A key challenge for developing economies wishing to strengthen their social protection systems and expand access to education and health is how to raise the necessary revenue in the context of a large informal sector.
The informal sector is typically characterized by high levels of self-employment, low skill levels, and often multiple and volatile sources of income. This limits the potential to raise revenue by taxing income—especially from lower-income groups—which requires the ability to verify total individual income. In the context of social insurance, it also means greater reliance on financing through general government revenue sources than on the contributory models emphasized in advanced economies.
Recent research also finds that countries move to a higher growth path once tax revenue reaches about 15
This large variation in tax ratios within emerging market and low-income countries suggests that many have ample room for higher taxation. Some have succeeded in increasing their tax ratios in recent years, sustainably increasing tax revenues to bring them close to or above 15 percent of GDP. Georgia is a leader in this group, having increased tax revenue by 12.9 percent of GDP during 2004–08. Maldives raised revenue by 11 percent of GDP during 2011–15. Others that have made significant gains over similar periods include Dominica (7.5 percent, 2002–06), Ghana (7.3 percent, 2000–04), Mauritania (6.1 percent, 2010–14), Mozambique (6.1 percent, 2007–11), Guinea (5.8 percent, 2008–12), Malawi (5.7 percent, 2003–07), and Cambodia (5.0 percent, 2012–16).
As countries modernize their tax systems, they typically expand broad-based consumption taxes and selective excise taxes and prioritize the development of progressive income tax systems (see Chart 2)