According to the International Labor Organization, the informal sector is broadly characterized as consisting of units engaged in the production of goods or services with the primary objective of generating employment and incomes to the persons concerned.
These units typically operate at a low level of organization, with little or no division between labor and capital as factors of production and on a small scale. Additionally, the labor relations - where they exist - are based mostly on casual employment, kinship or personal and social relations rather than contractual arrangements with formal guarantees.
A research conducted by the International Monetary Fund (IMF) on the informal economy of Sub-Saharan Africa indicates that the informal sector is a significant component of most economies in sub-Saharan Africa, contributing approximately 25 to 65 per cent of total gross domestic product and accounting for approximately 30 to 90 per cent of nonagricultural employment. The informal sector in sub Saharan Africa remains one of the largest in the world and this situation places constraints on domestic resources mobilization.
Domestic resource mobilization plays a crucial role in financing sustainable development, economic growth and poverty minimization and as such minimizing the activities within the informal sector to ensure formalization is crucial and governments should aim to ensure that it's achieved.
Research by World Bank has shown that the average size of the informal sector in low-income countries is 40.6 percent. Taxation, in turn, is often seen as a key ingredient of formalization, and developing countries might benefit from increases in revenues, growth effects from improved productivity, and a more vital relationship between taxpayers and the state authorities.
The large informal sector in underdeveloped countries has a negative impact on tax revenue potentials and consequently, minimized countries' abilities to domestically mobilize revenue to finance development and other priority expenditures.
Further research shows that efforts to improve informal sector taxation do not necessarily lead to substantial increase in governmental revenues especially in instances when the associated costs of tax collection are high. In this regard, taxing the informal sector as a means of domestic revenue mobilization is inherently a matter of costs and benefits.
However, investing in the formalizations of the huge informal sector from a long-term perspective, might contribute to the overall productivity of informal firms and thus ultimately lead to economic growth and a higher revenue potential.
In addition, the IMF regional report on taxing the informal sector in Sub Saharan Africa highlighted that creating more opportunities for resources to migrate from the informal sector by expanding the formal sector would increase productivity in the economy and could be an important mechanism to unlock sustained inclusive growth, although transformation is expected to be slow as policies must also be set to support household enterprises that provide a safety net for those who would otherwise likely be unemployed.
In an effort to domestically mobilized revenue, the Liberian revenue Authority in the 2017/2018 financial year developed the domestic resource mobilization strategy that is focused on expanding the revenue base through identification & registration of informal businesses and minimizing the revenue loss through voluntary compliance and tapping into potential sectors (formalization). Liberia, like most low-income countries is a hub for untapped revenue potentials.
The amended revenue code of 2011, in section 200 allows "generous provision" that are applicable to various categories of businesses (presumptive tax for small taxpayers), as a way of formalizing the informal sector & widening the tax net. Under the amended revenue code of 2011, small taxpayers that are a legal or natural person carrying on a trade or business with a turnover of less than L$3,000,000 (three million dollars LRD) are required to pay 4 per cent of their turnover.
Under the amended code, all smaller businesses that made a turnover of less than LRD 200,000 turnover were subject to an annual tax deduction of 2,400 LRD, 1200 LRD,& 480 LRD based on the category as provided by the code.
Similarly, during the 2019/2020 budget, the Rwanda Revenue Authority committed to increasing and strengthening domestic revenue collections by pursuing policies such as Increase efficiency in administration and collection of domestic revenue and widening the tax base through identification and registration of new taxpayers and formalization of the informal sector.
As a means of formalizing the informal sector, article 12 of the income tax was amended to specifically, exclude "liberal professions" from being taxed under the lump sum tax regime of 3% of the annual turnover. Under the repealed income tax law, all businesses that made a turnover of less than FRw 50 million were subject to a flat-rate tax of 3% of the turnover. The new law excluded liberal professions from this regime and they are now taxed under the real regime irrespective of the turnover. A liberal profession is defined as a profession exercised on the basis of special skills, in an independent manner, in offering services to the clients.
With efforts already being made by different revenue authorities to formalize the informal sector, we are of the stance that the informal sector when formalized has the potential of enhancing domestic revenue collection, create jobs and minimize poverty. Putting into consideration factors such as associated costs of tax collection is high, revenue authorities across Africa should put in place administrative policies and regulations that will minimizes informal activities, which will in turn help boost the economy.
Gifty Asmah Lama from Liberia and Aimee Dushime from Rwanda are passionate about tax research and tax education. They are also 2019 Mandela Washington Fellows from Virginia Tech University (VT) and Andrew Young School of Policy Studies (AYSPS) respectively. The views and opinions are those of the authors and do not necessarily represent the views and opinions of VT and AYSPS or the institutions they currently work for.