Pakistan's informal economy which once supported the robust growth in the country is now one of the biggest hurdles in her own development and growth. To document Pakistan's economy, the government needs to take several bold steps that must work collectively. In this article, I will discuss 5 key steps which if taken, will help the government to document the economy.
It is a universal truth that no one likes to be taxed, but it is one of the main sources of revenue that the government spent on the public. Despite several regulations, tax incentives, exemptions, Pakistanis seem not to trust their Government or to avoid taxation.
It is not only the requirement of IMF and World Bank, but it is also required for the Country to get rid of the debt trap mounting by each passing year.
Strong Economies tend to have strong ethical values with happy & contented masses.
There are always two ways to solve a problem, a simple one, and a complex one. I am proposing a simple hybrid solution which applies to both informal and formal economy, at the same time and can be implemented in the much lesser period, achieving the Government’s objective of documenting the economy, but also combating the malpractices which Islam prohibits.
But first, we need to understand the core issues and why such problems persist.
Pakistan key economic issues
To wrap up, Pakistan is battling against two fronts:
- Trade deficit
- Fiscal deficit
Pakistan's economy witnessed tremendous growth in the past but failed to sustain growth. So far, the Government is able to control the trade deficit (short-term solution) by increasing the exchange rates, import duties & taxes and higher interest rates, resulting in a reduction of imports, which also resulted in the contraction of economy and spike in the cost of doing business and standard living.
Regarding the fiscal deficit, Pakistan is struggling to overcome it and is due to, not having enough revenues and an increase in government expenditures.
Therefore, it a dire need to increase the documentation of Pakistan’s informal economy and to increase the tax base and revenues. The question is why so many Pakistanis still persist to keep their businesses and day to day transactions within an informal economy?
Impediments of an informal economy
This is a governance issue, and there are several reasons which may include the following:
- Overregulated taxation with a complex nature.
- Ample circulation of large denomination banknotes and cash equivalents.
- Ease of doing business than in the formal environment.
- Poor implementation of macroeconomic policies.
- Development of policies without consultation.
- Lack of good governance.
- Trust issues with the Government.
- Bribery, money laundering, misuse of power.
- Tax evasion.
- Capacity issues to implement and monitor policies.
- Poor accountability and favoritism.
- Failure to provide new jobs in the formal economy.
- Lower productivity and not able to use the latest technology to boost productivity.
In the past, the informal economy boosted Pakistan’s economy, and the Government had enough resources to meet both ends. However, with time Pakistan was not able to sustain its economic growth, and the transition towards documentation of the economy becomes a dire need.
Consequences of an informal economy
In an informal economy, the following conditions or symptoms are prevalent:
- High unemployment
- Poor wealth distribution
- Gender inequality
- Poor education and health facilities
People have no choice to work in such a hostile environment to earn enough income to sustain their livelihood.
Many businesses in Pakistan opt for informality to avoid taxation and undue prosecution, which encourages the rest of the community to follow.
In Pakistan, the underprivileged masses, who do not have access to basic health, education and social welfare facilities are prone to hunger and death. The food prices are almost doubled in the last 12 months, destroying the budget of the household.
5 steps to document Pakistan's economy
Although the Government is trying various methods to convince the businesses and masses to register themselves with tax authorities, yet this becomes one of the most tedious and unparalleled tasks to accomplish.
So how to document Pakistan's economy? This needs to be discussed at all platforms in order to find a sensible solution. I suggest the following steps which the Government is required to do. All of them are necessary:
- Leverage the NADRA database, which holds the identification data of all Pakistanis. Link it with financial institutions, taxation, health & education, traffic, police, telecom, and the rest of economic activities within the Country. This is very important to document the source of income and wealth. The adoption of such will eventually document the economic activities of a citizen.
- The cost of transition from informal to the formal economy should be reduced by deregulation of laws, centralization of registration of business under one roof or authority.
- The opening of a bank account is made simpler and adopting the FAFT risk management framework to assess the risk of providing financial services to individuals and companies, based on their risk profile. The NADRA ID Card, which holds the detail of an applicant is used to validate the information submitted by the applicant as such a card holds the economic activities of such applicants. Besides, a bank account is mandatory for those who wanted to purchase land, property, vehicles, jewelry, and luxury items.
- Here comes the interesting part: Complete removal of large banknotes (Rs. 5000 & Rs 1000). This step should be taken when all the data of a Pakistani is linked with the NADRA database.
- State Bank of Pakistan "SBP" provides a period (e.g., 3 months to 6 months) by which Pakistanis are required to open their bank accounts and deposit the big banknotes. After the expiry, such notes become null & void.
In addition, the Government shall provide incentives for moving towards the formal economy. This will include the equal distribution of resources, financial and social security systems, building up new factories to increase productivity.
In short, the right balance of incentives for the formality and disadvantages of the informal economy are communicated with the masses.
However, Pakistan is a debt-ridden country with corrupt officials and people who misuse their position and power to gain the benefit at the expense of the Country’s progress.
