**MONGOLIA'S INFORMAL SECTOR**

**Reasons for Growth**

**23**

-

vendors pay more tax than they would under the _Citizen 's Income Tax Law,_ while the boot repairmen are much better off under the system of flat taxes.

59. Box 6 elaborates on the difficulty that Mongolian authorities have had in understanding these important issues. While it is reasonable to expect citizens to pay taxes, special care should be taken when designing taxes for the irnformal sector. At the same time that the policy rhetoric is emphasizing poverty alleviation, support of micro-enterprise, and even the development of micro-credit, they are trebling the taxes that (lawful) infomial must pay. Counter to the goal of alleviating poverty, the _Informal Sector Income Tax Law_ hits the poorest of the informals hardest, impeding the ability of the poor to help themselves.

60. On balance, it is difficult to say how the different approaches to taxation between the formal and informal sectors are affecting growth of the informal sector. The _Informal Sector Income Tax Law_ may discourage entry to some degree, but many informals have little choice but to eke out a living however

# **The Popular Revolt Against the Informal Sector Income Tax Law**

Although the average incomes of some informal activities are frequently large relative to their formal counterparts, many informals earn considerably less than the average - it is these informals that are hit hardest by the _Informal Sector Income Tax Law._ The failure to recognize this fact led to policy mistakes sparking a popular revolt against increases in some taxes applied to informals during the spring of 1997. Proposed increases in vehicles taxes led to a threat by informal truckers to gridlock the nation's capital, and the trebling of the rates charged in the _Informal Sector Income Tax Law_ caused widespread dissent among informals. Although the new, higher, rates seemed modest relative to the _average_ incomes of informals, the new rates were clearly excessive for the poorer informals. Kiosks, for example, saw their monthly taxes go from 4,000 togrogs per month to 14,000 togrogs per month. Even under the old tax rate, 4% of kiosks were generating incomes below the official poverty line. **Under the new, higher, rates an additional 5% of kiosks were driven into poverty.** But even the more fortunate proprietors sensed the inequity of the law. Under the old rates, half to three quarters of kiosks were paying more tax than they would have under the _Economic Entities Income Tax Law_ or the _Citizen 's Income Tax Law,_ respectively. **After the rates were increased, 92% of kiosk proprietors were paying more tax than they would have under the** _Citizen's Income Tax Law._ Furthermore, the broadness of the categories of activities in the _Informal Sector Income Tax Law_ allowed - (required) discretion on the part of the tax collectors many petty street vendors with no permanent location were forced to pay the same tax as the largest, most profitable kiosks.

The popular discontent with the higher taxes on informal proprietors led to a policy reversal. The proposed vehicles taxes were vetoed, and once the dust settled, the _Informal Sector Income Tax Law_ rate applied to kiosks (for example) had been lowered from 14,000 to 6,000 togrogs per month.

# **Box 6**

_Source:_ Informal sector surveys conducted by the author.

they can. On the other hand, once someone has taken the informal path, the taxes they pay have no effect on the incentive to work hard, save, reinvest and grow. The simplicity of taxation of the informal sector may, on balance, be stimulating growth of informal activities. But it comes at the cost of equity, and if the taxation becomes excessive, or the perceived inequities becomes too great, the current approach to taxation of the informal sector runs the risk of driving law-abiding, tax-paying, entrepreneurs toward illegality.