FINANCIAL INCLUSION AND THE INFORMAL SECTOR TAX BASE: DOES DIGITAL PAYMENTS FACILITATE OR DETER TAX COMPLIANCE?

Abstract

The proliferation of digital payment systems has fundamentally transformed the economic architecture of developing and emerging market economies, raising profound questions about the relationship between financial inclusion and tax compliance among informal sector participants. This paper examines the dual nature of digital financial services as both a potential tool for expanding the tax base and a mechanism through which informal economic actors may navigate, or circumvent, formal fiscal obligations. Drawing on theoretical frameworks from information economics, institutional theory, and behavioral economics, alongside empirical evidence from Sub-Saharan Africa, South and Southeast Asia, and Latin America, this study investigates whether digital payment adoption facilitates or deters tax compliance in informal economies. The analysis reveals a nuanced picture: while digital payment trails create unprecedented opportunities for tax authorities to observe previously opaque economic transactions, structural barriers including digital literacy gaps, trust deficits, and inadequate regulatory frameworks often undermine compliance gains. The paper argues that the net fiscal effect of digital payment adoption depends critically on the complementary institutional environment, including the design of tax incentive structures, the capacity of revenue authorities, and the inclusiveness of financial regulation. Policy implications center on the need for integrated strategies that pair financial digitization with proportionate, trust-building tax frameworks tailored to the heterogeneous character of the informal sector.