The reasons behind informality

-This article was originally published by Ashesh Shrestha in The Himalayan Times on February 19, 2017.

Informal economy—generally defined as the economic activities that are not recognized and recorded by public authorities, and thus unregulated and unprotected—accounts for a large portion of the national economy in developing countries. Even though its contribution cannot be determined with certainty, it has a major role in income generation and poverty reduction. A large number of people have also been working informally, setting up the micro enterprises with little capital and thus contributing to the actual National Income—the part not covered by government’s national income accounting in Nepal as well. We can see street traders, small retail stores, tea shops that are being informally operated. On one hand, the non-formalization of these enterprises has cost tax revenue to the government that it could have otherwise collected, and on the other hand, and more importantly, the entrepreneurs operating in the informal economy suffer even more for they face the problem of lack of business guarantee, limited access to credit, vulnerability to socio-economic changes and lack of access to government services and facilities which deters them form growing. Studies have identified several barriers that have kept the informal enterprises from getting formalized.

Excessive Bureaucracy

The Peruvian economist Hernando De Soto claims that the informal firm owners would like to be formal but costly regulations and bureaucratic delays prevent them from doing so. When an entrepreneur has to go to a multitude of government agencies, provide same documents at each agency, and face similar problems from bureaucracy, it increases time to get the enterprise incorporated and results in an increase in the cost to the entrepreneur.

In Nepal, there are at least three agencies to be visited for completion of the registration procedure for a firm. The World Bank’s Doing Business Report 2016 claims that it takes as much as 17 days to start a business. This is one of the highest in the world. It is important to note here that the report looks at incorporation of a company, and not registration of a private firm. However, since all countries are ranked based on the same parameter, it gives a fair reflection of how one has to deal with a more cumbersome bureaucracy in Nepal. The larger the number of days taken to register a business, the higher is the opportunity costs, that is, the income the entrepreneurs would have to forgo as they could not operate their enterprise or get involved in other productive activities. When the registration process takes less time, the entrepreneurs can promptly start the business operation and start generating income. In order to avoid the bureaucratic hurdle, the one stop shop solution is the most advised.

Policy Disharmony

The lack of harmony/coordination between the laws creates confusion to the entrepreneurs. When it comes to micro entrepreneurs, they may have hard time understanding the provisions, specifically when the laws are not harmonised. For example, the new Industrial Enterprise Act has recognized micro enterprises and given special priority to them by giving income tax exemption for at least a period of five years from the date of operation. As no amendment has been made in the Income Tax Act, 2058 and the Finance Act, 2073, pertaining to such provisions, micro entrepreneurs are not likely to get tax exemption. This can create confusion among them and can make them hesitant from registering their businesses.

Additionally, an entrepreneur would have to look at numerous laws/Acts in order to get clear picture of the provisions. This is cumbersome and will cost them their time. Harmonizing the Acts and policies is the must to bring the informal enterprises into formal sector. For this to happen, the regulatory agencies must co-ordinate with each other so that there may not be differences/contradiction in the Acts formulated by different line ministries that would create confusion among the people.

Lack of Proper Information

Micro entrepreneurs lack proper information about the process, number of government agencies to be visited, time and cost incurred in registration. This may well work as a barrier to formalization of the micro enterprises and also the reason that many micro enterprises are not registered in all the required agencies. The lack of proper dissemination of information and confusion that arises from the unclear laws like the ones aforementioned above is the reason that the micro entrepreneurs do not have accurate information. So, the work of finding the accurate and proper information is further added to the registration process; this makes the entire formalization process burdensome and increases the time required to do so. This hinders them from getting registered in the authorized agencies.

When entrepreneurs do not have a clear understanding of the complete registration process, changes rise that they might not get registered in all required agencies. For example, if an entrepreneur registers his/her business in only Municipality/VDC and not in the Office of Cottage and Small Industries and Inland Revenue Office, these regulators can come anytime and close the business. The entrepreneur, by registering in Municipality and VDC and paying the enterprise tax, the tax that is to be paid to the Municipality/VDC where the business is located as according to the Local Self Governance Act, 1999, might think that the business is legally registered. But, as the formalization procedure is not complete, other agencies do not recognize it as legal and may force to shut it down any time.

One of the very effective ways for the solution of this problem is making available all the information and consulting service available in the local offices. This can help the micro entrepreneurs gain accurate information about registration process, tax compliance, tax rate etcetera.