Therefore, capital (money) is required to provide the necessities to the masses, and Pakistan lacks such capital.
Impact of documenting the economy
The total amount of money in circulation stands near to Rs 21.8 trillion (Nov 2019). With a massive population of around 220 million people, it is next to impossible to transit from informal to formal economy within a short period of time. Therefore, I suggest the following steps which the Government can implement to document the informal economy:
- Demonetization of large banknotes (Rs. 5000 & Rs. 1,000), people are forced to open their bank accounts.
- A natural person can only be allowed to withdraw a maximum of Rs 25,000 to 100,000 per month. The Government can set the limit as they deem fit, but should not be very high. Whether a person has one bank account or several bank accounts in various banks, all financial data will be linked with the NADRA ID card in real-time. The Government may choose a higher limit and gradually decrease it. A real-time link is preferred, but banks may share day end transactions with the Government if such a system is difficult to build.
- Only financial institutions are responsible for collecting direct taxes from their account holders, and there shall be no need for any other person (Company or business) to act as a withholding agent or tax collector.
- There shall be no need for sales taxes or any other sort of indirect taxation. As banks are financial institutions are the ones where money supply and demands are met. Hence, tax authorities have to liaison with banks to implement additional tax regulations.
- All the cash inflows and deposits received by the bank are automatically charged with a single tax rate of 1% or less. However, the Government may choose a different rate.
- In addition to point 5 above, daily, the banks are allowed to deduct a tax amount to 2% to 3% (Annualized) of the remaining balance in the bank account. The person transferring the money will not be charged with any govt. taxes. The daily tax on balance should always be kept significantly higher than the tax on each transaction.
- Additional taxes are discouraged and encourage ease of doing business.
All of the above must work in conjunction with each other, and Cherry-picking is highly discouraged.
By now you may have guessed the impact of such system, however, I can illustrate a few other benefits which may also occur:
- The supply chain of all businesses has no choice to get their money deposited in the bank accounts.
- People who have a pile of cash lying in their homes and private places earned from legal or illegal sources have no choice left but to deposit their money in the banks within a specified period.
- Ease of doing business by simplification of the tax regime. No hidden charges or taxes.
- No need for business to pay sales tax and the Government does not require to pay tax refunds.
- The use of online banking and banking instruments will increase manifold. The use of Fintechs and digital banking can play an important role in documenting the economy.
- There will be no choice for any Pakistani to take out the money as monthly limits restrict the cash withdrawals.
- This will have a direct consequence of the reduction in printed banknotes in the economy and masses have to conduct their transaction via legal channels only. Direct savings on managing the cash.
- Due to the limited circulation of hard cash, people won’t able to misuse their wealth, in the shape of bribery, and money laundering will under strict control.
- Banks will start witnessing a surge in liquidity, available for investment, and the stalled economy begins to roll. Therefore generating more tax revenues.
- Each banking transaction and day end bank balance will generate a constant supply of tax revenues for the Government, which is much easier to collect.
- The Government will abolish its dependency upon thousands of withholding tax agents for the collection of money.
- Rich masses tend to have large bank balances, who will be charged with daily nominal tax.
- Businesses with a large number of transactions have to pay a nominal amount of tax on every inflow of money.
- A very small portion of the economy will remain informal, which is acceptable.
- Reduction in audit and inspection from regulatory authorities.
One has to understand, that whatever, Pakistani Government earns from its taxation, almost half of it is spent on Defence and the other half on paying debts and related interest. Therefore, every year, the Government starts its budget with a negative balance (Fiscal Deficit). Hence severely impacting the Government's ability to spend on the public.
The actual objective of the Government is to develop a system that eradicates poverty and uplifts the Country at the same time, where all the resources/earnings of the Government spend in three equal parts:
- The first part-33% of the nation’s resources to be spent on the public, especially the poorest and underprivileged masses, to uplift them, resulting in healthy and educated masses. This part also includes spending resources on housing, infrastructure, paying local and foreign debts, etc. (Management).
- Second part- 33% of the nation’s resources to be spent on the people who generate income and sustain their capacity to generate revenues. (Labour). It means that the Government spends such resources to bear the expenses of its state institutions and day to day activities (Business as Usual).
- Third part 33%-Collected by the Government to further invest in existing and new state-owned companies to create wealth. (Capital). This also includes creating an environment for private investors and businesses to invest in the country to create new wealth and increase productivity.
Do you know that Pakistan is not able to fully meet any of its above criteria, and this is the main reason that even after 7 decades of independence, people are still living in poverty.
It is also noticeable that those countries which have savings to GDP ratio and Tax to GDP ratio are approximately 33% (Combined 66% – 2/3rds) or above are more likely to be a developed country (or in the transition to becoming one) with happy and satisfied masses.
- Tax to GDP ratio
- Savings to GDP ratio
If all masses are guaranteed with basic income, then there is a high probability that the Country will rise. But such a guarantee can be very expensive.
Pakistan is just one step away from the documentation of its economy.
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