INFORMAL ECONOMY

July 4, 2012 Economy, July 2012 Leave a comment

A Blissful Orchestration of the Frail Home-based Workers

Production and consumption of a country are based on its economic system. There
are two types of economies: formal and informal. Formal sector is regularised by
the government whereas informal sector is unrecognised; though the informal
sector is not completely unregulated, there are some norms to keep it ‘somehow’
regulated.
Informal sector includes brick kilns, livestock, fisheries, street vending, hawking,
domestic work, waste picking and home’ based work. Globalisation played a major
role in changing the economic conditions. Socio-cultural factors including
political, social and economic systems also have a direct impact on the economy;
thus, they should be favourable. Mushroom like growth in the informal sector
increases especially when there are no employments in the formal sector.

The role of the informal sector of the economy is two pronged. It is important as
well as controversial. On the one hand, it provides job to the downtrodden people
and reduces unemployment, on the other these jobs are low’ paid and lack job
security. However, non-government organisations for informal workers have a
pivotal role in improving the condition of HBWs. These organisations have a direct
impact in enhancing their vocational skills, their know ‘how about marketing and
bargaining skill.

Majority of the working women is working in the informal home-based sector. The
reason why most of the women work at home, i.e. fall in this sector is they are
generally not allowed to go out in the field to earn wages. Therefore, working at
home and associating to the informal economy becomes a natural choice for them.

Main reason for adopting this occupation is the unemployment or irregular job of
their male family members. Most of the home-based workers (HBWs) live in small
and shabby houses and live as a part of the joint family systems. Most of them are
illiterate. They can be single or married, widow or divorced. However, their age
and marital status do not change their wages.
Women HBWs comprise 70% of the informal labour sector having a great
contribution in the economy. They are the producers and artificers but are
considered as poor and dependent part of a country as they are least represented in
the national statistics. They need to be recognised as ‘labourers’. The government
should increase their productive skills by imparting trainings, giving them an easy
access to credit schemes, market opportunity. They should be protected by
legislation.
Most of them do not have written contracts; decreasing demands of handicrafts /
handmade products, and increasing interest rates and prices make their lives more
miserable. They face production challenges such as lack of modern equipment, no
easy access to micro credit schemes, due to irregularity and seasonal work, they
have to do different natured works to make their both ends meet. Lack of
information about the changing market trends, meager wages and in health
challenges, poor diet is most evident which brings all other sufferings related to
health.
Middle person is a great power. He can either make the lives of the HBWs easier
or miserable. He/she is the provider of ‘orders’ for the HBWs and gives them
remunerations for the value-added finished products. Irregularity in payments, non-
payments for first work/contract/’order’ and the threat for the non-availability of
new contracts is also due to the middle person.

Most of them do not have written contracts; decreasing demands of handicrafts /

handmade products, and increasing interest rates and prices make their lives more
miserable.
Role of the state cannot be denied in any sphere of life whether it is religion,
culture, or any form of wants and disparities, redress of issues of health,
sustainable development, or economic empowerment. It seems that the government
of Pakistan does not know the importance of the HBWs sector because the labour
laws do not give protection to the HBWs. Prime hindrance in this regard is that
HBWs do not come under the umbrella of ‘workers’. The need is to recognise
HBWs as workers and add the definition of HBWs in the documents concerning
every labour right, so that any further development in the legislation and statute
may be applied to HBWs positively.
Being labourers, they are entitled to all the workers’ rights, for example, facilities
of social security, health facilities, minimum wages, etc. But, as they are not
included in the definition of laborer therefore they are deprived of all these
facilities. It is not only against the human rights but also against the labour rights.
An informal worker has to opt informal sector, because s/he has no other cushion
to fall back on. There is a need to eliminate the negative features of the informality
on the condition that the informal workers would be earning a ‘decent living’ while
keeping in view that one of the essential feature of the informality on the condition
that the informal workers would be earning a ‘decent living’ while keeping in view
that one of the essential feature of the informal sector of the economy that is of
providing the downtrodden poor people with sustainable livelihood may not lose.

Factors that accelerate Informal Economy

April 20, 2018 April 2018, Pak Affairs Leave a comment
In Pakistan, the tax gap is estimated to be over 11 percent of GDP – a fact that
signifies the huge potential for tax revenue. The tax authorities need to exploit this
potential in order to mobilize additional tax revenue of more than Rs 3.3 trillion
that will jack the tax-to-GDP ratio up from the current 11.5 percent to 23.3 percent.
The huge tax gap – almost equal to tax collection of Rs 3.33 trillion – signifies that
the size of informal economy in Pakistan is as large as that of the formal economy.
Largely, the causes of informal economy are rooted in the tax system. Size and
structure of tax burden, efficiency of tax administration in collecting taxes, penalty
policy, complexity or fairness of the tax system and compliance costs determine
the size of the informal economy.

