Beware of Informality

Abstract

The words “taxes” and “informality” often occur together, and for good reason. In its currently most widely accepted definition, “informality” is failure by individuals or businesses to comply with regular tax obligations (and other regulations). Informality can hamper tax collection, but its consequences do not end there. Informal workers who are not covered by social security services lack protection against the risks of illness and economic insecurity in old age, and may not enjoy other benefits that their peers who are employed by formal firms receive. Meanwhile, firms that operate in the informal sector tend to operate on a very small scale, which in practice eliminates the risk of penalties. But operating on such a small scale may mean sacrificing productivity gains and possibly limiting access to productive resources, from credit to technology. Thus informality has costs for the economy and society that go far beyond loss of tax revenue.