Wednesday August 17, 2022

Informal is on purpose

November 12, 2021

LAHORE: Opportunity cost of informality is exploited more by the documented sector indulged in under reporting production and import invoice, and rent seeking bureaucracy, than the poor entrepreneurs.

Bribe takers do not even spare enterprises that do not hide their production or income. Such enterprises are forced to pay bribes at different stages of their business processes.

The problem is that it is not possible for them to report the hefty bribes they pay at income tax, customs, or other levels in their accounts. Since things do not move smoothly without speed money, the service charges of clearing agents or the income tax consultants and other service providers are ‘enhanced’, from where these bribes get paid. These agents then manipulate their accounts through numerous ‘made-up’ expenses.

Poor governance, flawed laws that suit those in power and other malpractices are responsible for economic turmoil. Rulers seek waivers in laws and taxes for their favourites, and encourage even formal businesses to carry out informal practices which keep the tax to GDP ratio low.

Technology is there to discourage the informal sector, but the government would simply have to muster the will to document the economy.

Technology would not spare wrongdoings of anyone, and powers of the rulers or officials to pass on undue favours would end.

Pakistan’s regulatory system is kept deliberately skewed to provide loopholes even to the formal sector to avoid taxation. The number of informal entrepreneurs outnumbers the registered enterprises; still, the tax evaded by the formal sector is much higher than poor informal traders and agriculturists.

Curbing informality is not in the interest of various regulators that benefit from informality. The state must fight on various fronts to arrest the growth of black money.

Smuggling is another major deterrent to formality. It is well spread because of rampant corruption in the society.

Besides developed economies, it is impossible even in neighbouring India to openly sell smuggled items.

Agriculture is exempt from income tax and this opportunity is fully exploited by all leading industrialists in the country. Their huge income from agriculture is considered white when they present certificates from their provincial governments that they have paid the agricultural income tax.

Other avenues available to whiten money are property business and stock markets. The number of informal entrepreneurs is much higher than the formal or semi-formal operators.

These small entrepreneurs have little voice and are easy targets of the bureaucracy to exhort money. The 1.8 million shops in the country dole out enough money to even the lowest level corrupt officials to live a comfortable life. The ever-increasing cost of living does not bother them.

This advantage is enough for them to resist any attempt to formalise trade. The bureaucrats facilitate the traders to launch protests against the documentation of the economy.

Informal operators of the economy are the target of tax officials, municipal regulators, and police; all of whom protect them in their informal trade.

With the available technology, the Computerised Tax Number of the owner of the enterprise can also be its National Tax Number. It should be made mandatory to display this NTN prominently at the premises of an enterprise. And it should be made mandatory for each business operator to file yearly tax returns.

The quality and productivity in the smaller, more informal firms remains very low as they do not employ skilled workforce. Firms that need skilled labour to improve their market share do not do so fearing that it may lead to formality.

Corruption imposes a tax on productivity and competitiveness. Quality of regulations in Pakistan remains lopsided as the violation of rules by the ruling elite dilutes the impact of improved laws.

Many antiquated laws are still operative at federal, provincial, and local levels. Opening of the economy has not been accompanied by changes in the laws and regulations, exposing inadequacies in the regulatory framework in the country.

The inadequacies in laws have increased arbitrary discretion on the part of government officials. The cost of this discretion has increased the cost of the formal sector, which serves as a deterrent for others to operate informally.

Financial sector is facing huge challenges. The National Savings Scheme is impeding the growth of the financial sector, as the interest rates provided under this scheme are irrational and a huge burden on debt servicing by the government of Pakistan.

The income under these schemes is virtually tax free. The recently introduced Roshan Digital Accounts have further increased the discretion.