The growth of informal economic activity has become a challenge throughout the Latin American region.
To address this, the Swiss-Chilean Chamber of Commerce recently held a webinar to discuss the challenges of informality (in employment, government, taxation), as well as the actions that policymakers, in the region and elsewhere, could take to halt an increasing trend resulting from the COVID-19 pandemic.
The webinar included a distinguished panel of specialists: Mr Fernando Barraza, current head of the Chilean Tax Authority (Servicio de Impuestos Internos – SII); Mr Norman Loayza, Director of the Global Indicators Group at the World Bank in Washington, DC; Ms Paulina Nazal, Consultant to the International Development Bank (IDB) and former Director General of the Office of International Economic Affairs for Chile; and Ms Jeannette von Wolfersdorff, Founder of the National Fiscal Observatory in Chile.
Mr Barraza began the webinar by presenting a paper titled: ‘The harmful effects of informality for the SII and implications for the development of good public policies’.
Although Mr Barraza was representing a tax authority, he made it clear that he did not believe economic informality was strictly a taxation/evasion issue. He went on to say that ‘this is a phenomenon which is extremely difficult to control, since many of those who operate ‘informally’ are not normally registered as regular taxpayers,’ making traceability of their activity complex at best.
Mr Barraza focused on areas of particular concern for the SII. He pointed out that in 2019, the tax authority identified 4,109 importers that were regularly using web platforms. Of these, 36% did not pay VAT. Due to COVID-19, in 2020, the number rose to 6,806 and non-VAT payments rose to 37%. Moreover, in the last quarter of 2020, informal transactions via e-commerce accounted for 13% of the total market and represented over $1.6 billion.
With regard to the tobacco industry, the SII estimated that 21.4% of cigarettes consumed in the country are illicit.
And in the fishing industry, SERNAPESCA (the government area responsible for regulating and supervising this industry) estimated illegal fishing to be over $300 million. Mr Barraza stressed that, more than just the tax implications of informal commerce, ancillary problems such as the over-harvesting of marine products, are also the result of informality in the economic cycle.
Estimates of total informal economic activity for Chile in 2018 range from 16-17% of GDP, compared to a regional average of around 30%. Mr Barraza theorised that both numbers have risen sharply due to COVID-19, especially in the e-commerce area, which is a tremendous challenge for any tax authority, as it is not an easily defined area to target.
Although preliminary information has not been completely updated, Mr Barraza believed that the final analysis may well show a doubling of previous informal economy numbers, as well as the subsequent tax evasion.
As part of the SII's strategic focus to promote compliance wherever possible, the institution has stressed the importance of prevention as well as structural and corrective measures. These include, but are not limited to:
1. Public education and making compliance simpler – many first-time taxpayers find the existing structure and rules daunting, complex and difficult to use. For this reason, the SII has set up an entrepreneur web page and Q&A emails for first-time taxpayers, as well as a guide for start-ups to establish their own e-commerce systems within the appropriate formal tax structure. Market data such as pricing for taxed products is also available so that those interested can know if they are purchasing a legal product.
2. Better information and usage of available data – the SII maintains a constant exchange of information with other governmental areas, such as SERNAPESCA, including analyses of existing businesses and potential tax risks, and identification of unusual activities in each industry.
The SII also uses machine learning, based on existing tax activities and potential risks or changes that require further action, and it has also set up an anonymous site for consumer complaints.
3. Promotion of the ‘morality of taxation’ – this entails constantly working with other areas, not just government, but also civil organisations affected by informal competition. The SII helps to provide training and data, as well as helping to promote consumer motivation to purchase legal goods.
Ms Jeannette von Wolfersdorff commented that ‘informality implies operating outside of the legal system, of the formal economy. The reasons behind this are often when the state or society is not functioning appropriately. When COVID hits, these areas that don't function well, those that feel injustice in the system, will also take this opportunity to increase their informal activity’.
Without justifying the move of less empowered individuals´ towards informality, what is most damaging is when large corporations are seen to promote, tacitly or not, informal commercial activity. This is a global issue (and does not just apply to Chile or Latin America) that is often seen by small operators/entrepreneurs as an incentive to evade taxes.
The morality of taxpaying is seen as unfair, as the public is aware of how large corporations use a legion of attorneys to avoid taxpaying, said Ms von Wolfersdorff. In many countries where equality is perceived to be an important social issue, small entrepreneurs will use informal commerce to improve their situation, coupled with a feeling of righteousness that they are doing this to feed their families or employees. This contrasts with large corporations, which are only trying to avoid taxes in order to increase their wealth.
That is why it is so important to stress to large companies that they should be ever more transparent and ethical in their behaviour, in order to promote a ‘morality of taxation’. Without all economic actors being perceived as ‘moral,’ informality will continue to be an issue.
Ms von Wolfersdorff stressed the importance of the role of the state as a regulatory authority, given that the autoregulation of markets has shown to be not as effective in reducing informality and illicit activity as originally hoped.
How can informality be reduced?
Mr Normal Loayza then presented a recent World Bank Study titled, ‘Informality: Why is it so prevalent and what can we do to reduce it?’
Appropriately, in agreement with Jeannette's comments, Mr Loayza mentioned that in countries where state use of tax income is inefficient, corrupt, or absent, informality will naturally be the best option for many members of society.
Mr Loayza confirmed Mr Barraza's figures, stating that 30% of Latin American nations' GDP is produced in the informal sector and, moreover, that over 70% of its workers are currently employed on an informal (and precarious) basis. Chile and Uruguay lead formality in the Latin American region, with Haiti leading in informality.
The positive side of informality is seen as employment options and flexibility, while the negative aspects are the inefficiency and risks associated with informality. As an example, Mr Loayza described a large informal textile market in Peru, full of workers and bustling with activity. In the next slide, he showed a similar market, in the same country, burned to the ground, due to the lack of any safety regulations.
Mr Loayza stressed that when attempting to promote a more formal environment, extreme measures don't work. Making formality too attractive is one extreme and heavily penalising informality is another. He believes that governments should move carefully along the axes of each extreme, using both of them in accordance with the country's level of need.
Francisco Mandiola is the Founder and Managing Director of Chilean-based consulting company FMA Secure, a strategic transformation advisory firm that helps both private companies and government entities in their adaptation to the latest digital and business environments. Francisco was a former Managing Director of the state-owned Casa de Moneda de Chile (the Chilean mint and security printer), where he led the team that presented several tax stamp innovation options to the Chilean tax authorities.