When we start a development programme we take a baseline, define the targets, and set strategies through a systemic analysis of what is constraining development. At every point on that route we choose between options, and each option carries a trade-off.

Take the battery rickshaw. The government wants to ban and evict them to ease congestion and stop the poaching of electricity from the national grid. It then has to weigh the loss of employment for hundreds of thousands of rickshaw pullers against the electricity saved and the unrest that follows. So it runs a small eviction that makes headline news for a day or two, then lets the matter die. The ban ordered in May 2024 was reversed within days.

A wrong trade-off compounds into a cycle that is hard to leave, and we have done that with the informal economy. The government cannot give jobs to men and women, young and old, so it lets the informal economy grow. People come to the city, take a small space on the street for a daily payment, and start a fruit or a cloth stall. A nexus forms around them. The consumer is happy as he/she pays no premium, the local leader is happy with his/her commission and the administration is happy with its share.

The baseline we therefore hold is that of a large number of informal producers, an administration that earns from informal transactions, and, in my reading, a government that finds the informal economy useful for holding grassroots politics. What is it costing us, and is there a way out?

The first cost is that the trap does not shrink when the economy grows. Informal employment was 87.7% in 2005-06 and 84.0% in the Labour Force Survey of 2024. Income per head more than tripled over those years while the number of informal workers rose from 41.5 million to 58 million. The second cost is that the enterprises do not grow either.

The Economic Census of 2024 counted 11.7 million economic units, of which 95.4% are cottage or micro and 0.39% are medium or large. The units rose 49.68% since 2013 while employment in them rose 25.03%, so the average unit got smaller. We are adding units but we are failing to scale.

The third cost falls on the worker. 96.6% of employed women and 92.7% of employed youth are informally employed, the country runs no pension or insurance that an own-account worker can join, and the ILO puts genuine social protection spending at 0.9% of GDP against 3.8% for South Asia. The fourth cost closes the cycle.

Tax revenue was 7.30% of GDP in FY23, and about 380,000 of the 11.7 million units are incorporated, so the revenue system reaches a small fraction of the economy and attempts to take as much as it can out of that fraction. Eventually, the compliant firm carries the cost of the one that does not. The incentive to remain compliant diminishes.

The informal economy is not cheap. It costs the firm more than being formal would. Then why do firms remain informal? According to Transparency International Bangladesh, a conservative estimate of the extortion collected from private buses and minibuses is around Tk 1,059 crore a year, and it goes to party men, police, BRTA staff and city corporation representatives. This should tell you that informal enterprises do pay tax and the extortion is the tax they pay. But why?

They pay it to guarantee their spot on the street, their access to the illegal electricity connection, their protection from extortion from competing factions of the same political parties. The government tax will not buy any of these guarantees. And the government knows it cannot offer that guarantee either, as the demand is so high and its supply so low. Eventually, the government trades its tax for extortion and its development for encroachment. How do we break out of this nexus?

Campos, Goldstein and McKenzie randomised 3,002 firms in Malawi and found that where registration was offered free, 75% took it, and where it was bundled with tax registration, 4% took it. The firm was not avoiding the paperwork but it was avoiding the tax net.

So if the government wants firms to be registered to tax them, the firms will never take it. If the government wants firms to be registered to give them access to spots, safety from extortion, they might. Registration bundled with a bank account raised sales by 20% and profits by 15%, while registration alone had no effect on profit.

Uruguay merged the social security contribution and the income tax into one monthly payment collected by the social security agency rather than the revenue authority, and informal employment there fell from 42.8% in 2001 to 21.5% in 2022. Brazil built the same design and reached about 15 million registrations. In both cases the payment is one fixed published amount and it remains the same everywhere. The local officials cannot negotiate it and they cannot raise a commission on it.

However, these schemes cost more than the revenue they collect for the government. Brazil's cost 2.56 times the revenue it raised. Revenue is not the gain for the government. Offer the informal trader a place to trade wherever the state owns the land, and attach a pension to it if they register.

Offer them a TIN certificate without a tax. This gives the government the information on who is trading, in what and where. The government needs this data to plan its policies. The data allows the government to plan how many enterprises need to be relocated, where and into what.

The same applies for the battery rickshaws. We cannot evict the battery rickshaws as we cannot say how many rickshaw pullers would be put out of work by the eviction. A registered driver can be counted and a registered garage can be metered and this allows monitoring of the leakage of electricity from the grid.

The government thus has a trade-off. It has to let go of the hope to collect revenue. It has to invest and offer an incentive to register. Once the data is available, the government can decide how many vehicles it can take off the road and what it has to put in their place. This is the same rule that applies for the street hawker, the unregistered MSMEs.

But the trade-off for the government runs deeper. Formalisation will cost the local leader his/her commission, the administration its share. They will resist the schemes if the schemes don't pay them. What is the fix here?

A fee that does not remove the collector becomes a second fee. In Nigeria, Lagos introduced an ₦800 daily levy (about $1.93 at the 2022 exchange rate) in 2022 to replace the agbero, the touts who collect daily cash levies from commercial drivers at motor parks and bus stops. Drivers now pay not only ₦800 but also park fees, security fees and the rest. The formal fee was added on top rather than substituted.

The hard answer is that the collector has to be removed and not brought inside the scheme. Georgia dismissed all 16,000 of its traffic police in a single day in 2004 and rebuilt the force at ten times the pay.

Road-police bribery fell from routine to about 1% of the population reporting it by 2010. When the stance is against own party men and the very administration that the government relies on, the trade-off becomes tough. But this government has a choice to make and the choice should be in favour of the people that voted it to the government.

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Md. Rubaiyath Sarwar is the Managing Director, Innovision Consulting and Lead, Inclusive Development and Socio-Economic Equity, Panam Institute