Transcript Slide 1

FORMALISATION STRATEGIES
&
TAX POLICY DESIGN
Bert Brys
Sarah Perret
Senior Tax Economist
Tax Economist
Centre for Tax Policy and Administration
LAC Fiscal Forum, COSTA RICA
16-17 June 2015
Introduction
• Informality
– Why do agents operate in the informal economy?
– Why bringing agents in the reach of the tax system?
– A selection of other key lessons learned from the Informal
Economy literature
• Tax Policy & Informality
– “Tax policy and tax design” requires a “Tax and Informality”
strategy
– Key Tax & Informality policy lessons
• Tax, Informality and Skills
• Questions & issues for discussion
2
Informality: a variety of reasons why agents
operate in the informal economy
1. High and costly labour, product, environment, financial
market and tax regulatory burden augmented by the
(financial) tax and “non-tax” burden | level of governance “G”,
enforcement “E” and/ or net benefits “net B” < minimum threshold:
 stringency of rules and (administrative, accounting, legal,
financial, statistical & information and/ or time-related) costs to
comply in the formal economy, both for start-ups and agents
who want to continue operating in the formal economy,
 the tax and “non-tax” burden faced by formal agents net of the
tax and “non-tax” payments made by agents in the informal
sector
 Conditional upon governance, enforcement and/ or net
benefits < minimum threshold
3
Informality: a variety of reasons why agents
operate in the informal economy
2. Lack of Financial and other Net Benefits of functioning in
the formal sector (i.e. net of benefits realized by agents
functioning (partly or fully) in the informal sector):
 Low benefits of being formal including (perceptions about) poor
quality of public and social services;
 Strong eligibility criteria to benefit from public and social
services;
 Public services being available to informal workers as well;
 Higher public utility rates for formal businesses;
 Lack of access to resources including land and credit in formal
versus informal sector;
 Competitive pressures from businesses working in the informal
sector
4
Informality: a variety of reasons why agents
operate in the informal economy
3a. Poor Governance in the formal and/ or the informal sector:
low institutional quality; absence of rule of law; weak property rights in
the formal and/ or informal sector; low level of democratic
accountability, level of bribes that formal versus informal agents are
called upon to pay; and
3b. Low Effective Enforcement in the formal and/ or informal
sector:
poor effective enforcement of legitimate rights and entitlements; poor
effective enforcement of regulation; poor information provision to agents;
poor effective auditing, possibly strengthened by the lack of good quality
administrative information and/ or information flows between
administrations; low level of sanctions and fines when non-compliance is
found
5
Informality: a variety of reasons why agents
operate in the informal economy
4. Lack of trust in Governance institutions and their enforcement,
high degree of corruption faced by formal versus informal sector, low
level of democratic accountability
5. Absence of or imperfect “formal” markets: absence of – or a
too rigid functioning of – formal markets for particular inputs, such as
temporary work, or outputs; a poorly developed banking sector such
that it is difficult to obtain credit for businesses in the formal and/ or
informal sector | high and costly regulatory burden, strict Governance
structures and their Enforcement > minimum threshold.
6. High Poverty: poverty as measured by low income, the absence of
schooling, a high share of rural population, a high share of the
agricultural sector in GDP, and other poverty measures
6
Informality: why bringing informal businesses and
individuals within the reach of the tax system?
1. Tax raise Revenue: a potential significant source of tax revenue:
– Although many informal agents have low income so would have to
pay little tax; high tax collection costs for tax administration;
– But tax revenue will increase as formalized businesses grow; it is a
matter of building tax compliance within all firms.
2. To strengthen Equity: sustain tax morale and tax compliance among
formal agents. Formalisation may offer agents a measure of predictability
and protection from arbitrarily state and related racketeering action;
But:
– Agents typically have low- income and taxation is potentially
regressive = rationale for presumptive tax regimes!
– Efforts to tax the informal economy might increase the risk of
relatively coercive or corrupt behaviour by tax officials: these
concerns need to be tackled at source!
