Designing a Presumptive Income Tax Based on Turnover in Countries with Large Informal Sectors

IMF Working Papers, December 22, 2023

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Construct a simple model where a size threshold separates firms paying turnover tax from those paying profit tax (regular income tax).
Firms have the option of producing in the untaxed, informal sector.
The optimal turnover tax rate balances:
- reducing informality, and
- avoiding strategic reductions in sales by firms seeking to remain below the threshold for the profit tax.
Provide analytical results and calibrate the model using realistic parameter values.

Optimal turnover tax rate for countries with large informal sectors: around 2.5%.
Threshold separating the turnover tax regime from profit tax: for the most part between $65,000 and $95,000.
Introducing an optimally designed turnover tax reduces the rate of informality of businesses by about 12 percentage points in the calibrated model.

A presumptive income tax based on turnover can economize on tax administration and taxpayer compliance costs in developing countries.
Policymakers must set the turnover tax rate to strike a balance between:
- incentivizing informal firms to formalize (by keeping the burden on small firms moderate), and
- avoiding incentives for firms to artificially reduce sales to remain under the profit-tax threshold.
The threshold level is a key design parameter influencing firm behavior across the informal–formal margin.

Calibration uses realistic parameter values to compute the optimal policy.
Results are presented across most scenarios, with the optimal rate and threshold ranges cited above.

Feng Wei and Jean-François Wen, IMF Working Paper No. 2023/267 (December 22, 2023).