Informal Sector Taxation: An Approach to Expanding Nigeria’s Tax Base for Sustainable Economic Growth

Author: Kehinde Emmanuel Oladele | oladelekehindeemmanuel2405@gmail.com

The informal sector in Nigeria is a vital component of the economy, but it remains largely underexploited in terms of tax revenue generation. This sector, encompassing street vendors, small traders, and artisans, constitutes a significant proportion of the labor force and contributes meaningfully to the nation’s Gross Domestic Product (GDP). Despite its economic importance, the sector’s participation in formal tax compliance is disproportionately low. This raises an essential question on whether Nigeria can strategically leverage on the latent potential of the informal sector to broaden Nigeria’s tax base and stimulate sustainable economic growth? Addressing this question forms the primary focus of this research.

Meanwhile, to answer the above, we must look beyond the conventional tax systems and think about how we can make tax compliance more attractive, easier, and beneficial for those in the informal economy. Now, Nigeria informal sector makes up about 65% of the workforce, but it contributes very little to government revenue. This is a huge gap which the government needs to address if it hopes to reduce its dependency on oil revenues and secure a more stable and diversified economic future. Although, the challenge also lies in the fact that most informal businesses operate on a small scale and are often not registered with the authorities. They are cash-based, have no clear financial records, and many don’t see the need to pay taxes because they don’t feel they receive adequate services from the government in return. But if we look at other countries, like Kenya and South Africa, there are examples of how informal sector taxation can be structured to work. Kenya, for example, introduced a presumptive tax scheme for small businesses, allowing them to pay taxes based on estimated income rather than complicated calculations of actual profits. This model made it easier for informal businesses to comply without feeling burdened by complex requirements.

For clarification, Direct presumptive taxes are a way to tax individuals in the informal sector based on estimated income, especially when their financial records are unclear or unavailable. This method addresses the challenges of high tax collection costs and the burden of compliance for small businesses. To Joshi et al (2014) the approach differs by country; for example, Ethiopia imposes a 2% tax on turnover, while Kenya and Ghana use a 3% flat rate on turnover instead of VAT and income tax, and Tanzania follows a progressive system. However, it is to be reiterated that in Nigeria, presumptive taxes were introduced almost a decade ago in the year 2011 to help increase compliance among small businesses and informal sector operators, with the goal of broadening the tax base and boosting government revenue, and again emphasized by this writer.

For Nigeria, a similar approach could work. Implementing a presumptive tax system would provide a way to tax informal businesses without placing undue pressure on them. By using an estimated income model, we could simplify the tax process for small businesses, making it more manageable for them to comply. This would, in turn, help expand the tax base and increase the revenue available for the government to fund public services, infrastructure, and social programs that benefit all Nigerians. However, implementing an effective informal sector tax system requires more than just policy changes. As Torgler discussed in his research on tax morale, the willingness of individuals to pay taxes depends largely on their perception of the fairness of the tax system and the quality of public services they receive in return. This is where the Nigerian government has a unique opportunity to build trust with the informal sector. When people manifestly see the direct benefits of paying taxes, they are more likely to comply with tax laws. The truth remains that if we focus on improving public services that directly impact the informal sector, like the market facilities, transportation, and security, we can create a sense of reciprocity where tax compliance is seen as part of a mutual exchange between the government and the people. Then, the general saying on “give to Caesar, take from Caesar” would be practically accomplished as no one is ready to give without the expectation of taking or getting back. This realistically implies that; the Nigeria informal sector could cooperate when the government successfully utilize the proceeds of their Taxes paid into people’s development. In the same vein, the formal sector will desist also from Tax evasion and avoidance when the rightful things are done by the Nigeria government.

