Taxing the Informal Sector Katherine Baer Fiscal Affairs Department International Monetary Fund

Profile of a taxpayer in the informal sector F Owners often lack business skills and knowledge of tax obligations F Often do not register for tax purposes F Often have poor record keeping and systems F Easily fall into debt and return filing problems F Often cash based and prone to evasion

Some of the costs of informality F Lack of access to licenses/permits that may facilitate business activity, lack of access to bank credit F Dispersion of business activity F No possibility of carrying out publicity F Required to pay bribes to corrupt officials to avoid penalties and sanctions F Cannot sell to formal sector, or deduct tax paid on inputs purchased from formal sector F Barriers to growth of the business Result: affects overall productivity…..

Other costs F Prevents government from obtaining revenue needed to satisfy budgetary needs F Increased tax burden for other taxpayers F May inhibit growth of small business sector, employment in that sector

Aspects of tax system that can discourage small businesses from joining formal economy F High tax rates F Complex tax system F Overly complex procedures (high compliance costs) F Dicretionary application of tax laws (audit) F Low risk of being detected

How to promote formality? F Simplify tax system and modernize administrative procedures F Differentiate taxpayer universe by segments that reflect different risks to revenue, and design a strategy that targets each group according to their service needs (large, medium and small taxpayers) F Build competence in the tax system with training and strong HR systems F Improve integrity of the tax system

Basic steps to improving the tax compliance of small taxpayers F Ensure proper registration of small taxpayers F Use basic cross-checking to locate small businesses

The main characteristics of the small taxpayers and implications for tax administration F Highest % of taxpayers, lowest % of revenue F Lack of knowledge about tax obligations F Tax administration needs a simple regime, or else: –Tax administration will be unable to pay sufficient attention to large and medium taxpayers

Structure of Tax Collection: 2000 (excludes tax collected through customs) Type of taxpayer Argentina Peru Large Taxpayers (%) Tax collection (%) Medium size Taxpayers (%) Tax collection (%) Small Taxpayers (%) Tax collection (%)

Need realistic goals in setting up simplified regime F Identify main sources of underground activity and incorporate them into the tax system F Be sufficiently dissuasive without incurring too many costs F Motivate registered taxpayers to comply F Dissuade taxpayers who do not belong in regime from registering as small taxpayers F Reduce costs of administration

Simplified Tax Regimes: Options F Single tax or special regimes for existing taxes F Voluntary or obligatory F Minimum fees which are easily payable F Can have additional requirements such as: simplified book-keeping or return filing requirements

Simplified regimes should define: F Type of taxpayer that can join F Thresholds, excluded activities F Taxes covered by simplified regime F Methods of joining, classification and re- classification F Administrative requirements: book-keeping, filing, payment, penalties for noncompliance

Reasons for using presumptive methods for taxing small businesses: F Because it may be the only way to tax small businesses F Because it is a way to overcome tax administration weaknesses F Because of administrative ease for tax administration and taxpayer

There are several ways in which presumptive taxation may be levied F Estimate of taxpayer income F Use of of taxpayer’s assets to estimate profits F Use of gross receipts F Use of external indicators of income F Best to use systems that are based on fact, not judgement, using little tax administration effort for assessment

If information on turnover is not available, the tax administration must devise methods to determine it F In manufacturing--purchases F In restaurants, theaters, and barber shops-- number of tables, seats, and employees F In transportation--amount of cargo space

Argentina: Monotributo F Natural persons, sole proprietors, professionals F Turnover, energy consumption, area of business activity, etc. F Substitutes: Income tax, VAT, SS F Voluntary registration F Purchase and sales invoices required, but no VAT credit granted F No accounting requirements, no returns, includes pension and medical benefits.

Bolivia: RTS, STI, RAU F Natural persons and sole proprietors F Varies by regime: activity, assets, annual turnover, area of business activity, etc. F Replaces CIT, VAT, PIT and transactions tax F Voluntary registration F Purchase invoices required, no sales invoices F No formal book-keeping requirements

Peru: RUS F Natural persons and sole proprietors F Gross income, one establishment, number of workers, area of business activity F Replaces: Income tax and VAT F Voluntary registration F Purchase and sales invoices required, but no VAT credit granted F No return filing, monthly payments, no book- keeping requirements

Accounting basis and tax invoices F Make a cash accounting basis available for smaller taxpayers to simplify record keeping F Require/encourage taxpayers to keep income and expenditure cashbooks F Emphasize that claims for VAT paid can only be made if a tax invoice is held F Provide simplified tax invoices for small value transactions

Return filing and payment F Some return filing should be required F Payment in single installments F Form of payment: with payment form to the bank, automatic bank debit, electronic funds transfer, etc. F Payment periodicity varies: monthly, bi-monthly, quarterly, annually

Importance of taxpayer education F Prepare clear explanatory material that tells taxpayers what they have to do, when they have to do it, and how to do it. F Use simple language in explanatory material F Establish a Taxpayer Services counter in all tax offices to answer questions from taxpayers F Conduct seminars and advisory visits for new taxpayers.

Compliance control F Should be systematic and timely F Based on presumptive methods to categorize taxpayers or remove from simplified regime F Permanent audit program required to ensure large and medium size taxpayers are not hiding in this regime

Penalties for noncompliance… F Sufficiently high F Objective F Easily and immediately applicable In order to encourage voluntary compiance…

Type of penalties applied F Temporary closure of business F Seizure of goods