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How to tax informal sector in an informal way

15th February 2013
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Small scale mining is one of the sectors run informally in Tanzania. Yet if well utilized, can contribute a lot to government revenue and the country’s development. (File photo)

Tanzania  introduced the Tax Modernisation Programme in 1995 with the objective to enhance revenue collection by improving tax administration and reduce taxation costs both in terms of compliance and administration. The Tanzania Revenue Authority (TRA) has really advanced in terms of administration of various taxes. However, their efforts have been hindered by their natural inability to navigate through the informal sector because activities associated with this terrain of life are informal while TRA is formal.

However, economists and tax experts have always confirmed that there is a big room to widen the tax base in the informal sector and therefore improve government revenue performance.

It is unfortunate that the government endeavours to navigate in the informal sector by using formal tools.

Informal sectors are set of economic units which do not comply with legal regulations, yet whose products are considered legal and taken on board in national numbers.

Informal economic activities are mostly unrecorded, with scanty and disorganised information.

The term informality means different things to different people, but almost always relating to bad things; illegal, unprotected, low productivity, evasive to regulation, evasion of the rule of law, etc.

The World Bank acknowledges that there are numerous reasons to care for informal activities, and that, as such, they should not be ignored and be left on their own.

The Director General of the East African Community, customs and trade (Peter Kabuta) had earlier recommended for the need for East African countries to accord the region fast growing informal sector more attention with the view to contributing to the growth and development of the economies of the region.

The headache with many governments for the last two to three decades revolves around structuring an administrative model that can best work or fit in informal sectors.

Taxation is believed to be the most affected and most hit by existence of informal activities.

Informal sector activities in Tanzania include construction, transport, tuition, medical services, recreational halls, animal husbandry, milling business, entertainment and urban agriculture among others.

The founder of the term “informal sector”, a social anthropologist, Keith Hart (1971) insisted from the word go that one should not consider the sector easy.

Since then the term has gained popularity and has received high level attention but fraught with terminological discomfort.

Informal sector has been sometimes linked with bazaar-economy, disorder, black market, and at times, the world turned upside down.

Some economist have labelled it with underground economy, hidden, parallel, black, clandestine, household etc.

Such different definitions simply confirm that the term ‘informal sector’ is all confusion.

Different disciplines (economics, labour, finance, sociology, etc.) also define the term differently. There is therefore no unique and uniform definition of the term, but instead researchers, based on the various criteria, have attempted to define it in accordance with the problem at hand.

Tanzania has a large informal sector compared with the other East African countries. The World Bank Doing Business database ranks the country among the three countries in Africa with the largest such sector, together with Nigeria and Zimbabwe.

Economists suggest that informal sector is here to stay and grow. The Integrated Labour Force Survey, 2000/01 – Analytical Report reveals that 61 percent of the total households in urban areas had informal sector activities (including urban agriculture) in 2000 as compared to 42 percent only in the 1990s.

In the rural areas the informal activities (excluding rural agriculture) had also grown from 21 percent in the 1990s to 27 percent in 2000.

The presence of large informal sector renders it difficult for governments to efficiently work out and programme any development plans.

It is also believed that economies with large informal sectors have lower capital return and growth rates because the contribution of public services to productivity decreases with informality.

Informal sector consume a large share of the public services that are financed by taxes mostly collected or paid by formal activities in the formal sector.

Performance of the government revenue in developing countries as well as other developed countries is therefore directly and seriously affected by the presence of large informal sector in the countries.

My discussions in this issue centers on one of the possible methods to work around the challenges of taxation of the informal sector in Tanzania, a developing country with its own and unique characteristics, and whose definition of informality is specific to itself.

The truth is that informal sector in Tanzania contributes little to the government revenue (or not at all), and it is not easy to work out a taxation model that is suitable for informal activities and/or the informal sector.

All sorts of blames may be wrongly directed towards the Tanzania Revenue Authority (TRA), the institution which is formal in itself, and which requires a formal approach to assess tax.

