Barriers to Formalization of Businesses In Cameroon: High Tax Rates

FISCAL POLICY LETTER  N^o3: Barriers To Formalization Of Businesses In Cameroon: High Tax Rates

Foreword

Clearly expressed in its National Development Strategy 2020-2030 (SND30), Cameroon’s desire for the coming decade is to achieve sustainable growth driven by the manufacturing industry. Thus, the government hopes to increase (i) manufacturing value-added from 14.5% in 2017 to 25% in 2030 and (ii) the share of manufacturing exports to 54.5%. However, in the absence of an efficient industrial sector, the economy tends to specialize in the “end of the chain” activities, including extraction (mining and oil) and subsistence agriculture on the one hand and trade and services on the other.

According to the Third Survey on Employment and the Informal Sector conducted by Cameroon’s National Institute of Statistics in 2018, nearly 90% of the Cameroonian labor force remains trapped in the informal sector. The sector comprises a set of individual companies – generally nonagricultural – that operate on a small scale and are not registered with the competent authorities. Many entrepreneurs choose to operate informally because of barriers to formalization. For example, businesses spend an average of 624 hours to make 44 payments per year to the tax authorities. The total tax rate remains one of the highest in Central Africa, at 57.7% of business profits than 47.1% in Gabon (World Bank, 2020).

While the informal sector offers employment and income opportunities to more than 50% of the labor force that would otherwise have no means of survival (African Development Bank, 2020), it nevertheless constitutes a real obstacle to the achievement of emergence objectives. To contribute to the strategies put in place by the government to promote the formalization and competitiveness of local businesses, this third edition of the Fiscal Policy Letter, entitled “Barriers to Formalization of Businesses in Cameroon: High Taxes Rates,” presents some possible solutions.

Beforehand, we determine the factors that explain the informality of companies in Cameroon. Drawing on the definition of informality as introduced by the British anthropologist Keith Hart in 1971 – then expanded by the International Labour Organization in 1972 – it emerges that informal firms are distinguished from formal firms by the absence of protection and official recognition of employees, family ownership of their activities, low incomes and wages. Among the elements that explain the informality of these firms are: Limited absorption of surplus labor by the formal sector, high tax burdens, regulations in force, and corruption. We note that the informal economy plays an important role in job and income generation. Its existence responds to the needs of poor consumers by providing them with accessible, low-cost goods and services.

Following this article on the explanatory factors of the informality of companies in Cameroon, it seemed appropriate to analyze the nature of the relationship between taxation and economic growth. Using an error-correction model on secondary data from the World Bank between 1989 and 2018, we show that taxation negatively and significantly influences economic growth in Cameroon. Indeed, a 10-percentage point increase in tax revenue would contribute to a 9.5 basis point decline in growth. To reduce the tax burden on SMEs, which discourages formal private investment and consequently growth in Cameroon, we recommend that the authorities use non-tax revenue mechanisms to finance public goods and services.

The third article focuses on the link between the informal sector and tax revenue mobilization in Cameroon. Concerning the socio-demographic profile of the main actors, we point out that the taxation of their activities is particularly aggressive. Suppose the budget deficit necessitates either resorting to indebtedness or increasing tax revenues to be financed. In that case, we show that it would be more rapidly resolved with the formalization of 90% of informal enterprises. This would also guarantee a degree of sustainability in public finances.

After highlighting the impact of taxation on tax revenue mobilization in Cameroon, we examine the implications of high taxation on local production units. We confirm the view that high taxation remains the main obstacle to the formalization of informal production units. To achieve this, we recommend that policymakers ensure that tax rates reflect their operating costs.

We finish the letter with an analysis of the transitional dynamics of Cameroonian companies to the formal sector. We estimate a simple regression model using annual World Bank data over the period 1991 to 2019. Our results highlight some strategies for the formalization of firms in Cameroon. We show that a 10% decrease in the tax burden on firms contributes to a decrease of about 4% in the number of firms operating in the informal sector. The improvement of the business environment, notably through the strengthening of fiscal transparency and the legal and administrative governance of small and medium enterprises, would promote a faster transition of many informal sector enterprises to the formal sector.