The dichotomy of the undocumented sector is that more the economy tanks or moves to a recessionary trend more the undocumented sector thrives. As revenues dwindle and the margins get squeezed an increasing number of businesses in order to survive opt out of the documented streamline in order to stay afloat by saving on the government’s taxes and levies. Interestingly, back in 2018, Schneider and Buehan (S&B) estimated the proportion of the average size of an informal sector in a country in accordance with the income group that particular country or its economy falls in. Meaning, according to the study that formed various groups of informal sectors as a percentile of the total economy, a) The lower income countries tend to typically have around 41% share of the informal sector in an economy, b) Lower middle income countries have a 39% percent as the size of the informal economy, c) Upper-Middle income economies around 24%, d) Other high income also tend to hover around the same number of 24% and e) the special group of the OECD countries have the lowest level of the informal sector gauged in their economies at around 20%. They further asserted that, the more the size of an economy, the less the proportion of the informal sector will be as a percentage of the total economy. Moreover, the regional analysis estimated the informal sector as the following in a continental or sub-continental context: i) Latin America and the Caribbean 40%, ii) Sub-Saharan Africa 38%, iii) South Asia 34%, iv) Europe 23%, v) Middle East and North Africa 23% and vi) East Asia 22%. Implying that invariably the larger informal sectors mostly persist in the lower income group and the developing countries.
So what do S&B recommend that countries do in order to minimise the informal sector in their respective economies? Principally, they opine that strong IT systems are the solution, the more efficiently and broadly a business’s data is compiled the less likely it becomes for that business to operate under the radar. An efficient and responsive IT system directly improves management controls, expands tax bases and revenues, enhances trade facilitation cum organizational productivity, and promotes multidirectional communication through a harmonised information management structure. However, more importantly, the study argues that a tax system can only be successful if it takes into account the reality of the taxpayers. Meaning, unless the taxpayers take ownership of the national tax system by genuinely being convinced that their own and the overall markets’ interests lie in remaining within the laid down taxation framework, the system will never succeed. And this is where our tax system and tax-collection culture has generally failed, because not only people find it coercive, but at most places grossly unfair. Needless to say that reforms are required; something that has been talked about a lot over the years, but yet to materialise tangibly. Also, one must remember that knee-jerk operations, amnesties, frequent changes, raids, harassment, etc never work. A good and effective reforms process is always one that is slow and on-going in nature in order to establish fairness and transparency. S&B argue that based on the evidences collection from almost all global economies, to succeed, it is imperative for governments to construct a tax regime, which stimulates inclusive growth and guarantees a fair and impartial sharing of the overall tax burden. Further, a good way to develop and nurture a progressive tax regime is where a government consciously examines and moves forward in finding suitable ways (according to the local environment) on how to reduce cash from the economy and eliminating foreign currency based transaction in the domestic economy to the barest minimum. Additionally, at some stage it would be necessary to make it mandatory under operational legal framework that transactions beyond a certain size or a total business quantum beyond a certain threshold can only be carried through the channel of a Limited concern. Lastly, arbitrary tax breaks and/or tax exemptions under any pretext are best avoided unless they seem absolutely necessary to perhaps target the poorest of the poor pockets or to prop-up particular poverty stricken areas.
Here in Pakistan, regrettably, the overall performance of our revenue collector, the FBR, has been quite lack lustre over the years, with little progress made on implementing key tax-reforms recommendations suggested by different financial quarters including the World Bank. While there is no doubt that there exists a great potential and opportunity to enhance tax revenues in Pakistan, however, to harness this potential the long elusive tax reforms drive will have to be adopted without wasting more time. Essentially, the main reforms should aim at establishing a taxation system that shifts the burden away from the existing taxpayers and more importantly, it should be packaged in a way that not only does it garner ownership from a wide spectrum of productive Pakistanis, but it also ensures that it boosts both, investment and productivity instead of hampering them!