CHAPTER TWO

1.0 Introduction
This chapter discusses the literature of the role of small business on GPD growth, the role
of small business on job creation, the effect of taxation on small business development.

1.1 0verview of small business

Small businesses can be identified as one of the important mechanisms that provides a
main share in the economic development of any country (Al-Khatib et al., 2015). The
small scale businesses are associated in the globalization, progression of the employment
creation, and economic development of the country. The unconstructive effects of
economic turndown critically affect the socio-economic circumstances of the
individuals[CITATION Sal141 \l 1033 ].

80% of the new jobs are created by the small businesses in the USA with 99.7% of the
firms having less than five hundred employees (Link & Scott, 2012). Jobs are lost and the
community losses the tax paying institution when the small businesses dissolve for any
reason. Although, it has been confirmed by the researchers that small businesses tend to
collapse before completing 5 years. Limited data is available on the contribution of such
factors, which may result in the closure. Therefore, more firms would flourish and
survive in case of data presence during first four years (Ji & Hanna, 2012). A study
conducted by Welsh et al., (2014) has revealed that the women in Saudi Arabia are highly
educated and gain strong support for being an entrepreneur from their family and friends.
Women also rate themselves as successful individuals and have excellent innovative
skills. It has been observed that 55% of the women owned businesses in Saudi Arabia.
More than 51% of the businesses have been owned by 70% of the Saudi women and 42%
women started their business themselves [ CITATION Hag17 \l 1033 ].

The last three decades have witnessed China becomes the world economic champion in
terms of development, growth and impact. Compared to other world economies, Chinese
economic development has proved to be unique and distinctive with small and medium
enterprises (SMEs) forming the foundation of this “economic miracle” (Li & Matlay,
2006). The entry of China to the world economy has destabilized the economic and
political monopoly of the Western countries that must now recognise and acknowledge
the economic giant. While the world is still amazed at how China has emerged as a
superpower within a short time, to the Chinese Authorities, this is not an accident but a
well-orchestrated plan meant to transform and gain advantage of millions of small and
medium enterprises in the country (Chen, 2006). Through well organised reform
structures and economic reforms, China has succeeded doing what many countries have
desired to achieve for decades [ CITATION Sam18 \l 1033 ].

Micro, Small and Medium Enterprises (MSME) sector has emerged as a highly vibrant
and dynamic sector of the Indian economy over the last five decades. MSMEs not only
play crucial role in providing large employment opportunities at comparatively lower
capital cost than large industries but also help in industrialization of rural & backward
areas, thereby, reducing regional imbalances, assuring more equitable distribution of
national income and wealth. MSMEs are complementary to large industries as ancillary
units and this sector contributes enormously to the socio-economic development of the
country. Ministry of Micro, Small & Medium Enterprises (MSME) envision a vibrant
MSME sector by promoting growth and development of the MSME 2 Sector, including
Khadi, Village and Coir Industries , in cooperation with concerned
Ministries/Departments, State Governments and other Stakeholders, through providing
support to existing enterprises and encouraging creation of new enterprises [ CITATION
Sub15 \l 1033 ].

Small business in India creates largest employment opportunities for the Indian populace,
next only to Agriculture. It has been estimated that a lakh rupees of investment in fixed
assets in the small scale sector generates employment for four persons. MSMEs not only
play crucial role in providing large employment opportunities at comparatively lower
capital cost than large industries but also help in industrialization of rural & backward
areas, thereby, reducing regional imbalances, assuring more equitable distribution of
national income and wealth. MSMEs are complementary to large industries as ancillary
units and this sector contributes enormously to the socio-economic development of the
country. The sector contributes significantly to manufacturing output, employment and
exports of the country. In terms of value, the sector accounts for about 45 per cent of the
manufacturing output and 40 per cent of total exports of the country. It is estimated to
employ about 60 million persons in over 26 million units throughout the country. There
are over 6000 products ranging from traditional to high-tech items, which are being
manufactured by 35 the MSMEs in India. It is well known that the MSME sector
provides maximum opportunities for both self-employment and wage-employment,
outside agriculture sector [CITATION Şte142 \l 1033 ].