TRA requires enough information and reliable records, which is not the case with informal activities in the country.

There have been plenty of literature and discussions going around in Tanzania on how to tax the informal sector, and therefore improve the government revenue performance.

Unfortunately most of the discussions turn around and discuss taxation of informal sector by employing formal tactics. Most of the arguments and solutions to taxation of informal sector turn to be only relevant to formal activities.

As mentioned above it may be illogical to show fingers to TRA because TRA is itself formal, with its approach and tools all formal.

The institution is not vested with resources or the right maneuvering tools for informal activities.

Though TRA is vested with the obligation to tax and collect tax from any person who has taxable income, the agency requires well structured records and information to be able to register taxpayers and administer/assess their taxable amounts.

It is important to note also that it is difficult to draw a fine line between formal activities as opposed to the informal activities.

They are sometime intertwined. However, all of us are pretty sure that there is enough tax revenue from the informal sector.

How to go about getting the tax from the informal sector remains to be a headache. Taxation of informal activities has always posed challenges to governments.

Taxation is traditionally built on three pillars, namely tax policy, tax law and tax administration.

However, it is the administration part of it that turns the wheel into money (government revenue) in the bank.  Different tax regimes require different types of administrative arrangements.

For any tax system a decision has to be made as to which agency should be responsible for such tax and what is/are the tax-points (time and place).

While the tax administration will have the main responsibility for the administration and collection of taxes in general, different methods suitable for different taxes might be chosen.

While VAT in Tanzania, for example, is administered and collected through registered traders and the customs offices, corporation tax is administered or assessed directly through the corporate tax offices.

It is the nature of different taxes that calls for such different tax points and tax agents, or in general, tax administrative arrangements.

What is the tax arrangement that can fit well in taxing the informal activities is the point at issue.

I feel comfortable to humbly confirm from my experience that informal activities in Tanzania are numerous, not predictable, full of confusion, with unreliable data and information, not friendly, with no proper hierarchy of responsibility and therefore very rough.

In such situations, where the tax points are not easy, governments around the world have always resorted to administering tax at source.

Taxation at source has always worked well in informal sectors. This is where tax is paid or collected when the payments from certain sources are actually made. Taxation at source is a mode or form of paying tax where and when payments are made. It may be through withholding or remittance.

Withholding tax is when the person making the payment (payer) deducts the amount of tax before passing over the balance to the person receiving the payment (payee). Taxation by remittance is when tax is topped up when making payments for specific goods and services.

The person who pays is required to add a certain percentage for tax. Economists assert that taxation at source makes tax administration more effective, widens the tax base where taxes would otherwise not be collectible and reducing compliance costs.

The agents in taxation at source may be either the sellers (Remittance) or the buyers (WHT). Together with its other advantages, taxation at source has always been the solution of taxation in difficulty or fragile situations like in the informal sectors.

Taxation at source drives its origin from the concept that the entire economics revolves around one principal; “somebody’s income is somebody’s payment”.

Ideally the results from taxing payments should not vary much from taxing incomes. Different countries have employed taxation at source to manage taxation on slippery situations or government feels high risk of losing revenue.

Taxation at source is also asserted to be more economical in some cases. Different countries work out a list of sources of income that have to be taxed at source. The size of the list varies from one country to another.

From the above discussed facts, the government in Tanzania could endeavour to work out and earmark specific payments/transactions to be included in its list of sources of incomes and payments to be taxed at source, either through withholding taxation or through remittance.

The list should be carefully and completely compared and contracted with the spirit of taxation at source to make sure that incomes from informal sectors are captured and therefore taxing the informal sector informally.

The government could work out informal tax points where taxation of the informal sector could informally be administered at source.

Certain tax points can be established and presumptive levels be introduced to tax the informal sector informally.

The idea is to depart from using formal tactics in taxation of informal sector and resort fully taxing the informal activities at any source.

