Tax Burden, Incentives, and Informality: Determinants of SME Growth and Formalisation in Emerging Markets

This study investigates how tax policies affect small and medium enterprises in developing countries between 2005 and 2023. Panel data regression analysis is employed to examine how performance indicators such as revenue growth, employment generation, and formalisation processes are linked to tax rates, costs associated with complying with value-added tax, the structure of value-added tax, incentive mechanisms, levels of informality, and the quality of public services. The results show that higher rates of tax compliance and effective tax rates negatively influence the performance of small and medium enterprises, supporting the resource-based view theory, which holds that such enterprises are more adversely impacted by tax burdens due to their limited resources. In contrast, tax incentives have a strong positive effect, while informality has a significant negative impact. Through this study, fiscal exchange theory is validated in the context of developing countries, indicating that small and medium enterprises are more likely to comply with tax regulations when they perceive public services to be of high quality. The analysis integrates data from multiple countries and draws on classical economic theory and institutional theory. The key policy implications explain that developing countries should simplify tax systems, design targeted incentives, and adopt digital mechanisms to enhance the competitiveness of small and medium enterprises while addressing informality. The study addresses gaps in the literature related to taxation in developing economies and guides policymakers seeking to strengthen the role of small and medium enterprises in promoting economic growth and employment.