7
Informality: why bringing informal businesses and
individuals within the reach of the tax system?
3. To improve Social Welfare:
– Informality may impose significant economic risks and create
vulnerability (in case of unemployment, health problems,
disability, maternity, old age, etc.).
– On average, informality leads to underinvestment in the human
capital of current and future generations, leading to long-run
economic and social exclusion.
4. To improve Efficiency:
– The informal sector generates a negative externality: informal
activities use and congest public infrastructure without paying a
contribution (free-riding).
– Informal businesses take market shares from formal companies
such that the latter lack a sufficient scale of production to
increase their productivity (but albeit limited evidence).
8
Informality: why bringing informal businesses and
individuals within the reach of the tax system?
5. To stimulate Economic Growth: While informality helps firms
avoid certain costs, it may also preclude access to certain opportunities,
including greater access to and/ or cheaper credit, increased
opportunities to engage with larger firms and government contracts,
reduce harassment by police, and access to broader training and support
programmes.
Some recent evidence provides nuanced evidence that formalisation is
growth enhancing.
– The growth benefits of formalisation are positive but are
heterogeneous across firm types. The smallest firms frequently
benefit the least while mid-sized firms typically benefit the most.
– As informality can be explained, to some extent, as rational
sorting of firms and workers based on inherent productivity
characteristics, formalization per se may not address the
fundamental determinants of productivity.
9
Informality: why bringing informal businesses and
individuals within the reach of the tax system?
6. To strengthen good governance: there is some but limited
evidence that firms that pay taxes engage with the state, thereby
promoting legitimacy, good governance and political accountability.
There are 3 channels:
1.
In order to increase tax compliance, the state may be more
responsive and accountable to groups that pay taxes;
2. Agents that pay taxes are more likely to make demands for
responsiveness and accountability;
3. Efforts to tax informal sector operators could catalyse
collective action and political engagement by informal sector
associations.
10
Informality: a selection of other key lessons
learned from the Informal economy literature
Exclusion versus exit requires different strategies.
The duality “formal>< informal” is misleading: a continuum of
firm types exists, from the most informal (subsistence-type activities)
to the most formal businesses.
• Depending upon the context, businesses often move along this
continuum, some seeking formalisation other falling into
informality as the cost-benefit calculations of being in one category
or another change.
• Formal and informal economies are intrinsically linked.
• Challenging to reconcile (especially) longer-run costs of informality
for society and agents with (especially) shorter-run benefits of
informality for individuals and businesses.
• Governments should make the cost-benefit shift in favour of
formality for as many business types as possible through broad,
including tax, reforms!
11
Tax Policy and Informality: Tax Policy and Reform
and country-specific “Informal economy” Strategies
Tax Policy and Reform needs to be embedded in a
country-specific “Informal Economy” Strategy
• The tax system and individual taxes can be designed such
that they provide incentives to the informal sector to
formalize and to prevent formal businesses to become
informal = The standard discussion in the “tax and
informality literature.
• However, the informal sector itself (its size, characteristics,
etc.) has an impact on how countries have designed and can
design/ reform their tax system (beyond the standard tax
and informality strategies).
12
Tax Policy and Informality: Tax Policy and Reform
and country-specific “Informal economy” Strategies
Tax Policy and Reform needs to be embedded in a
country-specific “Informal Economy” Strategy
• As a result, text book tax policy recommendations not
necessarily constitute good tax policy in the presence of
a large informal economy!
• Also, in light of those constraints, country’s
implemented tax policies not necessarily constitute good
tax policy in the longer run and may prevent countries
from entering a sustainable longer run growth path.
• First best: implement only those tax policies which
constitute good tax policy in the longer run.
13
Tax Policy and Informality : Lessons learned
from the “Tax and Development” literature
• Tax mix in developing countries typically include distortive
trade taxes, because revenues from other taxes are not
available. Because of a narrow tax base (low incomes, large
informal economy, poor tax administration, unproductive
businesses), countries typically have levied high direct tax
rates paid by those agents that do operate in the formal
economy.