Group of micro, small and medium enterprises (MSMEs) is a form of economic life of
most people of Indonesia. The existence of this group cannot be separated from the
national economic growth. The MSMEs Group according to BPS (2016) is able to absorb
more than 64 million workforces and contributes approximately 58.2% to the formation
of Gross Domestic Product (GDP). The existence of MSMEs according to Matambalya
(2010) becomes an important issue as a motor of growth and economic growth in many
countries in the world. High economic growth in many countries is a national economic
performance supported by efficient, productive and highly competitive MSMEs
[ CITATION Sur17 \l 1033 ].

According to the European Commission (2011) that the role of MSMEs in various parts
of the world is very central to the growth and development of the national economy of a
country. The same is true in the EU that MSMEs significantly contribute to the economy
of the country. The general contribution is in terms of labor absorption and in increasing
GDP. The number of MSMEs in France reaches 99.80% of the total companies,
contributing more than 56% of GDP and absorbing more than 61% of the workforce.
MSMEs in Germany reached 99.55% with a contribution of 53% of GDP and absorb
61% of the workforce. MSMEs in Italy reach 99.92% with contribution 71% of GDP and
absorb 81% of labor. While MSMEs in Nederlands reach 99, 72% with contribution 62%
of GDP and absorb 68% labor [ CITATION Ber91 \l 1033 ].

2.2 Small business on GPD growth

Gross Domestic Product can be defined as the summation of value added of each sector
of the local economy over a given period of time (refer to Appendix E &F for T&T’s
GDP values for the period 2000-2006). The concept of value added is very important in
calculating GDP via the output method because of its avoidance of double counting. This
method does not just look at absolute production but tallies the change in output
occasioned by inputs of capital, labour and land at each stage of production

SBEs( small business entrepreneurs) are expected to make a significant contribution to

GDP mainly because of their large numbers and income generation effects in the form of
wages and salaries paid to workers as well as profits directed to entrepreneurs. Thus
SBEs play a vital role in servicing localized markets. Further, with reference to
intermediate goods/value added, many small firms exist to serve particular demands as in
the case of consumer goods for which considerable diversity of taste exists. Also, small
firms are important suppliers of specialized intermediate goods, that is, goods used in the
production of other goods. Thus of great importance is the SBE effects on the
manufacturing sector as it relates to GDP contributions [ CITATION Hod12 \l 1033 ].

Additionally, it may include in this assembly type and related industries sub-sector highly
innovative products such as the steelpan and all of its recent variants manufactured by
entrepreneurial small businesses. Although its impact on value added will be currently
low and seasonal at best; great potential exists in this field with regards to exports, but the
risk-taking drive of small business steelpan producers appears low although their
innovative skills are high [ CITATION Sam04 \l 1033 ].

Small business’ is difficult to define. In South Africa’s National Small Business Act,
passed in 1996, the definitions provide for ‘micro enterprises’ to have fewer than 5
employees, ‘very small businesses’ to have 6 to 20, ‘small businesses’ to have 21 to 50,
and ‘medium businesses’ to have fewer than 200 employees [ CITATION Sub15 \l 1033 ].

Government has recently raised the status of its small business initiatives with the
creation, in 2014, of a department dedicated to this cause: the Department of Small
Business Development, under the political leadership of Minister Lindiwe Zulu, with an
annual budget of approximately R1 billion. Previously, programmes dealing with small
business development fell under the Department of Trade and Industry and the Economic
Development Department[ CITATION May14 \l 1033 ]

Estimates of the contribution of small, medium and micro enterprises (SMMEs) to the
economy vary. In terms of contribution to GDP, an estimate of 52 to 57 per cent has been
quoted by the Deputy Minister of Trade and Industry, Elizabeth Tha bethe, who put the
number of SMMEs in South Africa at 2,8 million and their contribution to employment
at 60 per cent. Moreover, looking ahead, the National Development Plan projects that, by
2030, no less than 90 per cent of new jobs will be created in small and expanding firms
[ CITATION Zol99 \l 1033 ].

