• Authored By: Amos Sanday
23 Aug 2023

Informality is a common feature in many developing and low-income countries. Globally, a significant portion of economic activity operates within the informal sector. Estimates show that about 50 per cent of global Gross Domestic Product (GDP), over 60 per cent of the workforce, and nearly 90 per cent of small and medium-sized enterprises (SMEs) operate in the informal sector.
Uganda exhibits a similar trend with about 72 per cent of businesses, 78 per cent of the labor force, and about 51 per cent of GDP generated from the informal economy according to the World Bank and ILOSTAT, 2022. The informal sector is an important source of livelihood for the vulnerable, especially the less educated, youth and women who would otherwise not find employment in the formal economy. Despite its importance in economic progress and livelihood, informality imposes significant costs on the economy.

The cost of informality

Most informal businesses tend to operate outside the formal regulatory frameworks, making tax information inaccessible. Informality thus, poses challenges to effective tax revenue collection, thereby eroding the government’s ability to provide public goods and services. According to the Ministry of Finance, Planning and Economic Development (MoFPED) informality costs the economy about 40 per cent of GDP annually due to tax evasion. A recent assessment by the Economic Policy and Research Center (EPRC) found that informal businesses in Uganda withhold about UGX 474 billion in potential tax revenue by operating in legally or fiscally informal ways.

The prevalence of informality also hampers sustainable development. Small, low-productivity informal businesses with limited financing options struggle to create productive jobs. Many informal sector workers engage in precarious employment, earning less than their counterparts in the formal sector with comparable skills. This wage disparity contributes to overall economic inequality and suppresses the growth potential of countries with sizable informal sectors. Additionally, the informal sector workers lack social protection hence they are more likely to experience poverty. Also, informal firms may be excluded from value chains and value addition through the supply of inputs, and procurement opportunities because they operate outside the legal framework.
Gender inequality is also closely linked to informality. In non-agricultural sectors, women constitute 83 per cent of informal employment, compared to 72 per cent for men, according to ILOSTAT, 2022. Similarly, informal businesses exhibit a high degree of mortality attributed to both fiscal and legal informality.

Uganda envisages to reduce the size of the informal sector from 51 percent to 45 percent by 2025 according to the Private Sector Development program of the National Development Plan III. Although the government has undertaken several interventions, such as the Tax Registration and Expansion Program (TREP) to incentivize formalization through simplified licensing and registration processes, improved business environment, and enhanced infrastructure. However, despite these efforts and the potential benefits of formalization, informality is still persistently high due to several reasons.

Why is informality so prevalent in Uganda?

Informality is linked to the inability of the formal sector to generate sufficient jobs to absorb excess workers. This is further compounded by lack of information and awareness about the importance of business registration and the high compliance costs associated with business registration and obtaining licenses which discourage informal firms from formalizing. According to a recent survey about 56 per cent of informal businesses in Uganda are unaware of the significance of registering their businesses and where to get information on registration. The complexity of tax return filing and obtaining Tax Identification Numbers (TINs) adds to these costs.
Relatedly, the high registration cost and licensing fees by Uganda Registration Services Bureau (URSB), Uganda Revenue Authority (URA), and the local authorities has exacerbated the problem. This is further worsened by bureaucratic inefficiency in the registration process due to long duration and delays in obtaining trading licenses upon submitting all requirements and payment of requisite fees.

What can be done to reduce informality?

To address these challenges, it is important to understand the nature and constraints of informal businesses and simplify administrative processes. Digitization of business registration and tax processes, along with harmonization of registration forms, could ease the burden. Eliminating excessive regulations and bureaucratic requirements could also motivate informal firms to formalise.
Moreover, establishing one-stop registration centers at the local level and leveraging business associations such Kampala City Traders Association (KACITA), Uganda Manufactures Association (UMA) and Uganda Small Scale Industries Association (USSIA) can facilitate registration and encourage formalization. Granting temporary legal status to informal businesses aligned with their needs and government objectives could also encourage formalization.

In conclusion, the informal sector plays a significant role in economies worldwide, including Uganda. Despite its contributions, informality has negative implications for tax revenue, sustainable development, gender equality, and overall economic growth. Government interventions to promote formalisation have been made, but challenges such as lack of information, compliance costs, and bureaucratic obstacles persist. Addressing these challenges requires simplifying administrative processes, leveraging on technology, and creating an environment that encourages and supports informal businesses to transition into the formal sector.

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