According to the ILO, the informal economy accounts for nearly 86% of all employment in Africa and over 89% in sub-Saharan Africa (SSA) specifically. SSA is predicted have a greater population increase than the rest of the world combined, with an additional 100 million 15-to-64 year-olds by 2035, account for an even greater share of Africa’s employed. The working population in SSA will reach 1.5 billion by 2050 and past trends indicate that a vast majority will be informally employed.
Despite being the major source of employment in Africa, it has been an extremely daunting task for governments to effectively quantify the ‘invisible’ economy of the informal sector. This has resulted in blind regulatory and taxation policy frameworks that have benefitted neither strategic economic development nor efficient revenue collection.
With an informal economy above 40% of GDP on average, SSA governments are under pressure to harness the tax position of their informal sectors to the benefit of their socioeconomic transformation.
Why is it Difficult to Tax the Informal Sector?
Measurement of the shadow economy is notoriously difficult as it requires estimation of economic activity that is, deliberately or inadvertently, hidden from state audits. Operators within the informal sector avoid taxation due to:
Many businesses in the informal sector have limited capacity and desire to keep high-quality financial records. Low education and sophistication levels in the sector compound with disinterest in adopting complex accounting procedures. At the same time, tax authorities lack the ability to accurately monitor informal sector transactions leading to comparatively low levels of revenue collection. 95% of consumer payments in Africa are cash, with businesses having considerable opportunity to report their own figures to the taxman. This means that they have very little motivation to make the effort of fully complying with their tax obligations.
Weak Administrative Structures and Regulatory Frameworks
SSA tax regimes have made little progress and still focusing use outdated means of administration. Governments are face challenges such as a lack of manpower to effectively enforce taxation within a highly populated sector. Even after identifying potential taxpayers, these outdated processes lead to inaccurate income estimation and under-collection. These outdated approaches cause high costs for tax administration relative to the additional revenues collected from the informal sector. Low awareness of nature of stop-gap presumptive taxes in the informal sector colour tax collectors as illegitimate, further driving down tax morale. This sums up the major drawbacks in governments’ quest to tap into revenue from this sector.
Challenges to the Notion of Equity
The vast majority of informal sector operators have very low incomes with the notion of tax equity creating a strong argument for their near-total exemption from taxation. On the other hand, many informal sector operators have very substantial incomes and should rightly be asked to pay their fair share of taxes. Without accurate records, governments cannot efficiently scrutinise and differentiate the low-income groups to target higher earners. A need for equity in the treatment of low earners sways tax policy towards lower tax burdens to preserve the ability of small earners to do business. Further, a lack of reciprocity from the government in the form of inadequate social protections and low levels of local development introduce feelings of alienation from government spending to the informal sector.
The prevailing tax regimes in SSA are therefore characterised by low tax compliance and morale as well as inefficient tax administration within the informal sector. Harnessing their tax position requires a revision of revenue collection strategies to identify tax bases better and increase compliance on a manifestly equitable basis.
As Fantu Cheru put it, ‘a closer look at the informal sector in Africa provides a glimpse of what could be achieved if Africa’s economies and financial policies were more attuned to the continent’s everyday realities.’ Cheru characterises Africa’s informal sector as being practically a community in resistance against state dominion through Western-derived formal tax regimes. As they hope for the increased formalisation of employment in SSA, governments must introduce flexibility to their revenue collection models to reign in the informal sector.
Road to Transformation: Presumptive Taxes
Many African governments are dedicated to transforming the informal sector. In the Addis Ababa Action Agenda, the international community deliberately laid out the need to invest in efforts to integrate the informal sector into the formal economy in line with country circumstances.
This trajectory supports target 8.3 of the Sustainable Development Goals that stresses the need to ‘encourage the formalisation and growth of micro-, small-and-medium-sized enterprises’ in order to promote sustainable and inclusive economic growth’.