In modern economies economic activity by small firms is increasingly important for

achieving economic growth. In the new context of the revolution of knowledge, of the
passage from the economy dominated by the physical, tangible resources to the economy
dominated by knowledge, the small and medium company becomes the main micro-
economic pawn [ CITATION Mar13 \l 1033 ].

SMEs play a major role in economic growth in the OECD area, providing the source for
most new jobs. Over 95% of OECD enterprises are SMEs, which account for 60%-70%
of employment in most countries. As larger firms downsize and outsource more
functions, the weight of SMEs in the economy is increasing. In addition, productivity
growth – and consequently economic growth – is strongly influenced by the competition
inherent in the birth and death, entry and exit of smaller firms [ CITATION Rol19 \l 1033 ].

2.3 Small business on job creation

It is apparent that SMEs play an important role in all OECD (Organisation for Economic
Co-operation and Development) economies: they make up over 95 per cent of enterprises
and account for 60 to 70 per cent of jobs in most OECD countries. The share tends to be
somewhat lower in manufacturing, although it varies between 40 to 80 per cent of
employment in manufacturing. The overall share of small firms in employment and
output may be even higher given that establishments or firms in the service sector are
normally of smaller average size than in manufacturing [CITATION OEC95 \l 1033 ]

It is not surprising that small enterprises/establishments play an important role in the job
creation process since they account for between 40 and 80 per cent of total manufacturing
employment. To see whether their role is disproportionately high, net job creation has to
be expressed in relation to the initial employment in small and large establishments. net
job creation rates are in fact often higher for smaller size classes. However, for a number
of countries it was found that the highest net job creation rates were among very small
firms whereas small to medium-sized firms (between 20 and 50 employees) did not
perform better than large firms [ CITATION OEC96 \l 1033 ].

In many countries, especially in developing countries micro & small enterprises are small
informally organized commercial operations owned and operated mostly by the poor.
They account for a substantial share of the total employment and gross domestic product
(GDP) contribute significantly to the alleviation of poverty and income creation. They are
often the chief economic defense of the most vulnerable households in high-risk
environment, such as civil conflict and natural disasters (micro enterprise laying the
foundation for economic development (MELFED 2004).

The MSEs sector is believed to be able to fill the gap that exist between the poor and the
rich in developing countries regarding income generation and, unemployment rate.
Successful small businesses are the primary engines for economic development such as
income growth and poverty reduction in many of the developing countries. These
businesses can also build foundation for stable communities and gender equality.
However, poor infrastructure, weak public service, inadequate mechanisms for dispute
resolution and lack of markets to their product and formal financing remain major
impediments to small business growth (MELFED 2004).

According to the 2003 Central Statistic Agency (CSA) report, in Ethiopia there were
974,676 micro and 31,863 small enterprise establishments in Ethiopia, which accounted
for 99.40 percent and 0.46 percent respectively of the industrial establishment. Large and
medium enterprises (employing more than ten employees) were 642 accounting for the
remaining of 0.11 percent. Micro enterprise and small enterprise provide employment
opportunities to 877,370 (89.75 percent) and 8929 (0.91 percent) respectively (CSA
2003). Large and medium enterprises on the other hand accounted for about 9.34 percent
and 0.91 percent of industrial employment respectively (CSA 2003). In addition, about
47 percent and 42 percent of these MSEs were engaged in manufacturing and petty
trading respectively. The remaining 11 percent were employed in traditional activities
(service, agriculture, transport, construction, mining etc). Furthermore, Gebrehiwot and
Wolday (2004) depicted that the average capital of micro and small enterprises amounted
to 3,528 birr and 38,354 birr respectively. In terms of number of workers, the average
employment is 1.5 persons for micro and 3.3 for small enterprises [ CITATION Are05 \l 1033
].

