Taxes–Necessary Evil or Blessing in Disguise?

> Posted by Mildred Callear, Executive Vice President, SEAF
This post is part of the Center for Financial Inclusion’s Expert Exchange: Building A Movement Toward Financial Inclusion by 2020, cultivating conversation around the goal of reaching full financial inclusion by 2020. For further questions about this series, write to Sonja E. Kelly, Fellow, Center for Financial Inclusion at ACCION International.
In the current political climate, and particularly at this time of year, it is rare that anyone speaks in favor of paying taxes! And when we think of financial inclusion, being included in the ranks of taxpayers is usually not the first item on the list.
But for those who operate primarily in the informal economy, NOT paying taxes can be the very thing that keeps them out of the formal sector and denies them a fair shot at real growth. Formal financial services are critical to breaking out of a subsistence level of business, yet even when informal firms have the choice to access such financial services, they may choose to stay out of the formal economy to avoid paying taxes and incurring other costs.
Joining the formal financial system means access to tools that can help create a better life, but it comes with a cost. Withdrawal fees on deposit accounts, transportation costs to get to bank branches, and revenue-related government efforts like taxes await potential microfinance customers when they start to operate on a more formal level.  In effect, there is a formalization penalty.
For small and medium enterprises (SMEs), these negative incentives can be even more daunting. For an informal yet medium-sized business struggling to find adequate financing to pay its employees, cover the costs of rented space and make essential capital expenditures, the prospect of paying taxes and becoming a firm that is “visible” to government officials can be enough to keep them out of the formal financial system.
As we think about actions to promote full financial inclusion, therefore, we find that positiveincentives beyond the actual financial tools are more and more important. Sure, we can point to access to credit as a positive incentive, but this on its own may not be enough. Beyond actual financial products, what other incentives can encourage SMEs to seek full inclusion in the formal financial system?
The Center for Financial Inclusion at Accion’s Opportunities and Obstacles paper listed “product range, informed by an understanding of client needs” as one of its action items. Indeed, the creation and maintenance of networks needs to be part of product development.
Imagine that you are one of the larger businesses in your community, employing a dozen people, and while you have gotten your business to this point, you don’t know where to go from here. A business network could offer you advice on how to move forward, how to grow your business, and how to avoid mistakes that others have made.
Although SEAF has been investing in SMEs in emerging markets for more than 20 years, it is only in the last five years or so that we have begun to build these types of networks with and for our clients. At the heart of these networks are our Centers for Entrepreneurship and Executive Development (CEED). CEED has a Top Class program that provides entrepreneurs business know-how through its accelerator programs, and also connects participants to successful local mentors and a community of entrepreneurs that can help take their small businesses to the next level. The holistic combination of market connections, community engagement, capacity building and access to capital seems to work.  One thing we have learned very clearly is that entrepreneurs don’t train themselves  (due to lack of money, commitments, ego, etc.). But they recognize the value of experience. They want to be around the right kinds of people who challenge them,   provide insight, have the right connections, and have blazed the path before. And they are willing to pay to be a part of this community of entrepreneurs in order to learn from each other and from their more experienced mentors.
This idea, of course, is not new. For decades, microfinance organizations such as Accion, Opportunity International, Grameen, FINCA, and others have been offering training and fostering networks through solidarity groups, village banks, and other group models.  But the solidarity group model started out as a means to assure repayments, and, with some exceptions, has not realized its potential to serve as a learning community.  In general, formal entrepreneurs are pretty independent actors and the group financing model is not part of their frame of reference. On the other hand, they see the benefits of creating a community and networks–practical knowledge, social and financial capital, and market access connections. And if the price for full inclusion in this community is formalization, the benefits may be enough to outweigh the frustrations of taxes or greater visibility to the government. A little creative thinking is in order.  For instance, governments can reduce the impact of the formalization penalty through staged implementation, tiered fees and positive incentives. Initiatives such as these would be a real boon to efforts to encourage full financial inclusion.
We can move people past the burden of the formalization penalty by offering them a greater value-add beyond just formal financial services. So while taxes may be a necessary evil in the eyes of many, let’s not forget that for informal firms, inclusion in the ranks of taxpayers may indeed be a blessing in disguise.
For more information, sign up for updates from the Financial Inclusion 2020 campaign.
Mildred O. Callear has more than 25 years of experience in the emerging market investment arena.  She serves as the Executive Vice President of Small Enterprise Assistance Funds (SEAF) and as a member of the SEAF Board of Directors. She serves on the Executive Committee and SEAF is a founding member of the Aspen Network of Development Entrepreneurs (ANDE), the first organization to focus exclusively on small and growing businesses in the developing world.
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