Why formalising informal sector is a song with no end
Year on year, the finance ministry, economists and government planners advocate for formalising the informal sector. Fast forward to now, the radio is still playing the same song.
Following the recently concluded Uganda Revenue Authority (URA) open minds forum, panelists at the conference urged government to yet again formalise the informal sector. The Commissioner General of the authority, Ms Doris Akol, revealed that the sector contributes 49 per cent of the country’s GDP yet less than one per cent is collected as taxes from the sector, culminating into great loss for the country’s tax collection.
URA recorded a 1.6 per cent deficit in GDP from the targeted 5.5 per cent growth in financial year 2016/17.
The International Monetary Fund (IMF) and regional Economic outlook on the informal economy in sub-Saharan countries predicts the persistence of the informal sector in developing countries despite experiences from Western countries that indicate that development of a country eliminates the informal sector.
The informal sector is defined as unregistered household enterprises with market value or registered businesses that undertake underground production to evade taxes. According to the 2017 IMF report, the sector employs 30 to 90 per cent of labour in sub Saharan Africa.
A survey by Uganda Bureau of Statistics found that 27 per cent of the informal sector is in agriculture, while trade and services comprise 24 per cent. Mining and quarrying, as well as fishing linger with 1 per cent each.
Mr Andrew Rugasira, the chairman of Good African Coffee, says in an informal economy, jobs and business activities are not registered or protected by the state. They don’t enjoy any social benefits and often have no land titles or registered assets. This means they are inherently vulnerable, highly mobile and insecure. As a consequence, these unregulated entities do not pay taxes.
Why are they informal?
World Bank’s 2017 report on Doing Business indicated that the Sub-Saharan Africa region has economies with the least business-friendly regulations. Mr Rugasira last year said the delays in registration are compounded by burdensome compliance procedures, complex tax regulations, corruption and cost of initial business registration, consequently discouraging entrepreneurs from formalising their businesses and making informality attractive.
According to the World Bank “Doing Business 2016” report, it takes more than 27 days to set up a new business in Uganda. The long procedures discourage the informal sector from formalising mostly if they see no gain from it.
However, Finance minister Matia Kasaija explained why government efforts to formalise the informal sector are futile saying it is because the informal sector is mobile. The businesses have no fixed address to follow up during registration and since location is a requirement to register a business, it discourages the informal sector from taking part in the formalising process.
Businesses in Uganda have been criticised for their low tax morale; their attitude towards tax payment.
Low tax morale forces youth to join the informal sector and some that are formal to evade taxes. A 2013 study titled: Tax evasion and Business Environment in Uganda, by Mr Joseph Mawejje found that 73 per cent of 563 firms sampled in Kampala, Jinja, Mbale, Mbarara and Lira took part in some form of tax evasion. However, during the open forum conference in August, former finance minister Saida Bbumba said some people evade taxes because they do not see the value for the taxes paid. She said government should ensure proper service delivery to encourage tax payments.
“The reason why Uganda collects less tax than some other countries in east Africa is because some people do not want to pay saying they do not see how their money is used. They want accountability,” she said.
In April 2014, the government embarked on an exercise to register every citizen of Uganda to be able to locate and know the people in the country. The exercise that is still ongoing is also a tool used by ministry of Finance to enforce formalisation of business.
The state minister for finance Mr David Bahati said the medium term strategy for URA this year aims at formalising the informal sector, youth empowerment and job creation. He said this will be done through the new reforms set up by the ministry.
“The new reforms that we are doing; the national identity card registration, the registration bureau is also registering companies, knowing who they are, issues to do with TIN by URA so that every company is registered, and incentives will be part of the formal sector,” he said.
The president, Mr Yoweri Museveni, has also come out to personally take a step in formalising the informal sector by donating money to Saccos and associations through bringing them together to get registered and financial assistance. In July, he donated Shs100 million to Kkubiri Furniture Makers in Kawempe to empower small businesses.
Uganda Registration Services Bureau is working with Kampala Capital City Authority, the local government and Uganda URA to identify all kinds of businesses including to register them.
According to the bureau, more than 550,000 business entities were registered in the last four years, in all its seven regional offices under the World Bank’s Centre for Development, Environment and Policy (CEDEP) project.
Benefits of formal business
The regional Economic outlook on the informal economy in sub-Saharan countries indicates that as the formal sector increases through movement of informal entities to the formal sector, productivity gains are likely to materialise and the tax base is likely to expand, facilitating the revenue required to finance public services to sustain development.
In cases of tax evasion, the cost/benefit assessment challenge is eliminated since productivity is high, formal business also have fixed assets and location of the enterprise is available, cutting on costs used during debt collection.
Once a business is formalised, it gains access to credit facilities, earning credibility since it is not a risky investment thus empowering the business to increase its capital and cut costs of doing business.
Ms Bbumba said the enterprises in associations get trainings and open markets to diversify their product demand.
Former finance minister Syda Bbumba believes that formalising the informal sector moves in tandem with education, facilitation and markets. She also believes that Saccos and forming associations that will encourage registration are vital if government is to achieve its formalisation goal.
She also says informal businesses should take a step in getting formalised because vast opportunities come with it such as open markets and easy credit facilities.
“Once you formalise your business, it becomes more stable, and you enjoy a number of benefits since you can borrow. But when you are an informal business, nobody wants to associate with you because you are unreliable,” she said.
However, executive director of National Planning Authority, Mr Joseph Muvawala, believes registering alone will not suffice. He said the only way government will encourage voluntary formalisation of business is through offering incentives and investing in enterprises.
“If you simply use registering them as a basis of formalising them, you will get nothing. They keep changing. There should be a strategy of formalising them through incentives such as loans.”
He also said for the incentives to be enacted, the finance ministry needs to create affordable financing for people to formalise through loan incentives.
Nature of informal business
A study by Financial Sector Deepening Uganda in 2015 concluded that informal businesses because of lack of capital to survive apply and depend on loans with over 40 per cent having applied for loans for capitilisation.
The businesses also operate in open areas such as streets, lake shores and containers or their homes. 60 per cent were found to use formal office premises while only 28.1 per cent keep business records.
Access to credit
According to World Bank, one in 10,000 entrepreneurs are able to successfully obtain credit. This is because many of the informal sector businesses lack security to guarantee servicing of loans offered. This, in turn, slows the growth and productivity of this sector.
Formal versus informal
IMF ascertained productivity of the informal sector is approximately 1/5 of the formal sector stressing the need for an improvement in policies geared towards growing the informal sector productivity since formalisation takes a long time.
Policy makers should create an economic environment in which the formal sector can thrive while creating opportunities for those working in the informal sector to improve their standards of living.