Looking at Nigeria’s tax-to-GDP ratio, which hovers around 10.86%, it could be gleaned that the country has room to grow in terms of expanding its tax base. For comparison, Kenya’s tax-to-GDP ratio is about 18%, while South Africa’s is around 28% and the giants of Africa is this regrettably low. This discloses a huge gap that needs to be closed. But how do we go about expanding the tax base when the majority of businesses are operating informally? The answer is in creating a tax system that is comprehensively fair and easily accessible. It is about making tax payments easier and making sure people understand the importance of paying taxes. This invariably brings us to the role of technology. Nigeria’s mobile money platforms are already being used by millions, especially in the informal sector, to conduct transactions. The hack is that; if our government can leverage these platforms for tax collection, it could dramatically increase compliance. Perhaps, we should envisage a system where informal workers can pay taxes directly from their mobile phones, without having to go to a bank or fill out complicated forms? This approach would undoubtedly simplify the process, making it more accessible and less daunting, which could encourage greater compliance. However, this author recognizes that a significant portion of Nigeria’s informal sector consists of individuals with limited education or none at all, many of whom struggle with basic literacy and lack the skills to navigate technological tools. This ultimately raises the question’; how effective would this system be in Nigeria, given these challenges?

I will say that there is more to it than just technology. Tax education and sensitization could contribute significantly in changing attitudes toward taxation. Many informal sector workers do not understand how paying taxes can benefit them, and this lack of knowledge can lead to outright resistance. Public awareness campaigns are needed to explain how tax revenue is used to improve the things that matter most to informal sector workers like the primary ones among others are; roads, security, healthcare, and education. If we can show how taxes lead to tangible benefits, we may see greater willingness to comply. In fact, the education barrier and non-accessibility of technology tools would not be a problem as the workers would by all means find ways to pay their taxes and the dreamed economic growth will automatically come with burdening any of the Nigeria citizen.

While this writer writes in favor of taxing the informal sector, it is to be noted that Taxing Nigeria’s informal sector is challenging due to several factors, among them are; the fact that many people lack a proper understanding of tax laws and the reasons behind paying taxes as explained above, with poor record-keeping being common or not existing in the informal sector. There’s a culture of tax evasion, multiple taxation, and corruption within tax authorities, making compliance even harder. Furthermore, the informal sector is poorly educated about tax responsibilities, and many feel there’s no benefit in paying due to poor infrastructure. The lack of proper databases and Tax Identification Numbers (TIN) complicates enforcement, while capacity issues within tax authorities, such as insufficient skilled personnel and equipment, further hinder efforts. Political interference also disrupts tax collection, as tax laws are often sidelined for political gain.

Therefore, to effectively integrate Nigeria’s informal sector into the tax system, a multi-faceted approach is imperatively essential. Firstly, it is recommended that simplifying tax processes, such as implementing a presumptive tax, will ease compliance for small businesses. Additionally, enhancing public services benefiting the sector and conducting widespread tax education will help build trust and improve tax morale. Also, issuing Tax Identification Numbers (TIN) and linking them to government services will further incentivize compliance within the informal sector. Most importantly, transparency in the use of tax revenues is crucial for reinforcing public confidence, the Informal’s are not ready when there is no transparent administration and policies, the government could as well employ the use of association of Tax collection. Addressing multiple taxation, establishing tax courts, and strengthening tax administration through well-trained staff will ensure effective enforcement. It is submitted that these measures will expand the Nigeria tax base, reduce reliance on oil revenue, and contribute greatly to this dying economy.

To sum up, it is important to emphasize that broadening the tax base by integrating the informal sector is fundamental to Nigeria’s economic growth and to maintaining lasting consistency in same. A well-designed framework for tax compliance within this sector has the potential to generate substantial revenue, significantly reduce dependence on oil, and foster a more diversified economy. Therefore, through the establishment of a more inclusive tax system that incorporates the informal sector, Nigeria can ensure long-term economic stability and sustainable development.

About the author

Kehinde Emmanuel Oladele is a dynamic law student at Ahmadu Bello University, distinguished by his passion for legal research and writing. His academic pursuits are focused on the intricate domains of Taxation and intellectual property. He has garnered acclaim through numerous publications addressing pertinent contemporary socio-legal issues. His commitment to scholarly exploration and insightful analysis underscores his dedication to advancing legal discourse.