ONE of the most serious challenges that needs to be tackled in the forthcoming budget is the growing undocumented, or informal, sector of the economy.

This is a structural weakness that has been worsening with each passing year for at least the last three decades.

Over the years, successive governments have tried to tackle the problem through policy measures utilising the tax code, or by using simple brute force, or administrative means that make it incumbent upon registered parties to retain identifying information of the unregistered parties they do business with.

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In every case, the government has had to stand down against a furore sparked as a consequence of its attempts. But the size of the informal sector has only grown, as has its reach. Today, property, manufacturing, trade and services all have large undocumented transactions taking place within them, and cash remains the preferred instrument through which to transact.

This is a big challenge for a number of reasons. For one, the informal sector makes the economy resistant to any policy-induced reform.

Second, the informal sector can host large illicit activity, and the same mechanisms through which transactions are hidden from the view of the tax and regulatory authorities can also be used to conceal criminal activity.

Third, the informal economy resists all attempts at taxation, and the foregone revenue explains a large part of our declining tax-to-GDP ratio, forcing the government to search for foreign assistance to bridge its fiscal shortfalls.

Fourth, the informal economy is highly uncompetitive and traps the economy behind a low-productivity barrier. The list gets longer and longer, but it should by now be sufficiently obvious to all that the continued clustering of economic activity in the informal sector is a very big problem that needs to be dealt with using a strong hand, as well as innovative approaches to incentivise documentation.

The budget this year provides a good opportunity to make a start. Some measures that need to be taken are strengthening the hand of the Federal Board of Revenue for audit and assessment, while reforming the institution to check the abuse of powers by petty officialdom.

But a top-down approach by itself has not worked in the past. New technologies, such as the potential of mobile banking and financial inclusion initiatives, should also be tapped to encourage greater utilisation of digital means of settling small transactions.

The problem is a large one, and will not be tackled in one budget alone. Nevertheless, a strong start needs to be made, and the finance minister would be well advised to consult with private-sector parties to explore innovative approaches to tackling the problem.

Continuing to be fearful of the power of informal-sector players is driving our economy deeper into the quicksand, and this drift needs to be arrested immediately.

Published in Dawn, May 20th, 2015

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