Recommendation No. 204 on the Transition from the informal to the formal economy: A new powerful tool for facilitating the formalization of economic units and employment and promoting an inclusive development Frédéric Lapeyre Head, Informal Economy Unit Employment Policy Department International Labour Organization This regional knowledge sharing forum on the formalization of both economic units and employment takes place at an important moment, a few months only after the adoption of a new ILO Recommendation No.204 on the transition from the informal to the formal economy at the last International Labour Conference in June 2015. This Recommendation provides relevant and useful guidance to ILO Members in their efforts to facilitate the transition from the Informal to the formal economy. Indeed, from the beginning of the drafting process of the Recommendation, ILO tripartite constituents have stressed the need to have concrete and effective policy guidance to assist them in that task which is at the heart of the post 2015 development agenda considering its expected outcomes in terms of poverty and inequality reduction as well as productivity and social protection increase. It is of strategic significance for millions of workers and economic units around the world who are working and producing in conditions of informality; as much as half the global labour force is concerned worldwide and as much as 90% of SMEs. Informal employment includes a multifaceted reality of the world of work from undeclared work or under-declared work to bogus self-employment and from own account workers to employers and contributing family workers in informal sector enterprises. In the specific context of Latin American and Caribbean countries, formalization of economic units and employment is a core or emerging as a core policy priority because it is increasingly viewed as a major threat or obstacle to the objective of inclusive development and sustainable growth. Indeed, informality compromises: Workers rights, income and working conditions; 7
The principle of fair competition for enterprises and self-employed; Productivity growth and the development of sustainable SMEs; The financing of the social protection system; Tax fairness and social cohesion; The fiscal consolidation efforts of Governments; ILO Members debated extensively about the complexity and diversity of drivers and characteristics of informality in different country and local and sectoral contexts. From this perspective, some successful experiences in reducing informal employment and formalizing MSEs in Latin American were at the heart of the formulation process of the new Recommendation. The exchange of national experiences in tackling informality clearly showed that effective responses were possible but needed to be tailored taking into account this diversity but also engaging a strong political commitment and effective social dialogue mechanisms. Drivers of informality are manifold and some of them fall outside the world of work. There is no unique list of drivers in large part because they include not only policies, but also conditions and trends in the economy which have multiple causes themselves. While some drivers of informality are transversal or common to all situations (e.g. inefficient public institutions, inappropriate macroeconomic frameworks, increased incentives to remain in the informal economy, etc.), many others tend to be specific to a particular type of economic unit (e.g micro and small enterprises) or a group of workers (e.g. undeclared workers or domestic workers). This is why most of the measures aiming to facilitate transitions to formality need to be tailored to the specific circumstances that the different categories of enterprises or workers face. Measures that address the transversal drivers of informality (e.g. interventions to improve the efficiency of contributory social security schemes or of labour inspection systems) need to be complemented with specific measures that target the obstacles faced by particular types of economic actors. For those reasons, a multi-stakeholders diagnostic of the domestic situation is required to assess: The main and specific drivers of informal employment and informal economic units; 2
The main barriers to formalization at national, local and sectoral levels, taking also into account the size and nature of the economic units; The existing legal and policy framework and the needed priority reforms to facilitate the transition from the informal to the formal economy. This new ILO Recommendation affirms that the transition from the informal to the formal economy is essential to achieve inclusive development and to realize decent work for all. It is a crucial objective to improve working and living conditions, to promote sustainable small and medium enterprises and to achieve fair competition and fiscal consolidation at national level. Thus it aims at achieving greater inclusiveness and cohesion in our societies, and to better design the Future of work that we want to shape for our societies. The Recommendation acknowledges two important things. First that most people enter the informal economy not by choice but as a consequence of a lack of opportunities in the formal economy and in the absence of other means of livelihood. Second, that to facilitate transition from the informal to the formal economy, policy makers need to pursue a threefold objective of (1) the transition of workers and economic units who are already in the informal economy; (2) the creation, preservation and sustainability of enterprises and decent jobs in the formal economy; and (3) the prevention of further informalization of formal economy jobs. From this perspective, formalization processes are those by which jobs, workers or economic units are moved under the coverage in law and in practice of formal arrangements. Formalization can take multiple forms: incorporation and registration of enterprises, extension of the scope of labour and social security regulation, registration of undeclared workers, greater access to formal employment for new entrants into the labour market, among others. Formalization can also be a consequence of economy-wide transformations leading to transitions of workers from informal to new formal jobs. Finally, ILO constituents have come to a shared understanding that it is through an integrated strategy and a policy mix to promote the employment and income opportunities, the rights and social protection of the millions involved that we will facilitate the transition to the formal economy. This integrated strategy cuts across several policy areas, policy instruments and entails action by different institutions. And the Recommendation underscores the key role of tripartism and effective 7