Small firm expansion boosts employment more than large firm growth, because small
firms are labor intensive, coinciding with the factor market structure of most developing
countries. Many analysts argue that within industries, for a given scale of production,
small firms are more labour intensive than large firms. However there are some evidences
suggests that enterprise scale is an unreliable guide to labor intensity because many small
firms are more capital intensive than large firms in the same industry. Labor intensity
exhibits more variation across industries than among firm size groups within industries
[ CITATION Hod12 \l 1033 ].

Government of less developed countries have been supporting for micro and small
enterprises through various programs such as credit schemes, entrepreneurship training,
technology support etc (Zaid and Torben, 2003). According to Todaro (2000) the
informal sector is a major provider of urban jobs in many Asian countries. Among
individual countries for which statistics available, the figure reaches 50 percenet in India,
45 percent in Indonesia, 35 percent in Malaysia and 60 percent in Pakistan. In the case of
Latin American countries 61 percent in Bolivia, 55 percent in Argentina, 56 percent in
Brazil, and 69 percent in Paraguay. Besides, ILO (1998) survey report of 17 African
countries found that the informal sector contributes on average 20 percent of GDP and
61percent of the sub-Saharan labour force employment. For instance, in the years
between 1980 and 1985 the employment share of MSEs for Kenya and Ghana was
around 40 percent and 80 percent respectively, out of the total urban employment
[ CITATION Jea05 \l 1033 ].

According to Staley and Morse (1992), 81 percent of the manufacturing establishments in

the United States in 1980 had small enterprises with less than 100 employees. These
establishments employed 25 percent of all manufacturing employees and produce 23
percent of the total value added by manufacturers. The relative importance of small
enterprises in West Germany and United Kingdom was also greater, 27 percent and 26
percent of all manufacturing employees respectively. The percentage of small enterprises
employment are even higher like in New Zealand 62 percent, Argentina 52 percent and
Japan 56 percent (Staley and Morse,1992) Hence, 13 this shows that micro and small
enterprises are contributing significantly even in developed countries [ CITATION Miz09 \l
1033 ].

In 2000 China had more than 20.85 million small-scale enterprises, with 128.2 million
employees and generating 2,720 billion dollar in added value, and 9.14 percent increase
every year of the small- scale enterprises [ CITATION TBO10 \l 1033 ].

In Kenya, according to the National Baseline survey of 1999, there were about 1.3
million MSEs, employing 2-4 million Kenyans, equivalent to 15 percent of the total
employment and contributing 18 percent of the GDP of the country. Moreover, the MSEs
sector in Kenya is very dynamic with rapid investment rates and enterprise growth
(Kimuye, 1999). According to UNCTAD (2005), the income contribution of the micro
and small enterprises sector in Tanzania was about 20-30 percent of the GDP, and they
consist of more than 1 million enterprises engaging three-four million persons, that are
about 20-30 percent of the labour force of the country [ CITATION Ber10 \l 1033 ].

2.4 Effect of Taxation on small business development

Tax is a charge levied on the citizens by a country or state. Tax is an obligatory payment
which the country imposes on its citizens, firms, and organizations not as a penalty for
any offence or immediate exchange of goods but as income to enable government meet
its expenditure (Ali-Nayea, 2008). The Income Tax Administration in Ghana started in
1943. This came as a result of the passing into law of the income Tax Ordinance No. 27,
1943 and the establishment of Income Tax Department. Over the years other taxes and
duties have been added to the income Tax Ordinance by way of amendments and
enactments [ CITATION Ali08 \l 1033 ].

Income taxation of SMEs considering personal and corporate income taxes. In addition to
personal and corporate income taxes, social security contributions may also apply to
SME income. In most countries, the taxation of SME under personal and corporate taxes
will depend on its business form; typically, unincorporated SMEs are taxed only at the
personal level whereas incorporated SMEs are taxed first at the corporate level and then
again when profits are distributed at the personal level subject to any integration
measures between these levels of taxation [CITATION OEC15 \l 1033 ].