These efforts are evident in different economies in SSA. Whether successful or not, efforts in taxing the informal economy are present and can notably be traced in Ghana, Tanzania, Zambia and Kenya. They are deemed to be at the forefront of transformation in harnessing the potential of the informal economies. The statistical pictures below are afforded by the ILO report on Women and men in the informal economy.
The ILO reports that over 84% of the working population in Ghana is informally employed.
Ghana has had a long history of presumptive taxes. First introduced in 1963, presumptive taxation required all business operators to pay a lump sum tax based on the industry in which they operated.
The Ghanaian Revenue Authority adopted an associational tax model in the 1990s to widen the tax net while avoiding the need to collect industry actors on a door-to-door basis. This was a system of negotiation extending to over 40 sectors between different informal sector associations, such as the Second Hand Clothes Dealers Association or the Second Hand Car Dealers Association and the national government.
These associations were able to negotiate better tax deals for their members, who in turn were more willing to comply. The devolution of tax administration to industry associations allowed for smaller daily or weekly payments which are more favourable to low-income earners than large one-time payments. The associations took a share of collections as administrative fees, but unfortunately became disruptively political and saw considerable corruption.
Continued attempts to bring Ghana’s informal sector into tax compliance led to the introduction of new tax approaches, such as Vehicle Income Taxes on public transport operators and a Tax Stamp system for small-scale retailers. This called for all informal sector operators to purchase a quarterly tax stamp, which was to be displayed on the premises of the business, and the price of which was based on the sector and the observable size of the firm. These innovations resulted in a relatively small increase in taxation revenue.
Trying circumstances saw the government implement a 3% presumptive tax for a defined category of individuals with a turnover of between GHS 20,000 (~USD 400) and GHS 120,000 (~USD 22,000).
The ILO report places Tanzania’s informal employment at 83.5% all employment.
In order to have more taxpayers in the tax net to and optimise tax revenue collection, the Tanzania Revenue Authority (TRA) introduced the Block Management System (BMS) known as the Kariako Ilala Kigogo model (KIK). The basic objective of KIK is to promote compliance and register all eligible small-and-medium-scale enterprises within a particular business, sectoral or geographical area, capturing their correct level of economic activities and gathering valuable tax information
The BMS was not fully operational in various regions in the country. A lack of administrative resources was a huge obstacle to the success of this model. According to a survey carried out by TRA, the Block Management Report 2010 proved that there was a shortage of staff whereby out of 10 staff required to work in a Block, only 2 or only staff were allocated and qualified.
Soon after, Tanzania switched to a progressive turnover tax regime, with a tax rate that has evolved over the years. As it currently stands, the Income Tax Act was amended in 2019 to introduce a hybrid tax regime combining presumptive and progressive taxes. It covers taxpayers with an annual turnover of TZS 4 Million (~USD 2,000) to TZS 100 Million (~USD 45,000) who will not be required to submit financial statements.
The ILO report shows that informal employment in Zambia accounts for 79% of the nation’s total employment.
In an effort to tax this sector, the Zambian Revenue Authority (ZRA) since 2004 has applied a range of informal sector taxes. These include a base tax of ZK 150 (~USD 10) on self-employed people such as marketeers and smallholder farmers whose income could not be estimated, a 3% tax on self-run businesses with a turnover of between ZK 36,000 (~USD 2,500) and ZK 800,000 (~USD 55,000), a tax on minibus and taxi drivers, and an advance income tax on imports by cross-border traders who are not registered with the ZRA. In addition, there are a range of taxes collected by the Lusaka City Council (LCC) and the market cooperatives that allow individuals to trade or run a business in the markets. The scheme raised compliance but collected a relatively small amount of revenue and was mired by logistical and political challenges.
Despite these unsuccessful efforts, Zambia remained committed to the presumptive tax model, with the Zambian National Budget Report of 2019 revising the base tax to 4% tax on turnover for businesses with turnover below K800,000.
