Taxing Africa’s Shadow Economy

A Path to Economic Growth

Africa’s informal economy, often termed the shadow economy, constitutes a significant portion of the continent’s economic activity, with estimates indicating that it accounts for approximately 40% to 80% of GDP in various nations. This sector encompasses a wide range of unregulated and unregistered economic activities, including street vending, artisanal crafts, small-scale manufacturing, and informal trading. While it provides livelihoods for millions, its unregulated nature results in lost tax revenue, limited business growth, and weak social protections.

Taxation — Tax avoidance & fraud.Informal Sector. Source: The New Times, Rwanda

The informal sector thrives due to several factors, including high unemployment and underemployment, particularly among the youth, bureaucratic barriers such as cumbersome registration processes and complex tax regulations, limited access to financial services, weak institutional oversight, and a lack of legal protections. These challenges discourage small businesses from formalizing, perpetuating a cycle of informality and economic vulnerability.

While the informal economy plays a crucial role in employment and local economic activity, its dominance presents several economic drawbacks. Informal businesses often struggle to expand due to a lack of credit, legal protections, and market access. Workers in this sector typically lack social protections, such as pension schemes and healthcare, making them vulnerable to economic shocks. Moreover, governments miss out on substantial tax revenue that could be utilized for public services, infrastructure, and social programs.

Formalizing the informal sector through effective and fair taxation policies could yield significant benefits. Experts suggest that taxing the informal sector could increase government revenue by 15% to 25% in many African countries. This additional income could fund critical infrastructure projects, expand healthcare and education systems, and reduce reliance on foreign aid and debt. For instance, Rwanda’s simplified tax regime for small businesses has significantly increased tax compliance, enabling the government to fund public transportation, healthcare, and digital services.

Beyond revenue generation, formalization can stimulate economic growth by enabling businesses to access credit, government contracts, and larger markets, leading to job creation and higher productivity. South Africa’s Turnover Tax, for example, allows micro-businesses to pay lower taxes with simplified filing, encouraging growth while easing compliance burdens. Additionally, formal workers benefit from social security, health insurance, and labor protections, reducing poverty and inequality. Kenya’s efforts to formalize digital workers ensure that gig economy employees, such as ride-share drivers, can contribute to and benefit from pension schemes.

However, formalizing sectors like agriculture and small-scale manufacturing requires careful consideration to avoid overburdening small farmers and entrepreneurs. Agriculture employs over 60% of Africa’s workforce, yet much of it remains informal, leading to lost tax revenue and limited access to credit and modern farming techniques for small-scale farmers. Similarly, small-scale manufacturing, including textiles and food processing, faces challenges such as unregistered operations and cash-based transactions, hindering formalization efforts.

The South African cartoonist ‘Zapiro’ on the shadow economy in the South African wine industry

The formalization of Africa’s shadow economy presents an immense opportunity to drive economic growth, increase tax revenue, and enhance social protections. Success depends on implementing gradual, transparent, and business-friendly taxation policies, providing financial support and incentives for small businesses, and strengthening governance frameworks to ensure that tax revenue benefits the broader economy. With the right reforms, Africa’s vast informal economy could become a major driver of sustainable growth, job creation, and national development.