Local taxes and fees as impediments to SME formalization

1. Local taxes and feesas impediments to SME formalization What is being done? Laurent Corthay PSD Specialist, WBGKIGALI - APRIL, 23, 2009

2. Content • Local fees as revenue instruments • What is the issue? Why does it happen? • How are local and fees affecting the business environment • Impact on SMEs and impact on formalization • Impact on the administration • What can be done? • Regulatory fees simplification: an integrated approach • Example from Yemen • Conclusion

3. Local revenue instruments: focus on fees • When talking about local revenue, in Tax Forum, standard taxes come to mind including: • Land and property taxes • Surcharges/piggyback on “national” business taxes (e.g. CIT) • Taxes on trade (e.g. octroi in India) • User charges (e.g. price for utility services) • Here, focus on other “non-tax” payments, often tied to regulations of business: • General trade/business license fees (presumptive levies) • Patente and forfait • Plethora of other fees

4. Local fees as revenue instruments What is the problem? • Complex web of local taxes and fees => not just a “tax” issue • Local fees/regulations proliferate and hamper business and investment • From a business standpoint difference between taxes and fees is blurred Why does it happen? • Fiscal decentralization: local authorities asked to deliver services; need for own source revenues • Weak revenue bases from standard taxes (most productive taxes are kept at central level); insufficient intergovernmental transfers; inability to borrow • Limited authority to raise taxes vs. discretionary regulatory power => fees as easier tax handle • Corruption: complexity creates opportunity for rent-seeking • Cost/benefit: inefficiency of regulatory fees is not on the radar screen Local authorities rely on regulatory fees to fill their coffers

5. How local taxes/fees affect the business environment? Burdens on businesses: • Effective financial burden: total package of tax + fees; • High compliance costs: multiplicity of instruments and requirements; • Lack of predictability (new fees/regulations introduced any time); • Perception of a heavy tax burden; confusion with multiple “tax” inspectors; Costs to administration: • Regulating is costly, absorbs scarce qualified HR; • Inefficient revenue generation tool => often “nuisance” fees which cost more to administer than revenue generated • Lack of transparency: complex revenue generation architecture; • Lack of accountability: who collects/receives revenue, for what use?

6. Example: Taxes and fees of a Hotel in Sana’a • Operating fee (District; 500+ categories, annual) • Professional permits fees (Governorate; other categorization; annual) • Registration fee (Ministry of Trade; annual) • Membership fee (Chamber of Commerce; annual) • 3 Local Council Support fees – monthly surcharges on: • Electricity bill (1%); Water bill (3%); Phone bill (1%) • 3 City Improvement fees: • Surcharge of 5% on electricity bill; • Hotel and residency fee 5% • Annual fee of YR40k for 5-star hotels • Tourism tax: 5% daily fee on rooms • Zakat – religious tax (2.5% on capital) used as a business operation levy (split Gov/District) • Standard taxes: • Property and property transfer taxes; • Fuel tax; • Earmarked contributions to social, transport, and development funds Different bases, agencies, payment procedures, inspections

7. Impact on SMEs • SMEs are affected disproportionally more • Fees are often fixed amount, weighs heavier on low turnover • No dedicated finance/accounting staff => absorbs manager times • Less leverage or protection against abuses (e.g. inspections) fees – patents market cess – charges business license – permit fees – property tax – motor vhc tax and more…

8. By contrast, larger “trucks” / firms can handle heavier “weights” / compliance costs

9. How local taxes and fees impact informality • Liberia Informality Survey (2007): • 66% of firms think formalization is good, yet ~75% are informal: • Why? 53% mainly to avoid taxes; 45% mainly to avoid licensing procedures incl. local (less than 5% have the proper licenses) • But this is costly: 20% informal firms pay an average 10% of annual revenue per year to maintain informal status • Sierra Leone Informality Survey (2006): • 80% cite high compliance requirements andlack of information as causes for licensing informality => only 1 copy of licensing & fees available at Freetown City Council • Most firms at District and 40% in Southern Region are believed not to report turnover => perceived high fin & admin burden at local level • Potential for formalization: 56% of informal firms would “seriously” consider if information was more widely available

10. When the “cost” of formalization is too high… • Businesses stay out of the formal economy and can get a “free-ride” • However: more risks, less opportunities (esp. access to finance) • Serious limitations to business growth… • Government is not reaching revenue potential • Spurs vicious cycle of “squeezing” the few compliers => ticket price↗

11. How to bring the costs down at local level? • Simplification of local fees and taxes • Focus on administrative or regulatory fees, “quasi-taxes” or parafiscalité

12. Approach to local fees simplification • Objective: Overcoming misuse and proliferation of regulatory fees at the local (and sectoral) levels • Why? Using “regulatory” instruments in lieu of “taxes” often is: • Not business-friendly • Not cost-efficient • Not transparent • Arbitrarily administered and open to corruption • How? Integrated tax and regulatory approach, considering: • Legality (is it allowed/supported by the law?) • Nature (is it a tax or is it a fee?) • And regulatory purpose (safety, health, environment, etc.)

13. Legal? Regulatory fees simplification: the approach • User fees and charges • Maximize use, and set fee as cost-recovery plus return on investment Comprehensive inventory Elimination / legalization • Nature of instrument? • Standard taxes • Apply principles of revenue productivity, accountability, equity, simplicity and non-distortion • Regulatory fees and charges • Licensing and permit fees • Business patents, and other charges Interests, royalties and rents Fines and penalties • Purpose of instrument? • Revenue-generating purpose: de facto a tax • Merge into one local business levy • Eliminate and address revenue loss through tax policy and transfers • Legitimate regulatory purpose • Set fees on cost recovery basis • Streamline procedures to limit compliance and administrative costs

14. Yemen: local taxes, fees reforms and SMEs • Introduction of an SME regime • Exempts small firms from income tax under $3600 turnover threshold • Introduce “patent” or “small business fee” (presumptive tax) • Integration with local taxes and fees reform • Most duplicative fees collapsed into one “local business fee”, which will be same as “patent” for SMEs • Collection and assignment of revenue to local authorities, not RA • Simplification instead of “one more instrument” => businesses are effectively relieved • Relieves RA of administration burden • Strengthened / more transparent local revenue source

15. What is going on in your country? • Patente synthétique in Francophone Africa. • Does it really synthesize all or mostother parafiscal / fee payments? • Single Business Permit in Kenya: • Meant to replace all “general business licenses and payments”; also has some regulatory function • But has it achieved its objective? Resurgence of fees at local level • What are your experiences?

16. Thank you Any question?