Informality: a major obstacle for microfinance’s success

Though access to finance has improved the standards of living throughout the world, access to capital alone has not broken the glass ceiling of informality. Informal workers generally do not have access to legal benefits, are highly exposed to market fluctuations and lack physical and financial security. Micro Finance Institutions (MFIs) have tried to fill the gap of low income worker need for capital by creatively catering to high risk borrowers who are in their majority informal. But without the support of sound national legal systems, informal workers continue working in the margin of societies.

GFI led a public opinion survey in 2009 in Nicaragua and Guatemala under the program PILAR. The survey showed a cross section of informality in Guatemala and Nicaragua, increasing the understanding of barriers to formality in both countries. In both countries it was clear that informal workers surveyed did not have access to diverse formal services such as social security, public health and financial services. Only one out of three informal workers polled in Guatemala City was able to obtain credit when they needed it.

And in Nicaragua, the investment of personal funds to create a new business is disproportionately large, with 52% of interviewees relying on their savings to start a new enterprise.

Without registration of the self employed and informal enterprises, financial services will only have minimal impact. As recommended by the Central Bank of Sudan for the developemnt of commercially sustainable microfinance “informality must be addressed for microfinance programs to thrive”

Extending Social Safety Nets, Reducing Informality & Expanding the Tax Base in Emerging Markets: A Look At Tax Registry Programs in Latin America

Even before the current economic crisis, official statistics indicated that the informal sector in developing economies accounted for nearly half of total non-agricultural employment in East Asia, over half in Latin America and the Caribbean, and as much as 80 percent in other parts of Asia and in Africa. To promote sustainable economic growth, GFI is leading efforts in Nicaragua and Guatemala to extend labor rights and social safety nets to informal workers, while simultaneously creating incentives for formalizing businesses and expand economic growth.

GFI is currently leading national roundtable discussions to finalize a national strategy (roadmap) for formalization for both countries.

The strategy being discussed is a voluntary registration system that allows small enterprises to pay a monthly set fee, which covers payment of a variety of taxes as well as payments for social security, health care and other social safety nets.

In Guatemala, national roundtables are reviewing the implementation of such voluntary registration projects throughout the region. For example, in Argentina registration for small enterprises was simplified under law 24.977 (passed in 1998), abridging separate tax payments and formularies. This law established the monotributo mechanism, which includes sales tax, added value tax, social security payment as well as contributions to a selected social project. To qualify for this program, small enterprises only need to meet the following criteria:

- Invoiced annual incomes less than US$144,000

- Unit sale price under US$870 (except furniture)

- No importation of goods or services

On the first month of the start of the program back in 1998, registration increased to 604,598 tax payers, which represented 11.4% of the total number of registered tax payers that year. Though registration continually rose since the inception of the project, collection of payments remained elusive. These changed thanks to a second amendment, which took effect on July, 2004. The amendment added categories of payment, where payment amounts are now organized in accordance to:

- The amount of gross receipts

- Square meters in use by enterprise

- Electricity used

- Average unit of sale

As, published by the Argentinean taxation Agency in 2006, it wasn’t until he amendment came into effect that in 2005 payments started to increase in tandem with registration, as seen in the graph above.

Thus, cost was a critical matter for compliance, even greater than benefits offered. Benefits were not minor, enterprises registered under the monotributo, for example, do not generate tax obligations of the sales tax or profit, have no need to submit tax declarations, do not need to keep accounting logs, and have access to public health care. Though lessons learned have been noted, the program has been considered a success; not only due to the increase in registration but also a fiscal success, as contributions compensated tax collection costs.

Chile’s system provides informal workers access to pensions for disability, widows, unemployment, and retirement. However, recognizing the frequency of unstable employment, the payments do not need to be monthly; instead, contributions are based on 80% of the taxable gross income and can be paid annually through a tax affiliate. Independent workers who have not had an income are exempt from mandatory contributions but can do so on a voluntarily basis, still covered under the pension system through government subsidization. The Chilean government has recently begun providing independent workers with educational resources necessary to learn about their rights, entitlements, and obligations.

Increasing the availability of these social safety nets by designing programs that adapt to the irregularity of these informal workers would allow the informal sector to better fare economic downturns and reach economies of scale. These are key goals for developing nations that strive to achieve sustainable economic growth.