Image: Ashish Koirala
To walk through Kathmandu’s bustling market is to witness commerce in its most vibrant form. Stalls overflow with produce, tailors measure customers amid the throng, and sizzling food stalls send aromatic plumes into the air. This is the lifeblood of Nepal, an engine of employment and ingenuity.
It is also, for the most part, invisible to the state. The country’s shadow economy is estimated to account for 51% of GDP, a figure that has barely budged in recent years, according to EY, an auditor. In other words, the value of unrecorded economic activity is roughly equal to half the size of the official economy. The persistence of this parallel world is one of the great policy challenges of the age.
The standard diagnosis is a failure of enforcement. The standard prescription is often to hunt down evaders. This is misguided. For the small vendor or artisan, the choice to remain informal is frequently rational. The immediate costs of formality such as taxes and compliance paperwork are certain and tend to be crippling for a micro-enterprise. The benefits are nebulous. What does registration actually deliver? All too often, it brings nothing but a sheaf of documents and the unwelcome attention of inspectors. The state offers little in return: no reliable access to credit, or social safety net, or protection for contracts. Why would a small entrepreneur invite such a burdensome guest to the table?
The result is a trap. Informal firms cannot prove their existence or creditworthiness to banks; so they cannot borrow to grow. They operate in a twilight world, vulnerable to arbitrary fines and shakedowns; yet cut off from public procurement and formal supply chains. They invest little and innovate less. The state, in turn, is deprived of a broader tax base and meaningful data on its own economy. Policy is made in the dark. The goal, then, should not be to force formality upon millions through punitive raids, but to make formality an attractive proposition. The state must learn to sell registration, not merely demand it.
This means a fundamental redesign of the state’s offer. The process must begin by dramatically lowering the cost of entry. Imagine a single digital form, accessible via a mobile phone, that registers a business for tax and licensing purposes in minutes. Community agents could help the less digitally literate. The aim is to eliminate the travel, queues and Kafkaesque paperwork that currently make registration a day-long ordeal for those who can least afford the time.
Once registered, a firm should find itself in a new world of opportunity. The state and its partners could provide tangible benefits from day one. A simple, presumptive tax regime, based on observable proxies like stall size or sector, would replace complex accounting. Crucially, payment of these taxes could be linked to concrete rewards: access to a microcredit scheme, enrolment in a subsidised health-insurance plan or a verified stamp that attracts business from formal buyers. A tax credit could be offered to those who use digital payment platforms, creating a self-reporting trail. The value proposition shifts from pure cost to calculated investment.
Regulation too must be recalibrated. A one-size-fits-all approach, which imposes the same labour or safety standards on a multinational and a market stall, is absurd. A tiered system is needed, where micro-enterprises face simpler, lighter rules. Enforcement should follow a similar logic. Instead of random inspections that can shutter a business on a whim, data analytics could flag anomalies in digital payment records for review. Penalties should be predictable, published and proportional. A quick appeals mechanism would protect small taxpayers from capricious officials.
None of this will be easy, however. A deep-seated distrust of the state, often well-earned, will not vanish overnight. Local officials may try to co-opt new systems for rent-seeking. Politicians may prefer the quick win of a tax amnesty to the hard graft of structural reform. To build trust, the state must deliver immediate, non-negotiable benefits with registration and be transparent about how new revenues are spent, perhaps ring-fencing them for local infrastructure or business development.
The end goal is to bring the informal sector into the formal economy as an equal partner, showing that formalisation is a step toward stability and prosperity, not a loss of freedom. ■
