Informal economy

May 21, 2024

EDITORIAL

The size of Pakistan’s informal sector has been a cause for much consternation for our policymakers
as its continued salience over time only serves to indicate the huge number of businesses and
individuals that lie outside the tax net, leading to the national exchequer potentially losing out on
hundreds of billions in tax revenue.

Now, a recent joint study carried out by the Small and Medium Enterprises Development Authority
and the International Labour Organisation has provided fresh and disturbing evidence of the
persistent growth of the informal economy.

According to a study, the total size of Pakistan’s informal sector is projected to be an enormous
$457 billion. This is in sharp contrast to the size of the formal economy, which as per official
statistics was worth $340 billion in 2023. This basically means that the former is almost 64
percent greater than the latter.

The unrelenting expansion of the informal sector reflects not only the failure of successive
governments to reduce its size, it also indicates their utter inability to arrest its rapid growth. Given
that a considerable share of the country’s small and medium-sized enterprises (SMEs) operates in
the informal economy, as well as a huge 72.5 percent of the country’s labour force is not working in
agriculture, it is clear that there is an immediate need for our economic managers to bring these
businesses and the labour they employ into the documented economy.

An analysis of the factors that have contributed towards the persistent rise of the informal sector
tells us that our convoluted (complex) tax structure, which relies largely on indirect taxation
(STA,1990), has been one of the major reasons for this phenomenon.

REASONS
1- Instead of taxing incomes and assets, the tax bureaucracy relies on taxing transactions, and
as has been noted in these pages before, for a small business with few resources, complying
with a withholding tax regime that involves keeping track of multiple tax rates applicable at
each stage of the business transaction, and then expending efforts and resources on
painstaking documentation of these is a complicated endeavour.

2- This is in addition to the complex administrative procedures enterprises have to comply with
and the costly, time-consuming process of registering businesses, with various licences and
approvals required from multiple federal and provincial government departments. All this
has combined to make the cost of doing business in the formal sector prohibitively
expensive, inhibiting entrepreneurial growth, and ultimately leading to a further expansion
of the informal economy.

SOLUTIONS
 1- What is urgently needed is the streamlining and simplifying of the relevant regulations that
govern the operation of business in the formal sector as well as overhauling of the prevalent
tax architecture. The reliance on indirect taxation exists because that is what the tax
bureaucracy finds easy to administer. This tendency of doing what is convenient for the
bureaucracy and the government needs to end.

2- Policymakers must realise that the goal for any governmental machinery is to improve the
life of citizens and make it simple for them to follow the law of the land. On current
evidence, this basic concept seems to be an alien one for our state apparatus.

3- Instead of placing undue pressure on businesses, all relevant departments, including the
Federal Board of Revenue, need to play the role of enablers and simplify the process of
becoming part of the documented economy.

4- The last thing Pakistan needs is the continued prominence of the informal sector, given the
country’s fast-shrinking fiscal space. The government must realise that reforming the tax
architecture as well as the labyrinthine process of complying with other regulations has to
become a priority if we want to bring in the billions in tax revenue that the country’s
entrepreneurs and the SME sector could generate, and whose tremendous potential has
long been constrained by operating as part of the undocumented economy.

Copyright Business Recorder, 2024