coordination across government bodies and other stakeholders to promote the implementation of this Recommendation. For all this reasons, this Recommendation is a landmark Recommendation. It is the first ILO instrument to address the informal economy in its entirety and encompasses a broad scope of application to wage and self-employment and to various types of economic units. Therefore it is now important to point out how this new instrument will impact decision making in the field of formalization. Indeed, the transition from the informal to the formal economy is an important issue for any inclusive development strategy, a crucial component of employment policies, and represents an important step towards decent work creation and the fulfilment of the post 2015 development agenda which will be adopted in September. The formalization of the informal economy is among the top priorities of the ILO agenda and its strategic planning. Indeed, the ILO is providing in particular through the FORLAC program in Latin America and the Caribbean - technical assistance to governments and social partners, in order to actively promote policies and incentives for the transition from informality to formality. Moreover, the relevance of the informal economy and the need for continuous support to ensure a sustainable transition to formality have been reflected in the Director-General s Programme and Budget proposal for 2016-17. Formalization of the informal economy, in fact, is one of the 10 key Policy Outcomes (Outcome 6) of the ILO Programme and Budget 2016-17. Finally, the new Recommendation was adopted at the ILC 2015 with a strong resolution calling for a strong involvement of the ILO in assisting its constituents in implementing the Recommendation policy guidelines and especially its integrated policy framework. The ILO in documenting and analysing good practices and facilitating the exchange of experiences have shown that many of the new policy measures that are being pursued in Latin America or Europe are transferable to other sectors and countries. But for each national context, it is important to investigate the main drivers of the informal economy and to provide an appropriate and efficient integrated policy framework to both facilitating the transition to formality and to boost formal job creation. ILO analysis on transition to formality highlight that where integrated approaches have been adopted, the results for formalization have been more robust. There is also strong evidence that an integrated approach to formalization should give priority to aspects such as sustained inclusive economic growth with quality jobs, improved legislation, stronger institutions, social dialogue 4
promotion, organization and representation, encouragement of equality and the fight against discrimination (i.e. women workers or migrant workers), support for corporate initiative, development of professional skills, greater access to funding for productive investment, the extension of social protection and local economic development. Indeed, information on all countries which have managed to cut their informal employment rate reveals that the countries have combined in a coordinated way several policy areas to facilitate the transition towards formality. With respect to informal employment, lessons can be drawn from the countries that have used a range of policy measures to incentivize declared work. These measures have involved simplifying compliance to help individuals operate on a declared basis, provision of various incentives for businesses to declare the work they engage, for suppliers of labour to make their work known, and for purchasers of goods and services to hire registered work. From this perspective, there is a very interesting initiative in Europe where a European platform was recently established to improve cooperation at EU level in order to prevent and deter undeclared work more effectively. This platform will bring together various national enforcement bodies involved in the fight against undeclared work. Programs to facilitate the formalization of the informal economy should focus on formulating an integrated regulatory and policy framework based on the following policy areas: a) Formal job creation The creation and preservation of decent jobs in the formal economy through appropriate and coordinated macroeconomic, trade, industrial, tax, skills development, sectoral and infrastructure policies that promote formal employment, enhance productivity and facilitate structural transformations. b) Procedures and regulations simplification The adaptation or simplification of regulations or procedures: There are various successful initiatives of this kind in the region, often combined with other tools, sometimes incentives and sometimes sanctions. Simplifications generally concern taxation, labour procedures, affiliation to social security, creation of enterprises, unification of procedures, etc. Simplification may involve innovative support such as pre-filling of forms, vouchers, use of IT for declaring small jobs (in conjunction with tax rebates) such as in household repair, tourism or agriculture, and simplified employment contracts, exploiting the possibilities of e-government, on-line registration. Employers associations provide support in registering, supporting recordkeeping and other types of business support. 7
