Informality is often defined as the failure to pay taxes due. And informality so defined is seen as a key challenge for the revenue systems of developing countries: so much so that “reducing informality” is often a central objective of tax reforms. The standard targets of such reforms are those engaged in the informal economy: that is, the self-employed in unincorporated enterprises and wage employed in unprotected jobs.
But there are several inherent contradictions to this standard approach. First, most informal workers earn too little to fall above the threshold for income tax. Second, many informal self-employed pay taxes of various kinds: operating fees, license fees, market rents. Also, many informal operators pay value added tax (VAT) on the goods or supplies they purchase to support their livelihood activities but often cannot charge VAT on the goods they sell or claim VAT rebates, as formal businesses can. Third, many informal workers are wage or sub-contracted workers who are not liable to pay payroll or corporate taxes. In brief, tax reforms targeted at the informal workforce will generate limited revenue and undermine already low average earnings.
But, as the Panama Papers have revealed, there is a deeper and more egregious contradiction to the standard approach to reducing informality through tax reforms. Namely, that informality defined as tax evasion or avoidance is taking place at an infinitely larger scale at the tip of the economic pyramid by large multinational firms, politicians and celebrities, than at the bottom of the economic pyramid by the working poor. In other words, the target of reducing informality so defined should be those at the tip of the economic pyramid—not at the bottom.
On April 3, 2016, a large batch of reports, known as The Panama Papers, were released linking 140 public figures, executives and celebrities around the world to overseas assets in offshore tax havens including Panama. Having an offshore company or account generally is not illegal, but the main reasons to go offshore are tax avoidance, tax evasion, concealment of assets or receipt of ill-gotten gains. For political figures who have offshore accounts, how the funds were obtained in the first place is often the key question.
There is a growing critique of what has been called “informality from above.” This critique has focused mainly on the collusion between government elites and economic elites to avoid—or make exceptions to—regulations, such as those governing the use of public space and resources. This critique needs to be expanded to focus on avoidance or evasion of taxes by government elites and economic elites. If measured in terms of lost revenue and ill-gotten gains, informality from above is infinitely larger and more egregious than informality from below.
Targeting tax reforms at those at the tip, rather than the bottom, of the economic pyramid would have several dividends. First, the revenue dividend would be infinitely larger. Second, it would serve to reduce income inequality. And, third, it would help reduce the widespread feeling among the poor and disadvantaged that the economic system is rigged against them in favor of the economic and political elite. The working poor know that they pay taxes of various kinds but get few benefits in return. They would like to see the stigma of avoiding taxes and regulations shifted to the economic and political elite.
Top photo by Juan Arredondo/Getty Images Reportage