Small business taxation reform needs accountability and consistence of policy

The main goal of small business taxation reform is to further participation in the formal economy and build a culture of compliance.

Yet in Albania we do have important non-tax barriers to formalization. Minimizing compliance cost goes beyond taxation issues and should include other start-up and operations procedures (i.e. business licensing and labor regulations). Bringing small operators into the formal economy requires their trust in the tax authority. Perceptions can be changed through improved outreach, services, and public-private dialogue to engage the private sector in the reform process from the outset.

Reforms to foster private sector development and to support innovation and growth, therefore, need to address and eliminate obstacles for small business formalization and increasing the level of tax compliance.

The overall level of tax compliance in a country is determined by a number of factors. These are partly business-related and partly reflect the economic and social environments. The educational level of small businesses, the general tax morale in the country, and the fear of the tax authority can also be important factors in this context.

Small business taxation should be designed with minimal compliance costs, requirements commensurate with taxpayer capacity and skills (in accounting, for instance), and very few interactions with government officials to limit opportunities for corruption. Compliance should be linked to the benefits of being formal. The administrative costs of dealing with small taxpayers must be kept to a minimum for resource and capacity constrained tax authorities. Combining and reconciling these objectives into a detailed and actionable strategy is difficult; tax policy-makers always face trade-offs between simplicity, fairness, efficiency, and administrative feasibility.

To tap into the growth potential of informal businesses, it is important to target those likely to benefit significantly from becoming formal. These entrepreneurs will see value in accessing new markets and financial services and in realizing security of tenure and investments.

Thresholds should be set to distinguish between three levels: i) subsistence micro-activities, ii) small firms, and iii) medium-sized operations. These thresholds will inevitably create incentives and result in strategic behavior among firms, so any special presumptive tax regime needs to include safeguards against abuses.

Small businesses are not necessarily small earners. Rates need to be high enough to encourage firms at the upper end of the threshold to join the general system and low enough to encourage informal entrepreneurs to comply. This process requires extensive survey-based analysis of small firms’ profit margins to determine presumptive tax rates.

Simplify the general system or create a special regime?

At the end of all reform propositions there are basically two options. First, reform measures can offer a simplified procedure based on the general provisions of the existing tax system. The same instruments apply, but they are streamlined for smaller firms. This approach is relatively common in more developed economies and seems that Albania has chosen this option.

The simplest approach, a presumptive tax based on turnover may well be the most appropriate solution for many developing countries with large informal sectors.

Presumptive systems are usually based on turnover, assuming that most firms monitor their cash receipts, or on specific indicators (for instance, floor space, number of employees, or electricity consumption) or a combination of the two.

Second option, is to approximate the small business’ taxable income as its cash flow, which is defined as the difference between cash receipts and expenses. The cash flow system has more record-keeping requirements than turnover- or indicator-based regimes, but is better suited in graduating firms to the general system. Turnover can be taxed directly at a low rate, or used to determine estimated income based on a factor approximating profitability.

The main idea behind all presumptive schemes is to reduce the time and costs of compliance and tax administration. These regimes trade fairness for simplicity and may introduce distortions into the system.

Indicators are usually crude proxies for business profitability. Turnover-based systems are burdensome for firms with low profit margins and generous for those with high margins. Special simplified regimes for small firms are in demand and frequently recommended to promote compliance.

Many developing countries already use some sort of presumptive tax systems for small contributors. Results are mixed. Again, the main challenge in most countries is to make presumptive taxation work on an administrative level.

Whether or not a special tax is introduced, a special administrative approach for small firms is indispensable. Low compliance costs are essential to encourage formalization, because the time and financial burden of complying with tax reporting is relatively higher for small firms.

Local government often plays a critical role in the tax administration of small operators. Municipal levies may inhibit the creation of formal enterprises.

Coordination between government agencies is usually poor, with inconsistent local and central government policies and multiple non-transparent taxes, fees, and non-regulatory licenses at the local level.

This dynamic provides ample opportunities for corruption and increases both firms’ compliance costs and the administrative costs of local authorities. Creating a successful small business administration is thus closely linked to the success of local capacities and administration of taxes for small businesses.

But, since the tax administration of small businesses is not in good track, seems that other options need to be found to solve the problem of tax corruption and lack of capacities to deal with small business problems and issues.

A complementary option to locally run small business taxation is to outsource the administration of small firms to the private sector.

While controversial, private collection is not a new concept and can help government reduce administrative costs and achieve more efficient tax administration. However, the state’s long-term interests to expand the tax base and encourage growth tend to conflict with private collectors’ interests in making (short-term) profits.

Government also needs to ensure that taxpayer abuses are avoided. Thus, while privatization reduces the direct costs of administering taxpayers, it requires substantial and costly monitoring efforts by governments to ensure justice and equity. As a result, privatization is recommended only for a few functions that can be easily screened and require little discretion of the private administrator.

Technology may open additional options for public-private cooperation in administering small firms. E-filing of tax returns to reduce administrative and compliance costs is now a reality for Albanian small businesses and offers good opportunities for capacity-constrained governments to cooperate with the private sector. Although the scope for full e-government solutions may be limited with heavy infrastructure constraints, there may still be widely applicable solutions based on technology already in use.

For example, tax payments via mobile phone-based banking systems could allow businesses to pay taxes and fees directly, thus reducing interactions with tax collectors and ensuring that payments arrive at their destinations.

As a final opinion, looks that a new design of instruments is often necessary to make administrative improvement possible, but insufficient without reform of day-to-day administration.