In Kenya, the informal sector makes up over 81% of the total working population. The presumptive tax was first introduced in the Kenyan taxation framework in 2007 with a view to tap revenue from the volatile informal sector. However, implementation of this tax phased out due to similar administrative challenges.
Through the enactment of the Finance Act 2019, the government re-introduced the turnover tax to improve compliance among small and micro enterprises. It came into effect on January 1 2020, with the first TOT payments coming due on or before February 20.
The turnover tax is only payable by resident persons whose annual turnover from business does not exceed, or is not expected to exceed, KES 5 million (~USD 50,000). Its aim is to facilitate equity as previously these businesses were subjected to significantly higher tax burdens under the ordinary regime. These micro and small businesses are now required to remit 3% of turnover, paid through the iTax platform which itself decreases administrative costs while affording taxpayers a convenient route to compliance.
Drivers for Compliance: Adjustments Needed for Successful Implementation of Presumption Taxes
During the Addis Ababa Action Agenda, states committed to improving the fairness, transparency, efficiency and effectiveness of their tax systems. This commitment includes broadening their tax base and increasing efforts to include the informal tax base.
A number of key steps towards harnessing the informal sector’s tax position have become apparent in the challenges faced and progress made by SSA tax administration policies. These include:
Decentralisation of the Tax Collection Responsibility
Distribution of responsibility for informal sector taxation from national tax authorities to subnational or sectoral authorities holds considerable promise for cost-effective models of increasing compliance. Authorities with specific and manageable tax jurisdiction have greater flexibility and responsiveness to identify the specific challenges of their tax bases and can tailor their approaches accordingly.
Sensitisation of Taxpayers
Providing education at a local level to create awareness of the tax regime and the importance of it would help promote trust between taxpayers and the government. Compliance remains a largely volitional commitment that hinges on good tax morale. As similarly done in the formal sector, it would now be the responsibility of taxpayers to pay tax on their own rather than placing the burden on public authorities to collect the tax on their own.
Improvement of Collection Capacity
This speaks towards having an optimal number of personnel armed with appropriate training and tools to collect tax in a cost-effective manner from different categories of tax payers. The use of innovative transaction-tracking methods allows for more accurate estimation and mitigate the amount of human effort required to calculate taxes due and monitor compliance.
Adoption of Technological Tools and Digital Assistance
Increasing the use of technologies that assist taxpayers to pay their dues can greatly simplify tax administration and collection. Digital tax platforms that help actors in the informal sector keep records of taxes due mitigate their capacity challenges. Likewise, facilitating payments through the integration of digital payment systems, and mobile money in particular, would make it easier for taxpayers to make payments. Developing countries can also boost the efficiency of their tax administration through the use of e-taxation.
Differentiating Policies for Specific Groups of Workers and Economic Units
This helps ensure that the taxation of the informal sector distinguishes clearly between those who are earning too little to meet the required threshold and bigger earners who hide behind the informal economy designation to evade taxes. This scheme could also be leveraged to incentivise the latter category to graduate into the formal economy.
Applying Presumptive Taxes Progressively
This would require levying proportionately higher charges on larger businesses in the informal sector while having thresholds below which informal workers and businesses are subjected to more favourable taxes or none at all. This requires tax collectors to maintain better oversight of the informal sector and to mitigate multiple taxation, but it affords the benefit of improved equity and tax morale.
There is a need to improve the information that taxpayers have about the burdens they are expected to pay, the purpose and structure of informal taxes, and how their taxes are collected. Tax literacy is itself aided by purposive improvements in government spending towards initiatives whose benefits are manifest to the taxpayers. Taxpayers can help themselves by staying informed, and governments can collaborate to this end by making their expenditures easier for the common taxpayer to understand.
Implementing Policies that Formalise Transactions
Legislation can be leveraged to incentivise the formalisation of transaction records across both formal and informal sectors. Requiring firms to do business with tax registered entities and adopt trackable double-entry bookkeeping models forces informal sector actors to register at least part of the operations.