The mounting fiscal pressures and debt burden plaguing most African countries have seen increased vigour in efforts to enhance domestic resource mobilisation. These efforts have taken the form of modernised tax systems, streamlining tax policies and establishing structures and guidelines for minimising/curbing illicit financial flows. Whilst there have been notable successes, as demonstrated by increased tax revenues in countries like Kenya, many countries are yet to figure out how best to tax a potential source of revenue –  the informal sector.

The informal sector forms a large proportion of the economy in many developing countries. In sub-Saharan Africa, the sector contributes between 25 and 65 percent of GDP.[1] Additionally, it is estimated that the informal sector provides employment for more than 70% of the population in Sub-Saharan Africa.[2] In Kenya, the informal sector has grown substantively over the years and is estimated to account for 35% of Gross Domestic Product[3] while in Uganda and Tanzania, the sector covers more than 50% of GDP.[4]

Size of informal sector in Sub-Saharan Africa | AfDB

The massive contribution of the informal sector to the economy is attributable to its free nature that allows for easy entry and innovation for anyone capable of monetising their skills. The sector also provides an alternative avenue for the trade of goods and services affordably, especially for middle and low-income earners.

Whilst the size of the informal sector portends the potential for broadening the tax base and bridging fiscal deficits, the nature of the informal sector makes it challenging to harness this potential. The architecture of the sector comprises largely unstructured and unregistered businesses, which makes it difficult for the government to capture their contribution to the economy using mainstream tax structures. The fluid structure of the sector means informal workers are not subjected to paying VAT as is the case with formal businesses. In essence, the tax compliance structures adopted for formal businesses are not effective in taxing the informal sector.

Over the past years, revenue authorities have been keen to streamline taxation frameworks to bring the informal sector into the tax bracket. These have mostly been in the form of a presumptive tax scheme, which manifests as a simplified tax schedule that aims to encourage record keeping and tax computation. Despite the various efforts made, the level of tax compliance among traders remains low. In Kenya, for instance, high administrative costs, low awareness and understanding of the taxes, mistrust and weak structural dialogue between the informal sector and government have contributed to low levels of tax compliance.[5] The rising cost of living also discourages most actors in the informal sector to adhere to these structures and provisions, as most seek to sustain their working capital, amid dwindling profit margins.

Jua Kali workers | Source: Business Daily

In Uganda, the presumptive tax system in place for the informal sector takes the form of a top-down approach where tax authorities impose taxes on businesses and force them to comply. The current relationship between tax authorities and taxpayers resembles that of a “cops and robbers” scenario. This has continued to erode the trust of taxpayers in government, particularly owing to the fact that, to the majority, government has failed in its mandate to deliver public goods and services effectively.[6]

In Tanzania, implementation of the presumptive income tax scheme applied to street vendors has been affected by the lack of a proper regulatory framework to accommodate the use of urban spaces. The presumptive tax requires street vendors to have a business license. But to obtain a business license, one needs a physical address whereas, street vendors operate in undesignated areas. The government, therefore, needs to collaborate with vendor associations to set up good working environments to accommodate street traders.[7]

These cases point to the need for a more pragmatic approach from the government to capture the informal sector within the tax bracket. This should begin by first strengthening communication and engagement with the informal sector actors to foster trust and incentivise them to fulfil their tax obligations. There is also need for more transparency with regard to government budgeting and the utilization of tax revenues.

It is also important to note that taxing the informal sector is not a ‘one size fits all’ affair. As such, efforts to tax the informal sector should begin with defining what the informal sector comprises. The International Labour Organisation uses various operational criteria such as registration, licensing, taxation and labour standards to define the informal sector.[8] Borrowing from this, the informal sector encompasses activities from petty traders operating in the streets of urban centres. For instance, traders involved in the sale of second-hand items like clothes, some in the business of shoe shining, street vendors, carpentry, vegetable selling, repair, construction work among others. The informal sector also comprises of better off ‘urban professionals’ such as doctors, lawyers, architects etc. who operate as unregistered businesses.

However, the definition should be further adapted to fit specific contexts. This definition is critical in establishing appropriate thresholds distinguishing those earning too little to meet VAT or income tax thresholds and those ‘hiding’ in the informal economy to evade taxes. Having a clear definition will chip into realising tax justice, bearing in mind that the informal sector already bears much of the tax burden through indirect taxes such VAT.

Lastly, taxing the informal sector should be coupled with critical reforms to curtail the loss of revenue such as reduction of loss in tax revenue through tax incentives and curbing illicit financial flows.

Until governments figure out the right taxation framework and enforcement mechanisms to ensure players comply, the sector continues to remain an untapped gold mine that has the potential to strengthen domestic resource mobilisation to fund government expenditures.

[1] https://www.imf.org/~/media/Files/Publications/REO/AFR/2017/May/pdf/sreo0517-chap3.ashx#:~:text=The%20informal%20economy%20is%20a,of%20total%20nonagricul%2D%20tural%20employment.

[2] https://www.un.org/en/ecosoc/integration/2015/pdf/eca.pdf

[3] https://s3-eu-west-1.amazonaws.com/s3.sourceafrica.net/documents/118220/The-informal-sector-and-taxation-in-Kenya-IEA.pdf

[4] https://www.repoa.or.tz/wp-content/uploads/2021/07/Taxing-the-informal-sector.pdf

[5] https://ijlhss.com/wp-content/uploads/2017/09/Informal-Sector-and-Taxation-in-Kenya-Causes-and-Effects.pdf

[6] http://jota.website/index.php/JoTA/article/view/232/181

[7] https://www.repoa.or.tz/wp-content/uploads/2021/07/Taxing-the-informal-sector.pdf

[8] https://www.ilo.org/wcmsp5/groups/public/---ed_emp/---emp_ent/documents/publication/wcms_820312.pdf