Higher tax burden

There is no denying the fact that higher tax burden increases the size of informal
economy. It is because increasing the tax burden makes it more cost-effective to
operate in the informal sector. In Pakistan, the tax base is extremely narrow with
1.26 million tax return filers for the tax year 2017. Tax burden of the assigned tax
targets has always been on existing taxpayers. Nonetheless, in view of the narrow
tax base and low voluntary tax compliance in the country, many forms of
withholding tax are being used to collect taxes from informal sectors; though
provisions relating to presumptive tax regime are regressive in nature. The sales
tax rate of 17 percent is considered significantly high; many supplies are, however,
subject to reduced and even zero rates. Moreover, exemptions are available to
many low-income societal groups. Major portion of the tax collection comes
through indirect taxes. It means a significant tax burden is on consumption sector
which directly affects the low-income groups.
Weak enforcement measures
The tax gap of 11 percent of GDP further signifies taxman’s limited capacity to
detect tax evasion. First, the tax administrators do not have human resource enough
in number to catch each and every tax-evader. Second, capacity and skill level of
the tax administrators is also too limited to detect tax evasion. Third, the tax
authorities do not always get assistance from other law-enforcement agencies in
nabbing the tax-evaders. Fourth, there are no adequate financial and logistic
resources placed at the disposal of the tax authorities so as to facilitate them in
carrying out the cumbersome work of conducting investigations against the tax
fraudsters. Fifth, tax audits are not being conducted so effectively that they create
deterrence against tax-evasion. As tax-evaders fear little of being caught for tax
recovery along with penalties and additional taxes, they continue to operate in the
informal sector. Sixth, the tax authorities have the capacity to select and conduct
audit، thereupon، of only tax affairs of the return filers. Persons not registered for
tax purposes continue operating in the informal sector.

Inadequate tax audits

Businesses and individuals do not always cooperate with the tax authorities during
audits of their tax affairs. Audits are largely concluded either ex parte or they are
based on third-party information, such as from banks. In a number of disputed
cases, huge tax liability is assessed on the basis of third-party information such as
bank statements or income tax returns. The assessment orders are declared void
and of no legal effect by the courts if they are not based on specific provisions of
the tax statutes. An immediate reasoning for the poor quality of assessment work is
the pressure of reporting every month the number of assessments and quantum of
the tax demand created, which is used as one of the criteria for assessing
performance of the tax authorities. Knowing the lacunae in tax audit policy and
weaknesses of the tax authorities in the conduct of audits, taxable persons foresee
little probability for detection of tax evasion. Furthermore, decisions of the
appellate authorities in favour of the taxable persons regarding sales tax liability
during the period when the taxable persons were liable to be registered also
encourage them to operate in the informal economy.
Penalties for tax evasion
In view of the limited tax capacity and deficiencies in the tax statutes, the
authorities are not always able to impose and recover penalties and additional taxes
for non-payment or late payments of due taxes. For example, although the tax law
prescribes penalty for non-filers of tax returns but the appellate authorities vacate
the orders of the tax authorities in case no tax is paid or payable with the returns.
Non-recovery of penalty for non-filing of tax returns encourages the taxable
persons to continue to operate in an informal sector.
Tax & criminal system
Tax criminal system has not yet established in Pakistan. The Directorate General of
Intelligence & Investigation (IR) has been established by the Federal Board of
Revenue (FBR) to initiate prosecution proceedings against tax fraudsters but owing
to lack of resources and excessive litigation issues, the Directorate General of
Intelligence & Investigation (IR) has not been so effective in nabbing and,
subsequently, initiating prosecution against the tax fraudsters at the desired level.
Weaknesses in the tax criminal system encourage informal business transactions.

Complexity of the tax system

A complex tax system riddled with frequent changes discourages taxable persons
to register for the purpose of tax and thus encourages taxable persons to operate in
an informal sector. For example, under the Sales Tax Act, 1990, persons registered
as manufacturers, importers, exporters and wholesalers doing business in textile
(including jute), carpets, leather, sports and surgical goods sectors were given
benefit to import and supply of goods at a reduced rate of 6 percent, 4 percent or 0
percent under the statutory regulatory order (SRO) 1058(I)/2011 dated 23
November 2011. This SRO was superseded on 1 January 2012 and sales tax rates
of 5 percent or 0 percent were introduced on import and supply of such goods
under SRO 1125(I)/2011 dated 31 December 2011. Again, this was amended 8-9
times. Through SRO 154(I)/2013 dated 28 February 2013, the zero-rating scheme
was withdrawn and replaced with sales tax rate of 2 percent. On 26 July 2013, the
rates were further amended to 7 percent, 5 percent and 2 percent under SRO
682(I)/2013. Under SRO 898(I)/2013 dated 4 October 2013, import and supply of
fabric was charged to sales tax at the rate of 3 percent and value addition at the rate
of 2 percent on commercial imports of fabrics. Such schemes not only provide
opportunities for tax fraud but also encourage businesses to keep their actual
transactions out of the tax net.

Fairness of the tax system

The tax system in Pakistan offers exemptions, reduced tax rates, zero rating,
special schemes, etc., to selected individuals and sectors of economy. Under the
prevailing tax system, some individuals and sectors of economy have to share
higher tax burden as compared with others. Such a lopsided tax system promotes
informal economy.

