Fiscal impacts of a presumptive tax for microenterprises in Rwanda

This report examines the impact of the 2012 reform to micro and small enterprise tax law, which created a presumptive ‘flat fee’ regime in both Personal Income Tax (PIT) and Corporate Income Tax (CIT). In this regime, taxpayers whose turnover falls within a given band pay a fixed liability, with a zero marginal tax rate. Subsequent years have seen growth in both registered taxpayers and total taxes collected under the PIT and CIT, but these are not necessarily attributable to the 2012 reform.

The authors identify four channels through which this may have affected tax revenues. Two of these are intensive -- they affect the revenues derived from existing taxpayers -- while the other two are extensive -- they operate through the entry and exit of firms to and from the tax net. Impacts on intensive margins are negative, and can be estimated directly from taxpayer behavior. Impacts on extensive margins are positive, but cannot be point identified without strong assumptions. Consequently, the authors estimate upper bounds that highlight the largest possible positive effects on these extensive margins that are consistent with the data. These upper bounds are then used to demonstrate how a range of assumptions about the strength of reform impacts on induced impacts and averted dropouts, respectively, can yield a positive total effect of the regime for recent tax years.

The authors estimate total losses on the intensive margin of RWF 332.1 million for the 2012 tax year. These losses are too large to be offset by entry into active taxpayer status alone, since they exceed the upper bound on that channel for 2012. Consequently, the likely fiscal impact of the reform in 2012 was negative. By contrast, in the 2015 tax year estimated losses on the intensive margins were RWF 254 million, while many taxpayers had entered the tax base for the first time via the flat-fee regime since its introduction: the total taxes paid by such flat-fee entrants in 2015 constituted RWF 721.7 million. Consequently, less than half of this upper-bound on positive effects through the entry mechanism need have actually been caused by the flat-fee regime in order for its net effects to be positive. Similar exercises can be conducted for other plausible assumptions about extensive-margin impacts. For example, if new entrants who file under the flat-fee regime would have entered one year later in its absence, the total benefit arising from the entry channel in 2015 is RWF 131 million. In that case, the flat-fee regime must also have averted the drop-out of taxpayers responsible for a further RWF 141 million in order for its net fiscal impact to have been positive in that year. This would constitute 20 percent of the taxes paid in 2015 by flat-fee taxpayers who also filed in 2014.

Taking these findings together, this paper argues that there is a reasonable policy case to reform rather than repeal the flat-fee regime. The reduced administrative burden for taxpayers and auditors is a social benefit not accounted for in the empirical exercise of this paper. Moreover, there has been a downward trend in intensive-margin losses since 2013. There remains scope for refinements to the design of the flat-fee regime to further reduce these intensive-margin losses, while easing the burden of joining -- and staying in -- the tax net.