• High direct tax rates and trade taxes have not contributed to
improving the productivity of domestic businesses.
• Policy advice developing countries typically have received:
abolish trade taxes.
• However, abolishing trade taxes may make domestic
businesses vulnerable to imports.
14
Tax Policy and Informality : Lessons learned
from the “Tax and Development” literature
• Revenue implications: governments may have to increase
direct tax rates even more, thereby further distorting the
economy!
• McNabb and LeMay-Boucher (2014) find empirically that
shifting the tax mix away from trade taxes towards CIT and
especially PIT will decrease economic growth!
• Also introducing tax incentives to attract FDI is expected not
to be good policy if it put domestic businesses at a competitive
disadvantage compared to newly attracted FDI.
• CONCLUSION: tax policy reform needs to be
accompanied by strategies that strengthen the formal
economy and the tax administration!
15
Tax Policy and Informality: lessons learned
from tax policy reform in Colombia
• Very distortive business income tax burden – need to make
economy and FDI less dependent on natural resources.
• Introduction of relatively strict international tax rules.
• Distortive financial transaction taxes as tax revenue raiser.
• Need to raise more revenues
• Very large informal economy (up to 70%) – very high
inequality – very high offshore tax evasion.
• Tax reform needs to be accompanied by reforms
that strengthen the formal economy, the tax
administration, the legal tax framework as well as
reduce offshore tax evasion!
• Making such a reform happen is a major challenge16
Tax Policy and Informality: lessons learned
from tax policy reform in OECD countries
• Belgium: introduction of electronic invoicing in bars
and restaurants; very high tax burden on labour income
– electronic invoicing (for VAT purposes) may force
many businesses into bankruptcy. A comprehensive
reform is required that strengthens tax compliance but
lowers the tax burden on workers at the same time.
• Mexico: why do the formalization strategies/ incentives
have an impact today while they did not work in the
past? Answer: tax is only one of the drivers of the
informality. A comprehensive approach is required to
make working in the formal sector more attractive!
17
Tax Policy and Informality: other key Tax and
Informality policy insights
Oviedo (2009): “policy packages can comprise a series of
carrots and sticks that need to be adapted to the nature of
informality in the country. In some countries, regulatory
reform might be more relevant, while in others it could be
regulation enforcement, administrative reform or tax reform”.
Strengthening tax enforcement ONLY may not be growthenhancing. Oviedo (2009): “strengthening enforcement will
work best when the appropriate incentives to formalize are
created, so that informal agents have a viable transition path
from informality to formality”.
Efficient tax and informality strategies within a country might
evolve over time!
18
Tax, Informality and Skills
• Informality will, on average, lead to underinvestment in
human capital and skills of current and future generations.
• Incentives to work, acquire skills, or refrain from socially
undesirable behaviour are seriously constrained when there is
no clear path out of social exclusion (IADB, 2008). Informal
workers may have fewer incentives to invest in their own and
their children’s education, creating an “informality trap”.
• Good foundation skills for all is key for inclusive formal
economy growth.
• Duality of economies will increase inequality, which in itself
might harm economic development and growth.
19
Questions and Issues for Discussion
• Do Participants agree that a “country
informality assessment framework” needs
to be developed?
• Do participants agree that “Tax and
Informality” recommendations need to be
embedded in such a broader Informality
assessment?
20
For more information, please contact:
Bert BRYS, Ph.D.
Senior Tax Economist
Head Country Tax Policy Team
Head Personal and Property Taxes Unit
Tax Policy and Statistics Division
Centre for Tax Policy and Administration
2, rue André Pascal - 75775 Paris Cedex 16
Tel: +33 1 45 24 15 97 – Fax: +33 1 44 30 63 51
[email protected] || www.oecd.org/tax
21