Formalizing The Informal Sector In Nigeria
posted by Michael Olafusi , on ,
The informal sector is generally regarded as the part of a nation’s economy that is not taxed nor regulated by government. In October 2015, the Federal Ministry of Labour and Productivity reported that the informal sector in Nigeria contributes about 60 percent of the country’s Gross Domestic Product (GDP) and employs about 90 percent of the nation’s workforce. Nigeria will hugely benefit from bringing mainstream that informal sector – regulating it, taxing it and, ultimately, turning it into part of the formal sector.
According to a World Bank report analyzing the informal economy across the world and using data from 162 countries over a span of a decade, the informal economy contributes an average of 17.2 percent to the global GDP. But the difference across countries are huge with developed countries having as low as 5 percent to 12 percent and developing countries having as high as 50 percent to 70 percent.
Figure 1: Size of the Informal Sector across the world (Targetmap, 2016)
The main reasons the informal sector exists are because people are trying to avoid government regulation, trying to avoid paying tax, unable to gain employment in the formal sector and are affected by poor government policies that make starting formal businesses very difficult.
In a research by the International Labour Organization (ILO) in 2002, the informal sector can be broadly split into two main categories:
1. People engaging in survival activities that fall outside the regulated and taxed formal sector, and
2. People engaged in illegal activities/businesses and are avoiding government regulation
Figure 2: The two broad categories of the informal sector
It is no coincidence that developed countries have much smaller informal sector compared to the developing countries. They have over time, with supporting public policies, enable people to legally start businesses, they have institutions set up specifically to support small businesses and integrate them into the formal sector, and they have well established and enforced regulations that prevent people from engaging in illegal business activities. The result has been increased tax revenue, growth of small businesses into global brands that employ more people and prevent them from engaging in illegal business activities, and accurate economic data for public planning as informal sector are never accurately measured.
For Nigeria to progress economically and be able to come up with effective data driven public policies, there is an urgent need to transition the informal sector into the formal sector. This can be achieved via four main strategies:
1. Supporting small businesses by simplifying the process of business registration, tax registration and tax payment.
2. Establishing institutions that support, fund and advise small businesses like most other developed countries have.
3. Giving tax incentives to registered small businesses instead of already big established conglomerates like Dangote Group.
4. Prosecuting illegal businesses to protect the legal ones from unfair competition that may disincentivize them from being registered and coming under government regulation
Currently, the process of registering one’s business with the appropriate bodies – Corporate Affairs Commission (CAC), State and Federal Tax bodies – is anything but simple. On paper it is simple. First, confirm from CAC that the name you want to use for your business is available and then reserve it. For sole proprietorship businesses you go to the nearest CAC office, fill and submit the business registration forms. For partnership and Limited Liability companies, you first get a lawyer who might double as your company secretary and he/she handles form filling at the CAC office. Technically, this should be an easy process but the reality is that it is only the name reservation part that often goes on smoothly. I have spent many days at the CAC office in Yaba, Lagos, interviewing entrepreneurs and lawyers trying to register all those three types of businesses. The CAC office opening hours are 10:00am to 3:00pm. Everything is paper and pen based. There are no clear guidelines for the first timer, especially the sole proprietors. And worst of all, if you don’t have a friend among the staff keeping a special eye on your registration request for you, there is no guaranteed date for your company registration to be complete. I have seen people wait for months to get feedback on their registration process, and that is after putting up with the often terrible customer service the CAC staff provides. All these make people unwilling to register their businesses except they will need to deal with clients who require that their businesses be registered. The result is that most small businesses, especially ones who operate a business-to-consumer (B2C) model and the consumers don’t care if the business is registered or not, do not bother to register their businesses. Registering with the Federal Inland Revenue Service and State Inland Revenue Services also require equally cumbersome processes. The government should smoothen this processes so as to encourage entrepreneurs to start and register their businesses from the day one.
The United States of America has SBA (Small Business Administration) department that assist small businesses with funding, counselling and other supports. Australia has SBDC (Small Business Development Corporation). South Africa has SEDA (Small Enterprise Development Agency). Canada has CSBFP (Canada Small Business Financing Program). We have MSME Development fund administered by the CBN. We have SMEDAN. But they are not operating optimally.
Many countries give incentives to small businesses to ease the starting phase. The United Kingdom has reduced tax burdens on small business and through its Department for Business Innovation and Skills made incentives worth £10,000 available yearly to small businesses. Nigeria does not have any incentives for small businesses. Now, when the business environment is very tough for small businesses, is a perfect time to provide such incentives.
Lastly, businesses operating illegally are not often prosecuted in Nigeria and take market share away from the registered and legally operating ones. The result is that more people are encouraged to ignore standards and regulations, set up business that operates unethically and illegally to save cost and maximize revenue rather. The trend should be halted.
If the government in Nigeria can put in place these four strategies, the informal sector will transition into the formal sector with immediate benefits like increased tax revenue and better economic data for the government.