Running a country requires funds. Usually those funds are obtained by levying taxes. Taxation can be carried out in many ways, but one of the components of a modern tax system is income tax deducted directly from wages. Income taxation enables a broad tax base and is difficult to evade.
But what if most of the workforce is outside the system of income taxation?
This is the unfortunate reality in many developing countries, says Jukka Pirttilä, a professor of public economics at the University of Helsinki.
“In Mozambique, for instance, up to 80 % of the people work in the subsistence economy, street vending or the grey economy. You can’t tax all of them.”
And it would not always be practical either. The purpose of income taxation is not only to collect funds, but also to reduce income differences through tax progression.
“If you think of taxation as a way to reduce income differences, it would be impractical to tax the poorest individuals, such as farmers in a subsistence economy,” Pirttilä points out.
When examining the job market, a good question to ask is whether the individual has pension coverage. Usually people who pay pension contributions also pay income tax.
However, an overview of the economy would be useful. Pirttilä has investigated the economies of developing countries together with the World Institute for Development Economics Research and local researchers since 2014.
He has focused on countries in sub-Saharan Africa. In the absence of registers, surveys are used to collect data on many of these countries.
“When examining the job market, a good question to ask is whether the individual has pension coverage. Usually people who pay pension contributions also pay income tax.”
One of the goals is to help developing countries put their taxation on a more sustainable footing or, in the words of Pirttilä, build a better world. Then again, research can also lead to the development of tools for exploring Nordic societies.
“Some of my colleagues came up with a tool to monitor how the rigid income ceilings applied in Pakistani taxation affect behaviour. The same tool has then been used in Finland to look at students whose financial aid is cancelled when their wages exceed a certain limit.
“These kinds of ‘welfare traps’ have long been viewed negatively, but the tool helps us analyse the actual consequences.”