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CAUSES AND FACTORS THAT LEAD TO THE CREATION OF INFORMAL SECTOR IN DEVELOPING ECONOMIES Francis O. Obri Assistant Director of Taxes Federal Inland Revenue Service, Nigeria. PREAMBLE. The key concepts in this topic are: The Informal Sector and Developing Economies. Outline

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  • The key concepts in this topic are:
    • The Informal Sector and
    • Developing Economies.
  • Outline
    • We shall be looking at some definitions of the informal sector and developing economy.
    • The characteristics of the informal sector
    • Causes and factors responsible for the creation of informal sectors
    • Taxation of the informal sector and
    • The way forward

informal sector definitions
  • What is formal or informal is often viewed from the perspective of ‘official’ or ‘unofficial’.
  • “all economic activities in all sectors of the economy that are operated outside the purview of government regulation” (I. Ekpo & O. Umoh).
  • non-structured sector that has emerged in the urban centres as a result of the inability of the modern sector to absorb new entrants (UNDP).

  • IS was first used by Hart in 1970 to describe “the multitude of often temporary economic strategies adopted by migrant workers in Ghana in the face of a marginal job market which, in the aggregate, responded to real social needs” (Cross).
  • However, IS was elevated to the international spectrum in 1972 by the ILO in its Kenya Mission Report (World Bank).
  • The phenomenon was initially seen as a survival strategy arising from undercapitalisation and lack of skills, it has now become a permanent feature.

origin cont
Origin (cont.)
  • It is particularly more pronounced in the developing nations because the modern sector has not had the capacity to absorb all the new entrants to the labour market.
  • It serves as an alternative to the high rate of unemployment in the formal sector.
  • In Nigeria for instance, it is estimated that as much as 70 percent of the nation’s economic activities and 60 percent of the country’s employment are in the IS.

developing economy in perspective
Developing Economy – In Perspective
  • A developing economy refers to an economy that is not industrialized.
  • It depends on importation for most of its needs.
  • Other characteristics include –
    • low per-capita income
    • low standard of living
    • low level of technology
    • inadequacy of experts in various and essential fields
    • dependence on a few sources for foreign earnings
    • The economy is primarily subsistence

characteristics of the informal sector
  • Building a business around an individual, often resulting in succession management.
  • The use of family and unpaid labour and common reliance on manual labour rather than on sophisticated machinery and equipment
  • Limited capital availability, injection or accumulation.
  • Flexibility, allowing people to enter and exit economic activities in response to market demand
  • High reliance on simple and indigenous facilities as well as ability to improvise.
  • A willingness to operate business at times and locations convenient to customers, and
  • A tendency to locate smaller markets, out of the reach of the larger firms.

causes of the is
  • Excessive Regulatory System
  • High cost of entry into the formal sector
  • Bureaucracy and Corruption
  • High level of unemployment
  • Culture of self-reliance or Entrepreneurship
  • Low literacy level
  • Low income levels in the public sector
  • Poor infrastructural facilities
  • Dependence on natural resources

is taxation problems
IS & Taxation: Problems

1. Poor record keeping culture.

  • high level of illiteracy
  • minimal record-keeping
  • at best, haphazard or incomplete records are maintained
  • different records for different purposes
    • one set of records may be to enhance the ability to obtain loans from banks while another may be kept for tax purposes.

is taxation problem 2
IS & Taxation: Problem (2)

2. Lack of clear cut distinction between ownership and business Capital.

  • non-separation of business capital from personal funds
  • thus difficulty in ascertainment of business profit for tax purposes
  • One way of tackling such cases is through the determination of increase in network of the business
  • techniques such as ensuring that only expenses “wholly, reasonably, exclusively and necessarily” incurred for the business are allowed for tax purposes.

is taxation problem 3
IS & Taxation: Problem (3)
  • Lack of communication between government and the business sector
    • key players in the IS lack faith in government polices and programmes
    • may be due to a misunderstanding of programmes
    • but is often because of absence of adequate communication between the government and the participants in the sector
    • creates apathy towards government and its programmes
    • resulting in the declaration of false incomes and consequent loss in taxes.

is taxation problem 4
IS & Taxation: Problem (4)
  • Lack of incentives/support by government
    • Governments’ lack of regard t for the critical role that the IS in their economies
    • Consequently, no training programmes in entrepreneurship, access to cheap funds
    • tax incentives are therefore lacking.
    • In Nigeria NEEDS/SEEDS - programmes have aspects aimed at improving on the productive potentials i.e. employment and income generation capacity of the IS.

is taxation problem 4 cont
IS & Taxation: Problem (4) cont.
  • Some other interventionist schemes include –
    • skills acquisition programs to train and improve on skills and technology
    • Poorer groups encouraged to form Cooperatives Societies and Trade Unions to enable them obtain credit facilities from banks
    • It is also hoped that recognizing and relating with the Unions will enable the tax authorities access requisite information from their membership registers and other documentation.

is taxation problem 5
IS & Taxation: Problem (5)
  • Provision of infrastructure for production of goods and services
    • The poor state of basic infrastructure in developing economies is common.
      • Entrepreneurs provide these amenities
      • find it difficult to recognize the existence of government, or
      • the reciprocal responsibility of voluntary tax compliance.
    • Common for a greater part of business profit to be spent in provision of basic amenities (responsibility of Government)
    • The Nigerian Tax system addresses this phenomenon by providing for Rural Investment Allowance –
    • A Company sited at least 20km away from the provision of electricity, portable water, tarred roads or telephony and has to provide same for the purpose of its trade can claim in addition to the normal allowance on capital expenditure –
      • Telephone: 5% of Capital expenditure on assets in use
      • Tarred Road: 15% of Capital expenditure on assets in use
      • Water: 30% of Capital expenditure on assets in use
      • Electricity: 50% of Capital expenditure on assets in use
      • No facility at all: 100% of Expenditure allowances on assets in use

way forward
  • Substantial migration from the IS to the formal sector can be achieved by encouraging the creation of the following –
    • Partnership
    • Mergers and Acquisition
    • Limited liability companies
    • Government corporation
    • Trade Association
    • Unit Trust

way forward cont
  • Insistence on maintenance of accounts in specified forms
  • Pragmatic programmes towards enlightenment in the sector.
  • Use of field officers on a continuous basis to gather information on the tax payers.
  • Inter-agency exchange of information.

way forward cont18
  • Re-invigoration of tax enforcement procedures.
  • Unique identification numbering system for each tax payer such that once in the system, it becomes difficult to loose track of the tax payer.
  • Insistence on Tax Compliance Certificate as condition for dealing with major institutions

summary and conclusions
  • The presence of large informal sectors in all economic activities is one of the most important characteristics of developing countries.
  • Government must be dynamic, responsive and willing to create the enabling environment for the migration of actors in the IS to the formal sector.
  • Beyond legislations and enforcement machineries, a sincere approach to the problem in developing economies lies with good governance.
  • Until entrepreneurs are encouraged to have a sense of belonging and are adequately considered in policy formulation, the solution would continue to be in the imagination than real.

Thank you