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Taxation and Formalization

This discussion explores the dual nature of taxation in relation to business formalization and growth. It highlights how taxation can act as a barrier through costs of compliance, registration, and visibility to authorities, while also examining potential benefits such as increased access to credit markets and improved resource efficiency. A balanced view on taxation encourages the need for better systems that support businesses rather than hinder them. Key insights focus on finding ways to make tax systems more equitable and efficient for fostering a thriving private sector.

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Taxation and Formalization

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  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

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