Formalisation of the informal economy

July 03, 2022

We need to reduce the size of the informal economy without impacting the poor employees

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very venture that earns money but pays no taxes, employs people but does not follows the labour laws or runs a business but holds no licence is part of an informal sector of economy. So basically, the informal sector is the part of an economy that does not comply with the laws.

Where does this sector stand in Pakistan? Does it stimulate economic growth or exploit the poor? How does it impact the society as a whole? As per Pakistan Businessmen and Intellectuals Forum (PBIF), informal economy constitutes 35 percent of Pakistan’s GDP. It stimulates business activities and provides jobs to millions in need. It also exploits the poor when it comes to wages and working hours. It demoralises the taxpayers and those who comply with the laws.

Pakistan needs to formalise its informal economy and overcome all impediments to the process of formalisation. One such impediment is the extensive use of cash that poses a serious threat to formalisation and makes it difficult for the government to trace most transactions.

In real estate business, for example, cash transactions are used to avoid documentation of wealth. To tackle this issue, there needs to be an effective policy. Everyone who buys a property should be asked to attach a banking instrument with the ownership documents as proof of legitimate funding. Besides, we also need to have an easier digitised payment system to minimise use of cash for off-the-books transactions.

Secondly, the government should work to extend its tax base so that it gets easier for all to run legal businesses while paying reasonable amount of taxes. Every budget brings new rates and burdens for those already paying their taxes. Meanwhile, those who work outside the law do not have to pay anything. This discourages every taxpayer who abides by the law and helps the state in collecting its revenues.

The informal sector gets stronger when the formal sector is over-taxed. Resultantly, competitiveness of tax-compliant industry is impacted both domestically and globally.

Thirdly, the world has digitised tax systems but the Federal Board of Revenue still has to upgrade its system for some very basic issues. There are thousands of high income individuals who file no income tax returns and still avail benefits of being a tax filer.

When an informal economy formalises, the employees get their due share and the state and its law stand by them in case of exploitation by the employers. The employers get legal status and become eligible for bank credit.

A filer pays one percent tax on property whereas a non-filer pays two percent. So when such an individual buys a plot he pays only 1 percent to the government by claiming that he or she is a filer. The government never tries to check whether the plot was even shown in his wealth statement or not.

Fourthly, all institutions relevant to business must be linked so that nobody tries to work outside the law. For example, after registration of a company with the Securities and Exchange Commission of Pakistan, there needs to be a proper system in place at the Federal Board of Revenue that should verify whether the company exists or not. If it does, it should be ascertained whether its sales tax registration has been completed or not.

Sometimes companies are registered but they file nil returns. That is usually because they use personal bank accounts. The company is an independent entity and has nothing to do with its owners. However, people often take this route and use their personal bank accounts instead of the companies’ accounts to hide their sales.

The governments need to have a database at the FBR that showing when a particular CNIC number is searched. In this way, it would be easier to trace those who hide their sales.

Fifthly, it is not all about money. FBR’s attitude too makes some businesses evade taxes and discourages them from legal compliance. Most of the entrepreneurs do not register their businesses because they think the government’s officials would blackmail them if they showed them their assets. This trust deficit needs to be reduced, personal involvement of officers with entrepreneurs should be limited and businesses should be given the respect and recognition they deserve.

Lastly, some businesses are legally registered but hide a portion of their production and thus, partly evade taxes. Some of these provide raw materials to informal businesses.

In this regard, policy of the previous government should be reintroduced. It required a CNIC copy for every purchase order of more than Rs 50,000. Resultantly, every legal business would show their sales and provide CNIC details of their buyers. This way, raw materials supplied to informal sector would be traceable.

When an informal economy formalises everyone gets its benefits; legal as well as corporate. Employees get their due share and the state and the law stand by them in case of exploitation by employers. The employers get legal status, become eligible for bank credit and are exposed to accountability by customers.

No government so far has been able to fully integrate the informal sector into the formal. What we need to do is to reduce its size without impacting the poor employees.


The writer is a certified public accountant (UK). He can be reached at ca_numanyahoo.com



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