SMEs are seen as more vulnerable to capital market weaknesses, making it more difficult
for a new business or SME to obtain raise to finance or require them to pay higher
interest rates. At the same time their small size may make it more difficult for them to
attract and retain equity finance. Difficulties for SMEs in accessing finance have been
exacerbated by recent financial crisis.(OECD,2009b) In these circumstances, it is argued
that tax preferences supporting SME finance are justified. However except where
information asymmetries affect access to finance, the more restricted access to credit or a
higher risk premium of SMEs may not be due to market failures. But it is related to the
inherently riskier and less profitable because of the nature of some SMEs or it may be
connected with general lack of investment [ CITATION Fre091 \l 1033 ].

Tax compliance has been seen to be a complex issue to define according to (Marti, 2010).
In simple terms, tax compliance can be defined as the fulfilment of all tax obligations as
specified by the law freely and completely. It has been found that regulatory burdens fall
excessively on small and medium enterprises (Pope & AbdulJabbar, 2008). The nature
and size of small and medium enterprises makes the issue of tax compliance one of
particular importance (Atawodi & Ojeka, 2012). Especially since most SMEs have access
to limited resources. and inadequate expertise to comply with diverse and complicated
regulation. Marti (2010) also believes that high compliance costs can result in tax
avoidance, tax fraud, and inhibit investment by way of diminishing competitiveness of
the country in terms of taxation attractiveness [ CITATION Ary01 \l 1033 ].

There is also the issue of noncompliance of tax and this could come in the form of: the
failure to submit a tax return within the required period or total non-submission of tax
returns, understatement of income, overstatement of deductions, failure to pay assessed
taxes by due date. In some cases noncompliance of tax may mean an outright failure to
pay levied taxes. Further, studies have shown that the problem of tax evasion is a
widespread in development worlds [ CITATION Mar10 \l 1033 ].

Empirical study by Fagbemi, Uadile and Noah (2010) have reported that noncompliance
of tax is prevalent in developing countries and it hinders development thereby leading to
economic stagnation and other social and economic problems. Chipeta (2002) has
identified high tax rates as one of the reasons of tax evasion. Chipeta (2002) further
pointed out that a higher tax rate increases the burden of the tax payer and reduces his
disposable income hence, the probability of evading tax is higher [CITATION Mne \l 1033 ].

Atawodi and Ojeka (2012) explained that, the choice of tax policy to employ depends on
the use of one or both two groups of instruments. The first being the use of special tax
preferences and the other incentives to support start-up and growth of small companies
(Atawodi & Ojeka, 2012). These incentives comprise of the lowering of corporate
income tax rates, special tax exemptions or tax holidays and relieves for small businesses.
The underlying reason for all these is to effectively raise revenue through measures that
suit a country’s circumstances and administrative capacity [ CITATION Pop10 \l 1033 ].

Taxation plays important role in the development of every economy as well as the growth
of Small and Medium Enterprises (SMEs). In a middle-income country like Ghana, the
role of SMEs is critical in pushing the socioeconomic development agenda of the country
further. Therefore, alignment of the tax system to the specific SME growth needs can be
considered an important agenda for the policy makers [ CITATION Ary04 \l 1033 ].

