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“The Nexus of Informality and Tax Policy” – Options for the Taxation of Small Enterprises in Africa. Michael Engelschalk and Jan Loeprick. Taxing SMEs properly is vital to growth. Traditional focus of taxation: raising revenue

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the nexus of informality and tax policy options for the taxation of small enterprises in africa

“The Nexus of Informality and Tax Policy”– Options for the Taxation of Small Enterprises in Africa

Michael Engelschalk and Jan Loeprick

taxing smes properly is vital to growth
Taxing SMEs properly is vital to growth
  • Traditional focus of taxation: raising revenue
    • Cost of administering small taxpayers outweighs short term revenues raised…► Small taxpayers neglected
  • But, taxation of small firms is critical bc of:
    • Long term revenue increase from wider tax base
    • Growth potential of small firms (effects of formalization)
    • Political economy implications (fiscal social contract)

The economic and social costs of informality need to be included (+ administrative costs can be reduced…)

1 by asking smes we learned that
1. By asking SMEs, we learned that:

FIAS surveys on barriers to formality and tax compliance cost

  • Firms are well aware of the benefits and disadvantages of operating (in-)formally
  • Tax (rates+admin) is seen as a driver of informality
  • There are significant direct and indirect costs stemming from tax avoidance
  • Other dimensions of formality are important and linked to tax formality decision
  • Fees, licenses and other nuisance taxes are a non-negligible burden, especially for small firms
  • Many firms have tried and failed to formalize: Information can go a long way…

→ There is a significant potential for voluntary formalization!

slide4

Cost to prepare tax returns in South Africa (Rand per year)

Source: FIAS Tax Compliance Cost Survey South Africa, 2007

regressive compliance cost
Regressive Compliance Cost

Firms registered for VAT

Firms not registered for VAT

Source: FIAS Tax Compliance Cost Survey South Africa, 2007

informality comes with significant costs for many firms
Informality comes with significant costs for many firms
  • Percentage of informal Yemeni businesses facing costs to avoid tax payments/ remain informal

Source: FIAS Tax Compliance Cost Survey in Yemen, 2008

what everybody agrees on general guidelines for msme tax design
What everybody agrees on: General guidelines for MSME tax design
  • For small firms, system has to be easy to comply with
  • For the authorities, the system must not require excessive administration
  • Tax system has to encourage growth of business (advantages to graduation)
  • Special regimes need to include safeguards against abuses
  • Need to distinguish firms which have a lot to gain from becoming formal from subsistence activities (SMEs? – Micro vs. Small vs. Medium)
it s a balancing act

1. Simplification of gen. regime

2. Special regimes

- Simplification of tax forms, filing and payment process, alignment of payments

- Reduced direct tax rates

- VAT simplification for SMEs

a. Presumptive tax to replace income tax (+VAT)

b. Single (presumptive) tax replacing all other taxes

1. Turnover based

2. Indicator based

3. Combined turnover and indicator based tax

4. Net cash flow scheme

It’s a balancing act…
  • What is “small”? No universal definition
  • How should the system be designed to avoid both over- and under-taxation of MSMEs?
  • What kind of safeguards are required to avoid abuse of system by larger businesses?
  • How to align the MSME regime with the standard tax regime?
  • System must be perceived as fair and transparent
  • How to provide incentives for keeping proper books and records?
  • What assistance to MSMEs is required to facilitate voluntary compliance with the regime?
  • How to reduce the administrative burden for the tax administration?
a lot can be learned by sharing experience
…a lot can be learned by sharing experience!
  • Some examples:
    • A single tax replacing local fees+levies (Algeria/ Benin)
    • Rental value of business premises as tax base for a presumptive regime (Benin)
    • Treatment of corporate and unincorporated businesses
    • Uniform or multiple turnover rates? (for example in Rwanda and Tanzania)
    • Drawing a line between Micro and Small firms
    • Introducing dedicated small taxpayer offices and services (Algeria)
other tax policy options for discussion in the coming days
Other Tax Policy options for discussion in the coming days
  • Simplified calculation of net business profit (cash accounting)
  • Reduced tax rates to compensate for higher compliance costs
  • Tax amnesty to facilitate migration of informal businesses into formal economy?
  • Disaggregate MSMEs and setting adequate thresholds between micro, small, medium
  • Determining profit margins and setting appropriate rates
  • Building-in linkages between taxation, licensing and business registration fees
  • Linking costs and benefits of formalization — offering carrots
  • Integrating small firms into the reform process!
and on tax administration
…and on Tax Administration
  • Establishment of a dedicated administrative structure for SME taxation (more than just an organizational change!)
  • Specialized SME service and information program supporting self-assessment of SME tax
  • Risk based SME audit program
  • Enforcement measures specifically targeted at SMEs (e.g. temporary closure of business)
  • Cooperation with small business associations
  • Withholding schemes