Opportunities and challenges for taxing the informal economy and subnational taxation

  • Dr. Thorben C. Kundt
  • Oct 2017
  • Knowledge, evidence and learning for development (K4D)
  • International

This report focusses on two distinct areas:

  1. the informal sector (which is, by definition, outside of the national economy), and
  2. the subnational level.

In particular, the report focuses on the revenue, growth and governance implications of taxation in these areas and provides some recent experience from developing countries.

A large informal sector is found to be a persistent phenomenon in low-income and emerging economies. Taxation, in turn, is often seen as a key ingredient of formalisation, and developing countries might benefit from increases in revenues, growth effects from improved productivity, and a more vital relationship between taxpayers and the state authorities. A key result of the report is that these effects, while convincing in theory, are often hard to assess empirically. They are also rather complex, which makes it difficult to draw some general conclusions whether informal sector taxation can lead to improvements in some or all of the above areas.

Regarding the subnational level, a common observation is that subnational governments (SNGs) seriously suffer from appropriate financial resources, particularly from own-source taxation. This might be a serious impediment for delivering local quality institutions, which in turn has some negative impacts on SNG governance. Subnational taxation might not only be a source of self-financing for SNGs, but also serve some broader growth and governance goals. Again, the implications of taxation for these areas are complex.