structural tax reforms in 2005, the new system dramatically lowered tax rates and brought forward 700,000 new taxpayers, an increase of around 47 percent.<sup>21</sup> For the first time, the 2008 Investment Climate Enterprise survey included 500 informal firms. About 89 percent of the sample consisted of microenterprises with fewer than five employees. Survey results confirm the value of specifying a continuum of characteristics to define informality. The firms surveyed operated in large part legally, with a degree of evasion and noncompliance only somewhat larger than the average small firm in the “formal” sample. In general, firms respond to the costs and benefits of being formal, so reducing the tax and regulatory burden and strengthening access to services for micro and small enterprises are two constructive paths for strengthening the investment climate.

# **C. South Asia**

## **1. India**

A majority of jobs in the Indian manufacturing sector is created in the unorganized/informal segment of the economy according to “Friend or foe or family? A tale of formal and informal plants in India,” [Ghani, O’Connell, and Sharma, World Bank (2013)]. Informal firms are an important supplier of inputs to formal firms. Employment and output in the organized sector are greater in those states in India that have a greater presence of unorganized suppliers of inputs. Indeed, there are even strong linkages between the household (“traditional”) segment of the unorganized sector and the organized sector. Conversely, unorganized employment and output are greater in states that have a greater presence of organized buyers of inputs. But there are two important asymmetries in the relationship between the organized and unorganized sectors. First, the unorganized sector is much more dependent on and responsive to organized sector presence than vice versa. Second, unorganized sector productivity is dependent on and responsive to organized sector productivity and presence but the reverse is not true. These results contrast with Africa where unorganized firms are important buyers of inputs from organized firms.

The results imply that all industrial policy -- which is usually targeted towards the organized sector -- must take into account the large employment and output spillovers that exist between the organized and unorganized sectors. Secondly, the organized sector remains unlikely to get productivity benefits from the unorganized sector despite the size of employment and output spillovers until the organized sector outsources more higher-end tasks.

## **2. Pakistan**

In “Production vs. Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan,” [Best et al., London School of Economics (2013)] the authors uncover information about the unreported economy in Pakistan by examining corporate income tax evasion among tax registered firms. Using administrative tax data, they plot the distribution of firms by turnover (or taxable income). In the presence of tax bracket thresholds qualifying for the minimum tax regime, firms have an incentive to “bunch” below the threshold, ie firms with a true turnover slightly above the threshold underreport their

> 21 Rita Ramalho, **_Adding a million taxpayers_ (** _Paying Taxes Case Study: Egypt_ )  in World Bank, Doing Business <u>2008. (Washington:  World Bank, 2007)</u>

24