The tattered Nepali economy has been sliding backwards as a result of the catastrophic earthquake and subsequent aftershocks. Internal political turmoil and an unofficial trade embargo have exacerbated the country’s woes. The economic loss from the earthquake has been estimated to be $7 billion while the government is expected to have lost $500 million in missed revenues due to the political and diplomatic dispute. Capital formation is dwindling due to minimal public and private investment, industrial and agriculture production has been badly affected, unemployment is soaring and the supply chain of not only consumables but also of merit goods like education, health, sanitation and public utilities have been throttled. People are getting frustrated by the endless and painstaking political haggling, hoarding, black marketeering, adulteration, smuggling, corruption and inflation. These political and economic maladies have spawned an informal economy.

Black marketeering

The issue of informal economy has been hyped in contemporary discourse. The informal economy, also known as black economy, includes activities that are neither accounted for nor reported to the national accounts and to the tax authorities as required by law. In taxman parlance, it is a tax gap, the difference between legally collectible tax and actually collected tax, engendered by the defiance of tax laws. High ranking government officials seem to have subtly given credit to black marketers for keeping gasoline flowing in the wake of the Indian blockade. Have they really been serving the general public by supplying public and private goods? Absolutely not, rather they are taking advantage of the indigent people and dipping into their savings that will eventually reduce investment and jobs. The cost to the economy outweighs the perceived benefits.

The government machinery is overly occupied with managing gasoline and maintaining basic law and order in the country. The agitating political parties are allegedly collecting funds to run their protests, and their goons are extorting huge amounts of money from traders. Youths in the villages near the border can smuggle necessary goods like fuel, medicines and food and also contraband like drugs, counterfeit money and arms. They have been engaging in illegal activities for quick and easy money, allowing them to establish an unofficial empire to run the parallel economy. Those who pay such informal taxes to the non-state sector for short-term benefits could become the biggest loser in the long run. This undermines the social structure and hits at the very root of Nepali society. Given the existing travesty of governance and investment climate, the informal sector is thriving, leading to labour and capital flight. The negative spiral of the informal economy is pushing Nepali society into chaos and despair that will eventually result in loss of pride and confidence.

Not a new phenomenon

An informal economy sprouts in a controlled economy, spreads its roots in a high tax regime with convoluted tax laws and flourishes where the risk management capability of the tax administration is weak. Other breeding factors are poor governance, excessive corruption and a close nexus between politicians, bureaucrats and tax dodgers which make the whole economy black. Although black marketeering has been thriving since the blockade, informal economy in the government, private and non-government sectors has been an omnipresent problem in Nepal. Almost a decade ago, the Asian Development Bank had estimated the size of Nepal’s informal economy to be 40 percent of the GDP.

As per the existing tax laws, real estate worth Rs 3 million and more is subject to capital gains tax. The government approved reference value for land seems to be much less than the market value. People fragment their land holdings and under-declare the value of the transaction to keep it below the threshold and avoid paying capital gains tax.

Private educational institutions collect hefty capitation and hospitals also charge their patients exorbitant fees which hardly get reported to the tax authorities. Some manufacturing industries and small and medium enterprises have been found under-reporting revenues and over-claiming expenses. It is widely accepted that imports are also largely undervalued while exports are over-invoiced prompting local vendors to resort to under- and non-invoicing. Self-employed people and hard-to-tax service sectors are largely beyond the bounds of tax. Some doctors, engineers, lawyers, professors, teachers and moonlighting employees hide their extra income. Another way to incorporate ‘illegal’ money in the market is the ‘hundi’, the so-called informal money transfer, which also offers an easy route to smugglers. All these economic transactions which are non-reported, misreported and under-reported are good conduits of the informal economy. The Nepali people are destined to face these political and economic woes.

Way forward

The burgeoning informal economy has been subverting the rule of law and it is emerging as a serious threat to governance. Unless the government stems the swelling informality, it may lose control over policy making and implementation, thus undermining its tax extracting and regulatory capabilities. In the short term, the government should immediately bring an end to smuggling and black marketeering in basic goods. Inter-agency cooperation and coordination between the Nepal Armed Police, Nepal Police, Department of Revenue Investigation, Department of Customs and their frontline offices are vital to deal with the underground economy. The government should not be lenient with the perpetrators. The Department of Money Laundering Investigation, watchdog organisations and the media can play a crucial role in curtailing the size of the informal economy. Political parties and bureaucratic organisations must reorient their cadres to comply with the laws and break their links with smugglers and tax evaders.

In the medium term, the government can reduce taxes and tariffs to neutralise the motive for smuggling besides launching a Voluntary Disclosure of Income and Properties scheme to lure wealthy people to disclose and register their untaxed incomes and properties. Furthermore, the government can roll out a policy for mobilising undisclosed gold by issuing gold bonds against the value of the disclosed gold and jewellery. Market monitoring and strict enforcement of the laws boost the tax morale of the people, which can be instrumental in reducing the magnitude of the informal economy. At this juncture, the government should set up a high-level taskforce to do a comprehensive study of the different dynamics of the informal economy and improve systemic efficiency to contain it.

Koirala is Chief Tax Officer at Inland Revenue Office, Bhairahawa