Designing a Tax System for MSEs: Guide for Practitioners , IFC, 2008
| Implementing agency(ies) | IFC | |
|---|---|---|
| Funding agency(ies) | Department for International Development (DFID) | |
| Date completed | February 2008 | |
| Issues/challenges | Small businesses are a unique phenomenon for the tax system: besides wage earners, who generally are only subject to income tax withholding, they form the bulk of taxpayers in the tax net. At the same time, however, small businesses are the major contributors to the informal economy operating outside the tax net. This is not an antagonism. In many developing and transition countries, micro and small enterprises (MSEs) are the most rapidly growing business segment. Their characteristics and also their tax compliance attitude vary significantly. On the one hand, a large number of MSEs register with the tax authority - voluntarily or as a result of enforcement actions. On the other hand, high costs, difficult formalization procedures, or the expectation of gaining a comparative advantage from not complying with tax obligations drive many small businesses into operating in the informal economy. Compliance risks and attitudes in the small business segment of the taxpayer population are fundamentally different from large taxpayer compliance behavior. In case of larger businesses, the core risk for the tax system is the recourse to tax avoidance strategies. Large businesses (and wealthy individuals) have access to sophisticated tax advice to develop strategies for the reduction of their tax liabilities, e.g. through the use of transfer pricing techniques. Smaller businesses are more likely to engage in tax evasion practices and either operate completely outside the tax net or hide a certain part of their business transactions from the tax inspector. The risk of detection of such tax evasion practices can be rather modest in countries with weak tax administration enforcement capacity or a high level of corruption in the tax administration. Operating in the informal economy negatively impacts society as a whole, especially the compliant part of the business community. It also affects the growth potential of informal businesses. Reforms to foster private sector development and to support innovation and growth, therefore, need to address and eliminate obstacles for small business formalization. The cumbersome tax system in most countries, both on the policy and the administration side, is considered as one of the top reasons for operating in the informal economy. |
- Description
This toolkit provides a number of options for reforming the tax system to facilitate small business compliance. While it does include some tax administration reform options, the focus of the toolkit is on the tax policy side. Further guidance on tax administration reform is provided by the paper: 'Tax Administrations and SMEs in Developing Countries,' IFC, July 2005.
The toolkit specifically discusses strategies and options to facilitate small business compliance with the tax system. It thus addresses one - although a particularly important - element of MSE formalization. Providing sufficient incentives for formalization has much broader dimensions, of course. As research in African countries has shown, 'tax resistance is likely to continue (and increase) if service provision does not improve, necessitating costly and coercive methods of tax enforcement that may undermine the legitimacy of the government.' Improvement in service delivery for the majority of citizens is therefore a necessary condition to improve tax compliance.
The existence of positive benefits in the form of public services, security, etc., may therefore increase the probability that taxpayers will comply voluntarily, without direct coercion. These findings confirm the importance of combining tax policy and tax administration reforms with improvements in public expenditure management and service delivery.
| Associated Activities and Documents | |
| Synthesis documents | |
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Concevoir un système fiscal pour les PMEs (1): Impact de la fiscalité et options de réforme (78 kB)