Small and Medium Enterprises have always been considered an important force for
economic development and industrialization in smaller economies (Aryeetey & Ohene,
2004 and Oludele & Emilie, 2012). These small enterprises have increasingly been
recognized as enterprises that contribute considerably to the creation of jobs, economic
growth and eradication of poverty in Africa. According to the 2005 World Development
Report, the creating of “sustainable” jobs and opportunities for smaller entrepreneurs are
the key strategies to take people out of poverty. Small and medium enterprises are mostly
private enterprises and they face difficulties when dealing with the government in general
and the tax administration in particular mostly the developing countries. Many of the
difficulties with the tax authorities may be deemed as the consequences of poorly
conceived tax policies and a lack of certainty regarding future policy changes. However,
it would be rare indeed to not observe complaints about the complication and/or
ambiguity of the tax laws as well as high tax rates [ CITATION Ali08 \l 1033 ].
If the tax structure is not adequately designed to the specific environmental conditions, it
may create a greater burden to the tax-paying organizations and eventually affecting the
final consumer due to the shifting ability of tax. According to a study report by Mnewa
and Maliti (2008), the majority of small businesses are less likely to attain or maintain
their growing profitability due to factors including tax policies. This implies that as a
policy maker and regulator, Government must consider the factors that could affect the
competitiveness of the small enterprises [ CITATION Mar13 \l 1033 ].

Despite the contribution that taxation can make towards the Gross Domestic Product
(GDP) of a country in general, much attention is also needed to the side effects of tax on
the growth of SMEs. This is because SMEs play a crucial role in driving economic
growth in both developing and developed countries. As highlighted previously, as a
group, they do not only generate more new jobs than large firms or macro-enterprises but
also introduce innovative ideas, products, and business methods. However, literature has
not contributed much in exploring the negative effect of tax payment on the financial
performance of SMEs in developing countries (Baurer, 2005). This situation raises a
serious concern about the issue of aligning the tax system to the specific requirements of
a particular country’s growth need, as it has to balance both short-term and long-term
impact of the policy [ CITATION Sam04 \l 1033 ].

2.5 Relationship
Small businesses provide catalytic benefits to the economy. They contribute to national
output, and to the society as a whole, beyond the spending and profit they generate.
Small business demonstrated its durability during the 1970s and 1980s in particular. At
the time, foreign competition led to a decline of basic, large-scale manufacturing
companies in such industries as steel, automobiles, and textiles. In the new global
economy, services became relatively more important while manufacturing became less
important, and that meant a growing role for small companies, which traditionally have
dominated many service sectors [ CITATION Gag13 \l 1033 ].

Economists saw additional reasons why small business would become a more important
part of the economic landscape. In the highly competitive and rapidly changing global
economy, they argued, companies that could innovate, customize products, and adapt
quickly to changing circumstances would have an edge. Small business, with less
hierarchical management systems and less unionized workforces, seemed to have just
these strengths. What is more, small businesses got an extra boost because declining
transportation costs and the emergence of the Internet made it easier than ever for them to
compete on the global stage [ CITATION Mar131 \l 1033 ].
In modern economies economic activity by small firms is increasingly important for
achieving economic growth. In the new context of the revolution of knowledge, of the
passage from the economy dominated by the physical, tangible resources to the economy
dominated by knowledge, the small and medium company becomes the main
microeconomic pawn. The globalization of the small enterprise will most likely be the
most important development in international business as we begin the new millennium.
Globalization – the growing impetus to think and act on a worldwide scale – will
continue to modify and mold the environment for small business over the next decade
and beyond. The globalization of the company means that more and more new firms must
export from their inception in order to be competitive. But they will profit from
globalization only if it gives them access to new markets. To be competitive, SMEs may
have to identify niche markets [ CITATION Ram12 \l 1033 ].
2.6 Summery
Small businesses can be identified as one of the important mechanisms that provides a
main share in the economic development of any country. The small scale businesses are
associated in the globalization, progression of the employment creation, and economic
development of the country. The unconstructive effects of economic turndown critically
affect the socio-economic circumstances of the individuals.

Small businesses contribute to local economies by bringing growth and innovation to the
community in which the business is established. Small businesses also help stimulate
economic growth by providing employment opportunities to people who may not be
employable by larger corporations.

Many small businesses also possess the ability to respond and adapt quickly to changing
economic climates. This is due to the fact that small businesses are often very customer-
oriented and understand the needs of the community. Many local customers remain loyal
to their favorite small businesses in the midst of an economic crisis. This loyalty means
that small businesses are often able to stay afloat during tough times, which can further
strengthen local economies.