresponsible – often resource-funded – populism or elitism in guise of populism) • Taxation and representation – the two pillars of democracy

10. And an equally strong case can be made for sub-national business taxes • Fiscally, politically, and administratively responsible local government: • Needs to look after own funding to significant extent • To do so, needs access to growing revenues as economy grows • Which will also gives them incentive to encourage such growth rather than regulate and tax it to death

11. Taxation, Business, and Government • Some have suggested a good business tax system might even prove to be an essential key to success for both business and government • For business, a guide and push to enter the modern world • For government, a means and push to do the same • In any case, since taxes are one of the major links between public and private sectors, it is worth a lot of time and effort to get them as ‘right’ as possible. • It’s never easy, anywhere. But we have to keep trying.

12. How to do it…some ideas • Ideas about how best to tax the informal sector still come more from assumptions and anecdotes than on evidence. • Projects in this area should be set up with their contribution to knowledge is not an afterthought but a central goal from the beginning.

13. Keep the key goals in mind • To help, not hamper, taxation’s primary role of raising funds equitably and efficiently – i.e. don’t lose sight of the ball! • To do so by making the best possible use of scarce tax administration resources – there’s not much money at this margin so don’t have unrealistic expectations or devote excessive resources • To encourage the growth of the modern (bookkeeping, known to the authorities, within the system) private sector

14. Some basic tools – all of which need to fit the particular local context • A simple and accessible registration process • Careful design (e.g. minimum/maximum thresholds, rates, scope of taxes covered) • Careful preparation (education, assistance, staff training) • Careful implementation (special unit?, monitoring, periodic evaluation) • Piloting can be both a good way to learn what can be done and a good way to collect some evidence about what should be done more widely • Patience, persistence and a long time horizon – characteristics all too seldom evident in either domestic political or international organization circles