MONGOLIA'S INFORMAL SECTOR Reasons for Growth _22_

# **Access to Premises? Not a Problem for Informals**

54. Informal operations, at least in Mongolia, rarely require a permanent place of doing business. Vendors at the various markets stake out their territory one day at a time, and informal transport carriers go where the market demands. Only a kiosk requires a permanent site. But even in the case of kiosks, - the amount of land needed is no more than a few square meters they are granted a place to establish operations as part of the licensing process. By contrast, formnal operations generally require a permanent place of doing business, and the supply of such premises is limited in Mongolia. There is still no private ownership of land,<sup>65</sup> and urban building permits are difficult to obtain.

# **Small Scale Means Independence from Formal Banking**

55. A significant barrier to entry faced by formal sector entrants is that credit is expensive and hard to find. Due to the scale of operations, however, informals can usually finance their activities through family savings or by borrowing from relatives. A sample survey of 30 informals<sup>66</sup> found that 20 had started their operations with personal or family savings, or by borrowing from family or friends with no interest; 8 had borrowed from family or friends with positive interest; 1 had borrowed from the organization where her husband worked; and the other, a street vendor of soft drinks, began her operations by borrowing from a pawn shop. This last case was the closest connection to formal finance - found during the survey none of the informals surveyed used commercial banks in any way.

56. Despite the relative ease of entry afforded informals by the limited need for finance, we must - remember that the informal sector defies stereotyping the average experience is not the universal experience. Although only about a third of the informals surveyed began their operations by borrowing money, those that did, did so at very high interest rates, averaging around 11% per monthli With inflation in the neighborhood of 3.5% per month, these are very high real interest rates, indeed.

# **Taxation of the Informal Sector - Rich Informals Win, Poor Informals Lose**

57. Formals and informals are taxed differently in Mongolia - indeed, this may be the best objective criterion for judging informality. Formal sector enterprises pay income taxes according to the rates in the _Economic Entities Income Tax Law,_ and their employees pay income taxes according to the rates in the _Citizen 's Income Tax Law._ Informals, on the other hand, pay a flat tax each month as dictated in the _Income Tax Law of the Citizens Who Individually Engage in Business Activities and Services Whose Income Can Not Be Determined Every Time._ (The latter is being referred to as the _Informal Sector Income Tax Law_ throughout this report.) Thirty-two categories of informals are covered by the _Informal Sector Income Tax Law,_ paying flat fees ranging from 60 to 4,000 togrogs per month in early 1997.68 58. The _Informal Sector Income Tax Law_ was written with practicality in mind. Informals frequently do not keep records, and to subject them to the formal income tax laws would be cumbersome. The - system of flat taxes makes for easy collection the tax authorities need only visit a shoe shine or a kiosk and demand either the tax or proof of prior payment. However, policy makers must understand that informals earn a wide rarige of incomes, and the imposition of such a flat tax inevitably means that poor informals will pay a large proportion of their income in tax, while for wealthier informals the _Informal Sector Income Tax Law_ is very mild. The rates themselves seem somewhat arbitrary. As can be seen in Table 1 and Figure 5, the rates in place in March 1997 seem disproportionately high for some activities and disproportionately low for others. Seventy-six percent of kiosks and 60% of cigarette and soft-drink