This paper attempts to establish whether significant scope exists for informal sector taxation in
Zambia. It reviews the methods available for measuring informality and compares the results
these methods have achieved in different contexts. Applying the Currency Demand Approach
to Zambia for the period 1973–2010, it finds that informal GDP averaged 47.7% of official GDP
per annum and that the informal sector’s tax potential averaged 42% of total tax revenues per
annum.
This seemingly large tax potential was found to be thinly spread among the 4 million plus
participants in the informal sector, implying that devoting more resources to tax this potential
would not be prudent in terms of either equity and efficiency considerations – at least not in
the short-to-medium term. Short-to-medium term measures should focus on strengthening
existing taxes and mechanisms for fostering the formalisation of the informal sector. This
would entail, among other things, exploiting personal income taxes other than PAYE and also
strengthening the administration of VAT, the most broad-based tax. In the long term, the
informal sector’s tax potential cannot be ignored, so the tax system should be simplified and
designed in such a way that it encourages informal MSMEs to graduate into the standard tax
regime, while also increasing the costs of non-compliance.
Put succinctly, what would be most prudent in both the short-to-medium and long run is not
the introduction of more taxes, but rather the strengthening of existing taxes and mechanisms
that foster the formalisation of the informal sector.