World Bank and IMF use flawed logic to eliminate the informal sector

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The Africa Conversation


MANY low- and middle-income countries face a myriad of challenges. But policies that can remedy this are few and far between. The challenges include high and growing inequalities, fiscal crises and the ongoing pandemic.

In a series of recent publications, the World Bank and the International Monetary Fund (IMF) have presented an approach that they believe can tackle all three crises at the same time: tackling informal economies.

Their arguments are based on the claim that informality undermines efforts to both slow the spread of the pandemic and spur economic growth. They also believe that abolishing informality will lead to increased tax revenues.

However, based on our organizations’ extensive research on informality and taxation, we argue that their analysis is fundamentally flawed in its understanding of both the causes and consequences of informality.

It is not a simple academic question. Their reports endorse policies that will fail to deliver on their promises of growth and higher tax revenues.

Blaming informal workers, rather than the structural conditions that leave them with no choice but to informal work, effectively blames the victims of global inequality while questioning why they are not lifting themselves up by their bootstraps.

Moreover, what is presented as pro-poor interventions in the reports may in fact actively increase inequalities and further disadvantage vulnerable populations.

Blame the symptoms or structures?

Recent flagship reports and accompanying IMF and World Bank reports demonstrate a somewhat casual approach to causation.

They do this by presenting informality as a cause rather than a symptom of a weak or faltering economy.

The authors of both reports are setting out on safe ground. They observe that countries with high levels of income inequality also generally have high rates of informal employment (informality).

They also correctly note that they cannot demonstrate causation and that there is no “one size fits all” policy approach.

But the reports then drop their own caveats when it comes to policy analysis or recommendations.

Demonstrating a similar logic, a World Bank blog, for example, insinuates that an increase in unemployment in Peru is the result of informality, rather than the Covid pandemic.

This is not just a harmless analytical sleight of hand or a benign semantic error. The result is that most of the policy recommendations that emerge from this analysis are aimed at eliminating the informal economy. They suggest that by simply removing informality, then inequality would decrease.

The World Bank’s bizarre approach to causation allows it to frame any policy that suppresses informality as also tackling inequalities, while largely ignoring a broader set of targeted interventions aimed at improving livelihoods. livelihood, security, stability and income for the most vulnerable workers.

Informality and taxes

The second fundamental flaw in the analysis of the reports concerns the assumption that eliminating informality will automatically increase tax revenues. This is based on the idea that tax evasion is “at the heart of informality”. This is then integrated into key concepts and measures.

However, this simply does not correspond to the reality of informality or taxation in much of the South.

Tax evasion does exist, including in a subset of the informal economy. But the analysis still distorts the majority of the sector. More importantly, he confuses deliberate evasion with non-payment of taxes by workers who would generally be well below tax thresholds.

Indeed, a large part of employment in the informal sector is made up of survivalist own-account operators. They are likely to earn too little to substantially “evade” tax.

In emerging and developing countries, direct measures of informal employment show that 78.1% of all economic units are self-employed in the informal sector.

This is even higher in African countries at 87.3%. In contrast, only 4.4% are informal sector employers.

Another indication of limited tax liability, the share of the working poor in informal employment ranges from 50.4% to around 98% in developing and emerging countries (at 3.10 USD PPP per capita and per day).

Informal workers pay taxes – despite these low income levels. The regressive way in which the informal sector is already (over) taxed is well documented.

For example, a 2013 World Bank study of informal microenterprises in Uganda found that 70% were below national business tax but still paid a substantial portion of their profits to local authorities. The poorest paid the highest share of the profits.

Carrot and stick

Based on their flawed premises, these analyzes further assume that the informal economy can be eliminated by reducing taxes for formal businesses (the carrot) while increasing taxes for unregistered or informal businesses (the stick).

For example, the World Bank argues that it is necessary to

Streamline tax regulations to reduce the cost of formal operation and increase the cost of informal operation.

But this understanding of the root causes of informality and the benefits of formalization is unfounded. It also leads to policies that do not generate much tax revenue, while actively diverting attention from policies that can help people in informal employment.

This often happens in two ways. First, policy interventions aimed at better “including informal economies in the tax net” – or formalizing them – are often sold with bold promises of the potential government revenue they can generate. This suggests that informality hides a “gold mine” for public coffers.

But many informal workers are not eligible for national taxation due to their very low income. The risk is therefore that little income is actually reported – while adding additional financial burdens to the poorest groups in society.

Above all, they can serve as distractions from the taxation of economic actors who could generate significant income. These include politically related businesses or unregistered independent professionals such as lawyers and dentists.

Second, focusing on taxation risks crowding out the meaningful support that people working in the informal sector need. People in informal economies face real and complex challenges: they range from harassment by authorities to unsafe workspaces, low income and lack of access to finance or social safety nets.

Focusing primarily on eliminating informality risks giving the impression that formalization can occur simply by putting people on tax records or reducing “costs of formality”.

This ignores the question of what the benefits of formality are and how accessible they are. And it risks distracting attention from the large and complex set of reforms that are needed to support people both in informal work and more broadly in vulnerable work.

A more productive path

The policy recommendations that flow from this reasoning will not be helpful in tackling inequalities. In fact, they can actually increase it by failing to address the underlying issues that lead to informality and informal employment.

Indeed, the suggestion that redistributive policies are bad for the poor in the informal economy, but that higher taxes are good for them is a confusing conclusion at best and deeply cynical at worst of the reports.

Rather than focusing on eliminating the informal economy, influential international actors like the World Bank and IMF and national policymakers would have a greater impact on inequality by focusing on progressive taxation and expansion. social protection for the poor, regardless of their employment status.


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