Financial development and small firms’ tax compliance in Sub-Saharan Africa

Lack of fiscal space in sub-Saharan Africa is a major preoccupation, particularly in the context of shocks. The majority of firms in the region are primarily in the informal sector and consequently do not pay taxes. This paper explores the effect of financial development on small firms’ compliance with value-added tax, profit tax and local tax. It equally explores the mitigating impact of informal finance on financial development’s role in driving small firms’ tax compliance. To demonstrate this, we estimate a recursive trivariate probit model. The results show that financial development increases the likelihood of firms being tax compliant. In contrast, access to informal finance decreases that likelihood. It also emerges that the lower the taxes, the greater the effects of low costs of banks on tax compliance. Another finding is that informal finance mitigates the effect of financial development on small firms’ tax compliance.

Keywords: taxation, Africa, financial development, informal finance, informality

JEL Classification: D22-E26-H26