c) Incentives The design and implementation of effective and appropriate incentives for formalization with many variants: One example is the mechanisms associated with taxation, mainly for smaller economic units, sometimes including own-account workers. Several countries have specific simplified systems for accounting, tax declarations and payment for SMEs. Some countries have linked tax incentives to social security contributions, integrating various payments in a single tax. Also, well-designed and targeted working income supplement and refundable tax credit for lowincome individuals is one of the best means to increase the attractiveness of formality and to alleviate poverty by providing tax relief. In a number of countries, in fact, eligibility to claim refundable tax credit is conditional on (current or previous) formal employment. In addition to incentives to firms, some countries have extended incentives to purchasers of declared work through tax deductions or issuance of discounted service vouchers (where government partially subsidizes the cost of declared service). Likewise, incentives are also extended to workers to stay declared. In some countries, worker and employer organizations jointly set up a fund to pay welfare to declared workers during lean season as an incentive for workers to remain in declared work and not seek out informal work. This has been applied to construction workers and can be extended to other work which is largely seasonal such as agriculture and tourism. d) Compliance The implementation of actions to increase the State s capacity to ensure that standards are met, either by improving information about the population s duties and labour rights, strengthening the structures, qualities and processes in the institutions that are responsible for labour inspection services and social security, applying sanctions or promoting agreements and alliances between workers and employees. The ability to meet the standards is directly proportional to their simplicity. As a result, all public procedures should adapt to the principle of simplicity as the foundation of the public institutions. Also, while there are groups (such as micro and small enterprises or own-account workers) which may require differentiated treatment because of their characteristics, this should not imply that for the remainder it is acceptable that procedures be complicated, slow and expensive. 6
Acknowledging this reality reinforces the need to constantly seek for administrative simplicity, together with the streamline of administrative procedures, the dissemination of these is fundamental, both in terms of the benefits and the sanctions if they are not carried out. The existence and enforcement of deterrent and effective sanctions are a part of any compliance response, and informal employment is no exception. Incentives must go hand in hand with strengthening deterrence mechanisms to detect and sanction non-compliance. In this field some key policy areas are important: Strengthening the capacity of labour inspection (i.e. human resources, IT system, number of workplace visits, salaries, etc.); Target suspect sectors or location for workplace visits to increase both the labour inspection effectiveness and the cost/benefit ratio of being informal; Promoting joint inspection teams (combining different enforcement authorities); Increase in an effective way the level of sanctions. And combining them, when appropriate, with some incentive and curative measures during a transition period to facilitate the compliance; Strengthening temporary non-financial sanctions such as: i) being baned from tendering for public work, ii) being excluded from receiving financial support/business services of the State, iii) being black listed as a sub-contractor or iv) being on a black list for purchasers; Awareness building and capacity building in understanding and implementing laws and regulation. cooperation between the various enforcement bodies in charge of tax, labour, and immigration or exchange of information between administrative databases; or the use of electronic payments for purchases over a certain threshold that could be made mandatory; Letters of appeal, client-oriented approaches to registration, efforts to address corruption and bribery, all contribute to engendering compliant behaviour. Finally, measures to tap into voluntary commitment are fundamental. Latin American and Caribbean countries have used information campaigns, featuring opinion leaders and role models 7
expressing the benefits of declared work, the value of participating in society or the benefits of a greater commitment to tax morality. Media campaigns can be launched to increasing awareness among the public on the risks and costs to society linked to informal employment, particularly as far as sanctions are concerned; social partners have a key role to play in this respect; informing citizens about the positive effects of full payment of taxes and informing them about the insurance nature of social security contributions. To conclude, strong evidences show that the transition to formality calls for combining the strengthening of detection capacities with in one hand more effective sanction and enforcement measures and, in another hand, better designed incentives and curative policies. The new compliance systems which are emerging in Latin America are based on such a combination of preventive measures, law enforcement and effective sanctions, to address tax evasion and avoidance of social contributions, labour laws and regulations. According to this approach, Governments, with the support of social partners, should provide for preventive and appropriate corrective measures to facilitate the transition to the formal economy, and ensure that the administrative, civil or penal sanctions provided for by national laws for non-compliance are adequate and strictly enforced. Moreover, any incentives should be linked to facilitating the effective and timely transition from the informal to the formal economy. But we shall keep in mind that all those specific policies to tackle the informal economy will need an inclusive growth context and a strong political commitment to creating productive formal employment, decent work and an enabling environment for sustainable SMEs which are necessary conditions for a better world of work in Latin America and Caribbean. Frédéric Lapeyre Informal Economy Unit, Head International Labour Organization 8