Tax compliance costs

In Pakistan, tax compliance costs are significantly higher as compared with
regional countries. Higher tax-compliance costs discourage taxable persons to
register under the tax statues and to make compliance of tax payments and other
tax obligations. To encourage formal economy, the tax authorities require to reduce
tax compliance costs and to facilitate businesses in filing tax returns, tax payments
and fulfilment of other tax obligations.

Tackling Informal Economy, Addressing the root cause of all social ills
Taxation policy has been widely used as an instrument to enhance the size of
formal economy, considered crucial to allow economy to operate at full
employment level, fizzle out underemployment, wipe out poverty, ensure gender
equality and stabilize economic growth. Empirical evidence shows that workers in
the informal economy face higher risk of poverty than those in the formal
economy. The working conditions in the informal economy are inadequate and
unsafe and workers have high illiteracy levels, low skills levels and insufficient
training opportunities. Therefore, informal economies have higher levels of
unemployment and underemployment.
In view of multifaceted nature of informal economy, it is not an easy task to reduce
its size rather it requires vertical integration and coherence across the range of
policies to curb informality. Pakistan is a lower-middle-income country typically
having a large informal sector, very high self-employment rates and low levels of
tax collection. Informal economy in the country is estimated to be as large as the
size of the formal economy.

The business concerns, especially small and medium ones, continued operating in
informal economy largely to avoid taxes by keeping costs and revenues off the
books. Such a trend restricted the growth of such firms and kept tax authorities
away from enforcement measures. Hence, there is an urgency to enhance the size
of formal economy to correct distortions induced by informality by facilitating the
firms to get registered under the tax laws. This can be achieved by lowering the
cost of registration and making it easier for the firms to pay taxes and file returns
and declarations.  
Since many years, it is being considered that property sector in the country is a
major destination of all types of black money. Under-declaring or mis-declaring
the value of property in order to avoid taxes has become a norm in the country. In
certain cases, the declared value of property transaction is as low as 20pc of fair
market price. Such a practice has weakened the efforts of documenting the
economy. The housing society developers have accumulated enormous wealth by
employing these tactics and avoiding due payment of tax. The money in the
property sector is considered idle and counterproductive for economic growth. It is
being suggested that we should induce money out of property and channelize it
toward productive economic sectors that would spur economic growth and result in
reduction in unemployment and underemployment.
Accordingly, in the federal budget for FY2016-17, necessary changes have been
made in Section 68 of the Income Tax Ordinance, 2001 (hereinafter ITO). The tax
authorities would not use Collector/DC rate as a base to determine property value
for assessment of tax rather fair market price of property would be determined by
the professional evaluators approved by the State Bank of Pakistan to be used as
tax base. Now, instead of the valuation of property by the approved panel of the
State Bank of Pakistan, the valuation table has been released by the Federal Board
of Revenue for assessment of property for the purpose of taxation. This initiative to
document the fair market value of property transactions is a step in the right
direction and requires true implementation to broaden the tax base. This would not
only generate additional tax revenue for balancing the budget but would also
document the economy by discouraging lending black money in the real estate.

Further, the government has empowered the commissioner to issue notices under
Section 114 of the ITO to a taxpayer who has not filed tax return for the past ten
years. Earlier, the time limitation for issuance of notice under the said section was
five years. With extended tax period, there are ample opportunities for tax
authorities to nab non-filers and to recover evaded amount of tax.

In the previous financial year, the government attempted to document the money
by imposing withholding tax on bank transactions exceeding Rs. 50,000 a day to
bring the non-taxpayers and non-filers into the tax net. It is because a considerable
number of persons engaged in trading activity are out of tax system. By bringing
these persons into the tax net, the number of tax returns filers can be increased
significantly.

As another measure to enhance documentation of unregistered businesses, the

government introduced tax amnesty scheme aimed at bringing business capital into
the tax net. It was expected that the amnesty would net thousands of non-filers and
would yield revenue to the tune of billions of rupees but the results fell far short of
expectations.

The Federal Board of Revenue (FBR) also attempted to enhance the size of formal
economy by taxing different transactions at different tax rates for filers and non-
filers. This tax policy has yielded some positive results and non-filers are forced to
file tax returns to get benefit of low tax rates.

Efforts are also being made to enhance the size of formal economy by denying the
input tax benefits to unregistered persons under the sales tax regime.  Section 2
(25) of the Sales Tax Act, 1990 reads that “a registered person means a person who
is registered or is liable to be registered under this Act provided that a person liable
to be registered but not registered under this Act shall not be entitled to any benefit
available to a registered person under any of the provisions of this Act or the rules
made there under.” Thus not only the registered person but also one who is liable
to be registered under the Act falls within the purview of ‘registered person’. The
‘proviso’ provided in the very definition of ‘registered person’ is an illustration of
the intention of the legislature to enhance the size of formal economy as one of the
means adopted by the legislature to achieve the aim of bringing as many persons as
possible into the formal economy is to provide incentives to persons who are
registered under the Act, while expressly disallowing the same to those who fail to
do so.