CAUSES AND FACTORS THAT LEAD TO THE CREATION OF INFORMAL SECTOR IN DEVELOPING ECONOMIES Francis O. O

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CAUSES AND FACTORS THAT LEAD TO THE
CREATIONOF INFORMAL SECTOR IN DEVELOPING
ECONOMIESFrancis O. ObriAssistant Director of
TaxesFederal Inland Revenue Service, Nigeria
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PREAMBLE

• The key concepts in this topic are
• The Informal Sector and
• Developing Economies.
• Outline
• We shall be looking at some definitions of the
  informal sector and developing economy.
• The characteristics of the informal sector
• Causes and factors responsible for the creation
  of informal sectors
• Taxation of the informal sector and
• The way forward

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INFORMAL SECTOR - Definitions

• What is formal or informal is often viewed from
  the perspective of official or unofficial.
• all economic activities in all sectors of the
  economy that are operated outside the purview of
  government regulation (I. Ekpo O. Umoh).
• non-structured sector that has emerged in the
  urban centres as a result of the inability of the
  modern sector to absorb new entrants (UNDP).

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Origin

• IS was first used by Hart in 1970 to describe
  the multitude of often temporary economic
  strategies adopted by migrant workers in Ghana in
  the face of a marginal job market which, in the
  aggregate, responded to real social needs
  (Cross).
• However, IS was elevated to the international
  spectrum in 1972 by the ILO in its Kenya Mission
  Report (World Bank).
• The phenomenon was initially seen as a survival
  strategy arising from undercapitalisation and
  lack of skills, it has now become a permanent
  feature.

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Origin (cont.)

• It is particularly more pronounced in the
  developing nations because the modern sector has
  not had the capacity to absorb all the new
  entrants to the labour market.
• It serves as an alternative to the high rate of
  unemployment in the formal sector.
• In Nigeria for instance, it is estimated that as
  much as 70 percent of the nations economic
  activities and 60 percent of the countrys
  employment are in the IS.

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Developing Economy In Perspective

• A developing economy refers to an economy that is
  not industrialized.
• It depends on importation for most of its needs.
• Other characteristics include
• low per-capita income
• low standard of living
• low level of technology
• inadequacy of experts in various and essential
  fields
• dependence on a few sources for foreign earnings
• The economy is primarily subsistence

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CHARACTERISTICS OF THE INFORMAL SECTOR

• Building a business around an individual, often
  resulting in succession management.
• The use of family and unpaid labour and common
  reliance on manual labour rather than on
  sophisticated machinery and equipment
• Limited capital availability, injection or
  accumulation.
• Flexibility, allowing people to enter and exit
  economic activities in response to market demand
• High reliance on simple and indigenous facilities
  as well as ability to improvise.
• A willingness to operate business at times and
  locations convenient to customers, and
• A tendency to locate smaller markets, out of the
  reach of the larger firms.

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CAUSES OF THE IS

• Excessive Regulatory System
• High cost of entry into the formal sector
• Bureaucracy and Corruption
• High level of unemployment
• Culture of self-reliance or Entrepreneurship
• Low literacy level
• Low income levels in the public sector
• Poor infrastructural facilities
• Dependence on natural resources

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• THE INFORMAL SECTOR AND TAX ADMINISTRAION

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IS Taxation Problems

• 1. Poor record keeping culture.
• high level of illiteracy
• minimal record-keeping
• at best, haphazard or incomplete records are
  maintained
• different records for different purposes
• one set of records may be to enhance the ability
  to obtain loans from banks while another may be
  kept for tax purposes.

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IS Taxation Problem (2)

• 2. Lack of clear cut distinction between
  ownership and business Capital.
• non-separation of business capital from personal
  funds
• thus difficulty in ascertainment of business
  profit for tax purposes
• One way of tackling such cases is through the
  determination of increase in network of the
  business
• techniques such as ensuring that only expenses
  wholly, reasonably, exclusively and necessarily
  incurred for the business are allowed for tax
  purposes.

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IS Taxation Problem (3)

• Lack of communication between government and the
  business sector
• key players in the IS lack faith in government
  polices and programmes
• may be due to a misunderstanding of programmes
• but is often because of absence of adequate
  communication between the government and the
  participants in the sector
• creates apathy towards government and its
  programmes
• resulting in the declaration of false incomes and
  consequent loss in taxes.

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IS Taxation Problem (4)

• Lack of incentives/support by government
• Governments lack of regard t for the critical
  role that the IS in their economies
• Consequently, no training programmes in
  entrepreneurship, access to cheap funds
• tax incentives are therefore lacking.
• In Nigeria NEEDS/SEEDS - programmes have aspects
  aimed at improving on the productive potentials
  i.e. employment and income generation capacity of
  the IS.

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IS Taxation Problem (4) cont.

• Some other interventionist schemes include
• skills acquisition programs to train and improve
  on skills and technology
• Poorer groups encouraged to form Cooperatives
  Societies and Trade Unions to enable them obtain
  credit facilities from banks
• It is also hoped that recognizing and relating
  with the Unions will enable the tax authorities
  access requisite information from their
  membership registers and other documentation.

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IS Taxation Problem (5)

• Provision of infrastructure for production of
  goods and services
• The poor state of basic infrastructure in
  developing economies is common.
• Entrepreneurs provide these amenities
• find it difficult to recognize the existence of
  government, or
• the reciprocal responsibility of voluntary tax
  compliance.
• Common for a greater part of business profit to
  be spent in provision of basic amenities
  (responsibility of Government)
• The Nigerian Tax system addresses this phenomenon
  by providing for Rural Investment Allowance
• A Company sited at least 20km away from the
  provision of electricity, portable water, tarred
  roads or telephony and has to provide same for
  the purpose of its trade can claim in addition to
  the normal allowance on capital expenditure
• Telephone 5 of Capital expenditure on assets
  in use
• Tarred Road 15 of Capital expenditure on
  assets in use
• Water 30 of Capital expenditure on assets in
  use
• Electricity 50 of Capital expenditure on
  assets in use
• No facility at all 100 of Expenditure
  allowances on assets in use

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WAY FORWARD

• Substantial migration from the IS to the formal
  sector can be achieved by encouraging the
  creation of the following
• Partnership
• Mergers and Acquisition
• Limited liability companies
• Government corporation
• Trade Association
• Unit Trust

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WAY FORWARD (cont.)

• Insistence on maintenance of accounts in
  specified forms
• Pragmatic programmes towards enlightenment in the
  sector.
• Use of field officers on a continuous basis to
  gather information on the tax payers.
• Inter-agency exchange of information.

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WAY FORWARD (cont.)

• Re-invigoration of tax enforcement procedures.
• Unique identification numbering system for each
  tax payer such that once in the system, it
  becomes difficult to loose track of the tax
  payer.
• Insistence on Tax Compliance Certificate as
  condition for dealing with major institutions

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SUMMARY AND CONCLUSIONS

• The presence of large informal sectors in all
  economic activities is one of the most important
  characteristics of developing countries.
• Government must be dynamic, responsive and
  willing to create the enabling environment for
  the migration of actors in the IS to the formal
  sector.
• Beyond legislations and enforcement machineries,
  a sincere approach to the problem in developing
  economies lies with good governance.
• Until entrepreneurs are encouraged to have a
  sense of belonging and are adequately considered
  in policy formulation, the solution would
  continue to be in the imagination than real.

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• Thank you