ECONOMICS MADE SIMPLE: Why formalise the informal sector in Tanzania

Debates about the informal sector in Tanzania and beyond are not new. They include issues of the nature of the sector, its magnitude, key actors, types of economic activities, what constitutes informality, issues related to formalization, tax payment by those in the sector and much more. Debates on formalisation of the informal sector for the purpose of increasing government revenues in general and tax revenue typology in particular are not short of supply. One sees these issues in almost all government budgets speeches especially on the challenges of collecting planned revenues in previous fiscal years and policy measures to collect more revenues in coming years. This was the case in the 2018/19 fiscal year budget as was the case in several previous years’ budgets. The need to get the concept of formalising the sector correctly cannot be overemphasized if the noble goals of formalisation are to become a success.

Formalising to broaden tax base

Discussions on the need to broaden Tanzania’s tax base are not new. They have emerged in a number of contexts and places. Among the main context in which the need to broaden the rather narrow tax base in Tanzania is that of annual budget in general and fiscal its policy part in particular.

This has been seen in a number of budget speeches by the minister responsible for finance and economy. It is in the 2018/19 budget as it has been in many other previous ones and arguably in many others in years to come. Various fiscal policy measures have announced in the bid to broaden the tax base in Tanzania. Among these include formalization of the informal sector of the economy and correctly so. Whereas the need to formalise the sector as part of efforts to broaden the tax base is undisputable, there are issues that are worth noting for eventual successful formalisation and by extension broadening of the tax base. Some of these issues are outlined in this piece.

Understanding the informal sector

The informal sector can be described in many ways. Typical descriptions would include the sector of the economy that is not in the formal system. More often than not, operators in the sector do not necessarily have all the needed papers like licenses, address, formal business premises and tax papers. The sector is populated mainly by micro and small enterprises although medium ones too do feature in this business typology.

The sector’s assets are seen as economically and legally dead. With informality a number of ‘door’ and opportunities tend to be closed. Access to some capital and tender may be blocked thanks to informality and regrettably so. Diverse types of economic activities are undertaken in the sector. Among the leading authorities in matters informal include the International Labour Organisation (ILO). It is to be very well understood and emphasized that operating in the informal sector is not illegally.

Formalisation

Formalisation of the informal sector implies turning those in the sector into formal sector. This is the sector in which most of policy, legal and regulatory requirements are in place. Formalisation of the informal sector in Tanzania has tended to include more use of stick than carrots. With sticks, informal sector is forced, including use of punishments to have all that it takes to be on the formal side of business. This is unfortunate and bad practice.

Formalisation should involve more carrots than stick. It should be about creating incentives for those in the informal sector to automatically and voluntarily graduate from informal to formal sector. By and large, formalisation of the informal sector should be a gradual and natural process. Informal sector operators should engage automatic gears of graduation from informal to formal sector at some point in their lifespan. 

Beyond papers

There seems to be a wrong assumption that formalisation is all about having the papers required by the authorities. Informal sector experts as well as experts in the micro, small and medium enterprises (MSMEs) would agree that formalization is much more than just having all the papers needed by policy, legal and regulatory frameworks. Having the necessary papers like business licenses, tax identification number (TIN), business address and the like is just part of going formal. Formalisation that matters in the context of the broader tax base that brings cash into the tax net is through formal operations of business transactions. It involves having all necessary transactions correctly in place. These include proper and adequate records of all costs, revenues and profits in all transactions. These records are important in computing taxes that are due to the taxman.

Taxing amidst informality

It is undeniable fact that informal sector will be around with us for the foreseeable future. It is a system that cannot and should not be eradicated in a day. Kissing informality goodbye is a process not an event. It is like building Rome. It cannot be done in a day.

This is partly so given the big size of the sector, arguably to the tunes of up to 60 or more percent of economic activities. Doing away with it therefore is a very tall order. Therefore there is a need of ensuring that reasonable and fair taxes are extracted from the sector. Waiting until it gets formalised would be a lost opportunity. Attempt to tax the informal sector have included presumptive taxation. If properly done and improving the practice based on lessons learnt over time, presumptive taxation stands to net some cash into the government coffers.