Tuesday, January 18

The World Bank and IMF are using flawed logic in their quest to end the informal sector


Many low- and middle-income countries face myriad challenges. But the policies that can address them are few and far between. Challenges include high and growing inequality, budget crises, and the ongoing pandemic.

In a set of recent results, the world Bank and the International Monetary Fund (IMF) presented an approach that they say can tackle all three crises at the same time: combat informal economies.

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Their arguments are based on the premise that informality undermines efforts both to slow the spread of the pandemic and to boost economic growth. They also believe that abolish informality will lead to more tax revenue.

However, based on our organizations’ extensive research on informality and taxes, we argue that their analysis is fundamentally flawed in its understanding of both the causes and consequences of informality. This is not a mere academic question. Their reports support policies that will not deliver on their promises of higher growth and tax revenue. Blaming informal workers, rather than structural conditions that leave them with no other option than informal work, effectively blames victims of global inequality as they wonder why they are not recovering on their own.

Furthermore, what is reported as pro-poor interventions in fact runs the risk of actively increasing inequality and further disadvantaging vulnerable populations.

Blame symptoms or structures?

Recent flagship reports and accompanying comment both the IMF and the World Bank demonstrate a somewhat frivolous approach to causation. They do so by framing informality as a cause rather than a symptom of a weak or faltering economy.

The authors of both reports are starting from safe ground. They note that countries with high levels of income inequality also tend to have high rates of informal employment (informality).

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

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

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

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

The World Bank’s bizarre approach to causality allows it to frame any policy that cracks down on informality as also addressing inequality, largely ignoring a broader set of specific interventions which aim to improve the livelihoods, security, stability and income of the most vulnerable workers.

Informality and taxes

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

However, this simply does not match the reality of either. informality or taxes in much of the Global South.

In fact, there is tax evasion, even in a subset of the informal economy. But the analysis still mischaracterizes most of the industry. Fundamentally, it combines deliberate evasion with non-payment of taxes by workers who would normally be well below any tax threshold.

In fact, much of the employment in the informal sector is made up of surviving own-account operators. They are likely to earn too little to substantially “evade” taxes.

In emerging and developing countries, direct measurements 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.

As another indication of the limited tax liability, the proportion of working poor in informal jobs ranges from 50.4% to about 98% in developing and emerging countries (at US $ 3.10 PPP per capita 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 the national business tax, but still paid a substantial part of their profits to local authorities. The poorest paid most of the profits.

Carrot and stick

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

For instance, the World Bank argues what is necessary

streamline tax regulation to reduce the cost of operating formally and increasing the cost of operating informally.

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 distracting from Policies that can help those in informal employment.

This usually happens in two ways. First, policy interventions to “better include informal economies in the fiscal network,” or formalize them, are often sold with bold promises about the potential government revenue they can generate. This suggests that informality hides a ‘goldmine‘for the public coffers.

But many informal workers are not eligible for national taxes due to very low income. The risk, therefore, is, that not much income is generated – all this adding additional economic burdens to the poorest groups in society.

Critically, they can serve as distractions to tax economic actors that could generate significant income. These include politically connected businesses or unregistered freelancers like lawyers and dentists.

Second, focusing on taxes runs the risk of crowding out the significant support that people in informal employment need. There are real and complex challenges that people face in informal economies: they range from harassment by authorities to unsafe work spaces and low incomes and lack of access to finance or social safety nets.

Focusing primarily on eliminating informality runs the risk of creating the impression that formalization can happen simply by having people sign up for tax records or by reducing the “costs of formality”. This ignores the question of what the benefits of formality are and how accessible they are. And it runs the risk of diverting attention from the broad and complex set of reforms that are needed to support people in both informal work and vulnerable work more broadly.

A more productive way forward

Policy recommendations that follow from this reasoning will not be helpful in addressing inequality. In fact, they can increase it by failing to address the underlying problems that lead to informality and informal employment.

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

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

Mike rogan, Associate Professor, Rhodes University; Max gallien, Research partner, Institute of Development Studies, and Vanessa van den Boogaard, Research partner, Institute of Development Studies

This article is republished from The conversation under a Creative Commons license. Read the Original article.


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