Explaining Informal Taxation and Revenue Generation: Evidence from south-central Somalia

Abstract

Most people in low-income countries contribute substantially to the financing of local public goods through informal revenue generation (IRG). However, very little is known about how IRG works in practice. We produce novel evidence on the magnitude and regressivity of IRG and its relationship with the state in a fragile context, Somalia. We rely on original data from surveys with over 2,300 households and 117 community leaders in Gedo region, as well as on extensive qualitative research. We first show that IRG is prevalent. Over 70 per cent of households report paying at least one informal tax or fee in the previous year, representing on average 9.5 per cent of annual income. We also find that, among households that contribute, poorer ones contribute larger amounts than richer ones, with higher incidence in relation to their income. Further, in line with theory and expectations, informal payments have inequitable community-level effects, with individuals in wealthier communities making more informal payments than in poorer ones and, correspondingly, having access to a greater number of public goods. We then consider four explanations for the prevalence of IRG. First, IRG clearly fills gaps left by weak state capacity. Relatedly, we show that IRG can bolster perceptions and legitimacy of the state, indicating that sub-national governments may actually benefit from informal taxation. Second, informal taxing authorities are more effective tax collectors than the state, with informal taxing authorities having greater legitimacy and taxpayers perceiving informal payments to be fairer than those levied by the state. Third, dispelling the possibility that informal payments should be classified as user fees, taxpayers overwhelmingly expect nothing in return for their contributions. Fourth, in contrast to hypotheses that informal payments may be voluntary, taxpayers associate informal payments with punishment and informal institutions of enforcement. Our research reinforces the importance of IRG to public goods provision in weak formal institutional contexts, to everyday citizens, and to policymakers attempting to extend the influence of the federal state in south-central Somalia. Foremost, informal tax institutions need to be incorporated within analyses of taxation, service delivery, social protection, and equity. At the same time, our findings of the complementary nature of IRG and district-level governance and of the relative efficiency of revenue generation by local leaders have important implications for understanding statebuilding processes from below. Indeed, our findings suggest that governments may have little incentive to extend their taxing authority in some fragile contexts.

Co‐financing community‐driven development through informal taxation: Evidence from south‐central Somalia

“…Finally, knowing that the ability to collect revenues can impact an actor's legitimacy (van den Boogaard & Santoro, 2021), we also consider whether DIALOGUE's impacts on informal contributions and on informal actors' legitimacy are interlinked. However, we find inconclusive evidence, with an interaction term (representing an increase in informal taxation attributed to the program) not being significant for any non‐state actors (Appendix, Table A7).…”

“…As noted above, however, there is an open question about the extent to which these findings are replicable in less secure or homogeneous areas in the country, with the degree and ease of informal taxation expected to differ based on clan family, degree of security and extent of social cohesion. Meanwhile, while south‐central Somalia may be unique in terms of its long history of reliance on informal institutions and revenue generation (van den Boogaard & Santoro, 2021), evidence suggests that it is not an outlier, as “informal taxation is not geographically isolated to a particular region of the world” (Olken & Singhal, 2011: 6).…”

“…Community leaders, including clan elders and religious leaders, play an important role in non‐state governance and public goods provision, including security and social welfare. As in many contexts, “informal taxation is one of the primary ways through which local public goods are financed” (Olken & Singhal, 2011: 12, see van den Boogaard & Santoro, 2021).…”

“…First, as our study only includes communities that opted into the DIALOGUE program, it is possible that participating communities had a stronger ability to mobilize informal taxation than communities that did not. While informal revenue generation is common across the country (van den Boogaard & Santoro, 2021), the degree and ease of informal revenue generation may differ based on clan composition, security, and the extent of social cohesion—all of which vary considerably across south‐central Somalia. Second, as communities had to be safe enough to allow DRC field staff to visit, they may not be comparable to ones in less safe regions (Tables A5–A14).…”

“…These findings deepen our understanding of how community contributions may be incentivized through matching grant programs and how they may contribute to CDD and public goods provision in a context of weak state institutional capacity. They have important implications for our understanding of the relationships and potential complementarities between informal taxing institutions, external financing, and the state in a context of weak state institutional capacity (Baldwin, 2019; Cammett & MacLean, 2014; Sacks, 2012; van den Boogaard, 2020). Despite these possibilities, we highlight significant risks of requiring co‐financing within CDD programs—including the lack of accountability of local non‐state leaders, the reinforcement of inequitable public goods financing, and the social impacts of non‐universal service and benefits provision—and suggest important new avenues for research.…”