The Optimal Turnover Threshold and Tax Rate for SMEs

IMF Working Papers, May 7, 2019

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Presumptive income taxes in the form of a tax on turnover for SMEs are pervasive to reduce compliance and administration costs.
The paper analyzes a model where entrepreneurs allocate labor to the formal and informal sectors.
Formal sector income is subjected either to a corporate income tax or a tax on turnover, depending on whether turnover exceeds a threshold.
The authors characterize the private sector equilibrium for any given configuration of tax policy parameters: corporate income tax rate, turnover tax rate, and threshold.
Given private behavior, social welfare is optimized; first-order conditions for welfare maximization are interpreted to identify key margins and the model is simulated in a calibrated version.

Agents choose labor allocation between formal and informal sectors.
Formal income faces either:
- corporate income tax (rate unspecified here), or
- turnover tax (rate unspecified here) when turnover is below/above a threshold (threshold unspecified here).
The paper derives the private sector equilibrium as a function of three policy parameters: corporate income tax rate, turnover tax rate, and threshold.
Social welfare is maximized taking private behavior as given; first-order conditions are used to interpret policy margins.
A calibrated simulation of the model is performed (calibration details not provided on this page).

The first-order conditions for welfare maximization identify the key margins that determine optimal policy (margins not enumerated on this page).
The calibrated simulations are used to determine optimal configurations of:
- corporate income tax rate,
- turnover tax rate,
- turnover threshold for SMEs.

Presumptive turnover taxes can reduce compliance and administration costs for SMEs.
Optimal policy design requires balancing corporate income tax rate, turnover tax rate, and the turnover threshold, accounting for labor allocation between formal and informal sectors.
Welfare optimization depends critically on private responses to the three tax policy parameters; policymakers should use calibrated models to inform thresholds and rates.