It’s early morning in Karachi, Pakistan’s biggest city, and Muhammad Nasir is outside his makeshift shelter of palm leaves, rags, and bamboo, washing up after breakfast. He uses water stolen from a nearby supply pipe that belongs to the local water utility. The 17-year-old bids farewell to his mother, an unlicensed midwife, and walks to his tire-repair shop, an open-air stand in a residential area with a table of tools and a wooden bench. He checks to make sure the electricity he’s drawing illegally from the overhead power line is on so he can run his tire pump. Then he sends 10-year-old Abid, one of his two employees, along with 12-year-old Irfan, to get tea from a nearby shop.
Nasir’s business, his home, his power and water supply, and even the cup of tea Abid brings him don’t exist in Pakistan’s official figures. They’re part of another economy that doesn’t pay taxes or heed regulations. It probably employs more than three quarters of the nation’s 54 million workers and is worth as much as 50 percent of Pakistan’s 18 trillion rupee ($200 billion) official gross domestic product. And while the documented economy had its smallest expansion in a decade at 2.4 percent in the year ended June 2011, soaring demand for cars, cement for houses, and other goods shows the underground market is thriving.
“Everything from auto parts to sports goods, knitwear, clinics, and beauty salons fall into the informal economy,” says Sayem Ali, country economist at Standard Chartered Bank in Pakistan. “All these make a significant contribution to employment and income, and that’s one reason why the economy is still growing. But since Pakistan has one of the worst tax structures in the world, these fall under the radar.”
Pakistan’s tax-to-GDP ratio—that’s taxes as a share of gross domestic product—was 8.6 percent in June, one of the world’s lowest, according to Macroeconomic Insights in Islamabad. Only 25 percent of the economy is taxed if the undocumented sector is taken into account, says Chief Executive Officer Sakib Sherani. Developing economies usually have a tax-to-GDP ratio of from 13 percent to 18 percent, according to Invest Capital Markets, a brokerage in Karachi. Former Finance Minister Shaukat Tarin said in 2010 that Pakistan loses 800 billion rupees a year in tax evasion: The government collected 1.7 trillion rupees in tax last fiscal year. That’s not enough to close the budget gap, which is 6.3 percent of GDP. Nasir says he pays 200 rupees a month to employees of the utility company to look the other way, and 400 rupees to the police to allow him to run his unregistered shop. Then there are the occasional political contributions to local parties—protection money, in other words, to keep the parties’ criminal components at bay. “I don’t think paying taxes to the government will do any good to me,” says Nasir. “We are already paying taxes.”
He spends the morning repairing tires and fixing motorbikes, taking payments in cash and never issuing a receipt. At lunchtime he sends for salad and yogurt or lentil curry from one of the nearby pushcart vendors, none of whom is licensed. His mother and sister, a maid, supplement the family income with jobs in the informal sector. After work, a religious teacher comes to give them lessons on the Koran at home, charging a monthly fee in cash that isn’t reported to the government. Once a month, Nasir pays 300 rupees rent to a man who illegally settled on the land where Nasir’s family dwelling was built.
Only 1.5 million people, less than 1 percent of the population, file tax returns, according to the finance ministry. That compares with 3 percent in India. “A low tax-to-GDP ratio means we get into a vicious cycle of high budget deficits financed by printing money or borrowing, which adds to the debt burden and creates inflationary pressures,” says Asad Sayeed, director of the Collective for Social Science Research in Karachi. Pakistan has the fastest inflation in Asia after Vietnam, and its budget gap may expand to 7 percent of GDP in the year ending in June, according to the IMF.
Courtesy: Bloomberg Businessweek