 

Tanzania  introduced the Tax Modernisation Programme in 1995 with the objective to enhance revenue collection by improving tax administration and reduce taxation costs both in terms of compliance and administration. The Tanzania Revenue Authority (TRA) has really advanced in terms of administration of various taxes. However, their efforts have been hindered by their natural inability to navigate through the informal sector because activities associated with this terrain of life are informal while TRA is formal.

However, economists and tax experts have always confirmed that there is a big room to widen the tax base in the informal sector and therefore improve government revenue performance.

It is unfortunate that the government endeavours to navigate in the informal sector by using formal tools.

Informal sectors are set of economic units which do not comply with legal regulations, yet whose products are considered legal and taken on board in national numbers.

Informal economic activities are mostly unrecorded, with scanty and disorganised information.

The term informality means different things to different people, but almost always relating to bad things; illegal, unprotected, low productivity, evasive to regulation, evasion of the rule of law, etc.

The World Bank acknowledges that there are numerous reasons to care for informal activities, and that, as such, they should not be ignored and be left on their own.

The Director General of the East African Community, customs and trade (Peter Kabuta) had earlier recommended for the need for East African countries to accord the region fast growing informal sector more attention with the view to contributing to the growth and development of the economies of the region.

The headache with many governments for the last two to three decades revolves around structuring an administrative model that can best work or fit in informal sectors.

Taxation is believed to be the most affected and most hit by existence of informal activities.

Informal sector activities in Tanzania include construction, transport, tuition, medical services, recreational halls, animal husbandry, milling business, entertainment and urban agriculture among others.

The founder of the term “informal sector”, a social anthropologist, Keith Hart (1971) insisted from the word go that one should not consider the sector easy.

Since then the term has gained popularity and has received high level attention but fraught with terminological discomfort.

Informal sector has been sometimes linked with bazaar-economy, disorder, black market, and at times, the world turned upside down.

Some economist have labelled it with underground economy, hidden, parallel, black, clandestine, household etc.

Such different definitions simply confirm that the term ‘informal sector’ is all confusion.

Different disciplines (economics, labour, finance, sociology, etc.) also define the term differently. There is therefore no unique and uniform definition of the term, but instead researchers, based on the various criteria, have attempted to define it in accordance with the problem at hand.

Tanzania has a large informal sector compared with the other East African countries. The World Bank Doing Business database ranks the country among the three countries in Africa with the largest such sector, together with Nigeria and Zimbabwe.

Economists suggest that informal sector is here to stay and grow. The Integrated Labour Force Survey, 2000/01 – Analytical Report reveals that 61 percent of the total households in urban areas had informal sector activities (including urban agriculture) in 2000 as compared to 42 percent only in the 1990s.

In the rural areas the informal activities (excluding rural agriculture) had also grown from 21 percent in the 1990s to 27 percent in 2000.

The presence of large informal sector renders it difficult for governments to efficiently work out and programme any development plans.

It is also believed that economies with large informal sectors have lower capital return and growth rates because the contribution of public services to productivity decreases with informality.

Informal sector consume a large share of the public services that are financed by taxes mostly collected or paid by formal activities in the formal sector.

Performance of the government revenue in developing countries as well as other developed countries is therefore directly and seriously affected by the presence of large informal sector in the countries.

My discussions in this issue centers on one of the possible methods to work around the challenges of taxation of the informal sector in Tanzania, a developing country with its own and unique characteristics, and whose definition of informality is specific to itself.

The truth is that informal sector in Tanzania contributes little to the government revenue (or not at all), and it is not easy to work out a taxation model that is suitable for informal activities and/or the informal sector.

All sorts of blames may be wrongly directed towards the Tanzania Revenue Authority (TRA), the institution which is formal in itself, and which requires a formal approach to assess tax.

TRA requires enough information and reliable records, which is not the case with informal activities in the country.

