Undocumented workers and informal economy

The Chairman of the Securities and Exchange Commission of Pakistan, Mohammad Ali, strongly feels that the size of undocumented economy is expanding. According to him, grey economy is now equal to white economy. Although, nothing is about the research or study on which one of key regulators has based his estimates, his warning is a source of immense concern. After all, the SECP is provided with audited balance sheets by the corporate sector ie listed and non-listed limited liability companies.
It is the proprietorship and partnerships concerns that are not required to submit their audited accounts to the SECP. These businesses outnumber the corporate entities and are more prone to suppress their correct sales and, therefore, hide their real income and underpay taxes. But they are not the only ones doing so. If this was true - banks would not be requiring personal bank guarantees of directors of listed, as well as non-listed companies, before offering loans. The incidence of double book accounting to reduce tax liability is said to be rampant in corporate as well as non-corporate sectors. Textile sector, which is over 50 percent of the overall economy, is regarded as a prime example - where owners become richer every year despite businesses showing a loss. Has the SECP even once been able to catch a listed textile unit on the basis of balance sheet submitted by it? The answer will be a big 'no'! And the reason: the SECP lacks the capacity to do so.
Perhaps, the SECP Chairman wants to push the agenda to lower the tax rates of companies - in a phase-wise manner; over number of years from 35 percent at present and, increase the tax rate of non-corporate sector from the present rate of 25 percent to induce corporatisation and in return raise the documentation of economy. Tax rate alone cannot be an inducement or a replacement for effectiveness of the tax collection system. Taxes are paid as a result of fear. And, it is the fear of getting caught and punished that induces the taxpayer not to hide or underpay. This is where effectiveness of the tax collection system comes into play.
The FBR has already warned businesses that they need to register with them and display their national tax numbers. The enforcement mechanism which country's principal tax collection arm claims to have envisaged needs now to come into play. Once fines are imposed, as required under the law, for non-display of registration and CNIC blocked for non-registration with FBR - if the income is above the Rs 400,000 threshold - only then would people start fearing as is said, seeing is believing.
The FBR plans to raise the number of taxpayers by 4 million this year through a CNIC mechanism. The law still needs to be approved by the Parliament. We hope legislators would act quickly so that the dividend to economy accrues within the financial year. It would only be long-lasting if those who obtain or are given NTN numbers this year are obliged to file their tax returns in the subsequent years. This is where audit and monitoring comes into play. Universal self-assessment can only be a success if it is backed by effective monitoring mechanism and in-depth audit. Sectoral input-output ratios need to be worked out at the board level and field force alerted in cases of under reporting of incomes by desk audit. Postings, transfers and promotions need to be merit-based and over-achievers rewarded and under-achievers penalised. For this to happen, the revenue officials' cadre needs to be different and free from the normal civil service rules. The present archaic establishment set-up is not working and will not work. Technology and its usage to determine expenditure of persons and businesses has to play a key role. Both the inland revenue side, ie, sales tax and income tax, as well as customs, are under-collecting. If the SECP Chairman is to be believed then FBR's potential is not Rs 2,500 billion but Rs 5,000 billion a year provided we get our act together.
Gross Domestic Product (GDP) constitutes all three sectors of economy: Agriculture, Manufacturing (Industry) and Services. Estimation of agri output is believed to be pretty accurate as output of both major and minor crops is captured by provincial revenue departments. Livestock estimates are carried out through periodic aerial surveys. The manufacturing and services are the two sectors where there is a greater possibility of underestimation. At present, manufacturing largely captures large scale manufacturing (LSM) while small and medium-size businesses are not fully documented and guesstimates are generously proffered on the basis of old surveys. In services sector, banking and insurance output are accurately gauged. Wholesale, retail sectors particularly those trading in agri and non-agri commodities are not fully documented. Estimation of informal-non-documented-sector is only possible through indirect means such as currency ratio to GDP and is still only a guesstimate which can range from 50 to 100 percent of the estimated GDP. It is, however, crystal clear that more than half of country's economic problems emanate from the fiscal side. If this problem area is attacked with gusto and political will - the benefits will cascade downwards. There are no two options that there is indeed a huge fiscal space available at present rates and application of existing laws, despite loopholes, to increase the tax to GDP ratio through a simple but transparent mechanism. What the country lacks is a clear-cut strategy backed by political will to expand the tax base at least to a level which can hold this country together. Not paying taxes because of bad governance is a lame excuse. People have the right to vote out governments which do not deliver according to their wishes. Taxation is the only power that a ruler has from time immemorial. All else such as defence and judicial system are mere functions. Last but not least. The SECP chairman is right because the sizes of undocumented workforce and informal economy are expanding - if not overtly, then covertly; if not for the law, then against it. But one must not seek to obscure the fact that the informal sector in the country is buoyant, and is generating jobs; incomes and demands for goods and services. This, in turn, is spilling into the real sector that is documented. "A vibrant informal sector is a blessing as it is driving formal economic activities and keeping Pakistan away from a full blown recession as seen in Europe," according to country's central bank, the SBP. The SECP chief needs to appreciate the fact that the informal sector of country's economy is growing because the size of working population is expanding and job opportunities in the formal economy are not keeping pace. Don't forget, the country needs to absorb more than 2 million newcomers in the job market every year. And this number will continue to grow. Unfortunately, however, the current economic trends are alarmingly contributing to the exclusion of both new and veteran workers from the formal economy. All political parties, particularly PPP, MQM, PML-N and PML-Q, are required to formulate their election strategies based on economic imperatives of the country, including the need for efforts aimed at spurring growth and creating new job opportunities.