Analysis of presumptive income tax for small business in informal economies: a case of Pakistan

Abstract

This thesis analyses the use of Presumptive Income Tax (PIT) in developing countries with large informal economies dominated by small business. It asks the question: “Are the current PIT designs used to tax small business in large informal economies appropriate?” To answer the question, this thesis makes a qualitative analysis of the causes of large informal economies in developing countries. Then, common PIT designs are evaluated qualitatively against the principles of a good tax system. Finally, legal analysis of Pakistani PIT legislation is undertaken with particular reference to the principles of a good tax system. This thesis makes a number of important contributions to the existing body of knowledge. First this thesis identifies the bookkeeping and other procedural requirements for tax compliance as the major reason why small businesses operate informally. Second, this thesis identifies a single PIT (that is, an asset based PIT) amongst a range of PIT designs, which logically is the most appropriate design to meet the needs of small business and tax administration in large informal economies. This identification is achieved by comparative analysis of PIT designs against the causes of informality. Third, earlier literature has not made comparative analysis of existing PIT designs against the principles of a good tax system for assessing their adequacy to tackle large informal economies. This thesis performs this task and finds that an asset based PIT is the most appropriate among all PIT designs in this regard. Fourth, prior to the analysis of PIT designs against the principles of a good tax system this thesis makes a contribution in the existing literature in terms of redefining and prioritizing these principles in context of large informal economies. This thesis suggests ranking simplicity, efficiency and equity in that order. Lastly this thesis provides the first ever comprehensive analysis of the Pakistani PIT to assess its ability to tax the informal sector and the level of its adherence to the principles of a good tax system. This thesis finds that the Pakistani PIT does not satisfy the principles of simplicity, efficiency and equity because of its inappropriate design, poor legal drafting and its intricate relationship with the normal income tax. The thesis recommends an asset based PIT along with details regarding its base, valuation techniques etc to tax the Pakistani informal economy.