There have been plenty of literature and discussions going around in Tanzania on how to tax the informal sector, and therefore improve the government revenue performance.

Unfortunately most of the discussions turn around and discuss taxation of informal sector by employing formal tactics. Most of the arguments and solutions to taxation of informal sector turn to be only relevant to formal activities.

As mentioned above it may be illogical to show fingers to TRA because TRA is itself formal, with its approach and tools all formal.

The institution is not vested with resources or the right maneuvering tools for informal activities.

Though TRA is vested with the obligation to tax and collect tax from any person who has taxable income, the agency requires well structured records and information to be able to register taxpayers and administer/assess their taxable amounts.

It is important to note also that it is difficult to draw a fine line between formal activities as opposed to the informal activities.

They are sometime intertwined. However, all of us are pretty sure that there is enough tax revenue from the informal sector.

How to go about getting the tax from the informal sector remains to be a headache. Taxation of informal activities has always posed challenges to governments.

Taxation is traditionally built on three pillars, namely tax policy, tax law and tax administration.

However, it is the administration part of it that turns the wheel into money (government revenue) in the bank.  Different tax regimes require different types of administrative arrangements.

For any tax system a decision has to be made as to which agency should be responsible for such tax and what is/are the tax-points (time and place).

While the tax administration will have the main responsibility for the administration and collection of taxes in general, different methods suitable for different taxes might be chosen.

While VAT in Tanzania, for example, is administered and collected through registered traders and the customs offices, corporation tax is administered or assessed directly through the corporate tax offices.

It is the nature of different taxes that calls for such different tax points and tax agents, or in general, tax administrative arrangements.

What is the tax arrangement that can fit well in taxing the informal activities is the point at issue.

I feel comfortable to humbly confirm from my experience that informal activities in Tanzania are numerous, not predictable, full of confusion, with unreliable data and information, not friendly, with no proper hierarchy of responsibility and therefore very rough.

In such situations, where the tax points are not easy, governments around the world have always resorted to administering tax at source.

Taxation at source has always worked well in informal sectors. This is where tax is paid or collected when the payments from certain sources are actually made. Taxation at source is a mode or form of paying tax where and when payments are made. It may be through withholding or remittance.

Withholding tax is when the person making the payment (payer) deducts the amount of tax before passing over the balance to the person receiving the payment (payee). Taxation by remittance is when tax is topped up when making payments for specific goods and services.

The person who pays is required to add a certain percentage for tax. Economists assert that taxation at source makes tax administration more effective, widens the tax base where taxes would otherwise not be collectible and reducing compliance costs.

The agents in taxation at source may be either the sellers (Remittance) or the buyers (WHT). Together with its other advantages, taxation at source has always been the solution of taxation in difficulty or fragile situations like in the informal sectors.

Taxation at source drives its origin from the concept that the entire economics revolves around one principal; “somebody’s income is somebody’s payment”.

Ideally the results from taxing payments should not vary much from taxing incomes. Different countries have employed taxation at source to manage taxation on slippery situations or government feels high risk of losing revenue.

Taxation at source is also asserted to be more economical in some cases. Different countries work out a list of sources of income that have to be taxed at source. The size of the list varies from one country to another.

From the above discussed facts, the government in Tanzania could endeavour to work out and earmark specific payments/transactions to be included in its list of sources of incomes and payments to be taxed at source, either through withholding taxation or through remittance.

The list should be carefully and completely compared and contracted with the spirit of taxation at source to make sure that incomes from informal sectors are captured and therefore taxing the informal sector informally.

The government could work out informal tax points where taxation of the informal sector could informally be administered at source.

Certain tax points can be established and presumptive levels be introduced to tax the informal sector informally.

The idea is to depart from using formal tactics in taxation of informal sector and resort fully taxing the informal activities at any source.

*Viann S.Komba is a senior tax manager with Ernst & Young and is based in Dar es Salaam.

SOURCE: THE GUARDIAN