Digitalization as a Solution for the Tax Collection of Informal Economy of Pakistan

Abstract

The informal economy in Pakistan, which contributes nearly 40% of the GDP and employs over 70% of the workforce, poses a persistent challenge to effective tax Collection and fiscal stability. Traditional mechanisms have failed to integrate this vast sector due to weak enforcement, poor documentation, and reliance on cash transactions. This study investigates digitalisation as a transformative pathway to enhance compliance and broaden the tax base. Grounded in deterrence theory and behavioural economics, and employing a mixed-method design, it combines regression analysis of national data with qualitative interviews and international case evidence. The findings reveal that a 1% rise in digital payments as a share of GDP is associated with a 0.25% increase in tax revenue. In contrast, Punjab's 2023 e-invoicing pilot resulted in a 387% rise in SME registrations and a 320% increase in revenue. Interviews highlight opportunities such as reduced harassment through digital records, but also barriers, including low literacy and regulatory complexity. The study concludes that digital payments, e-invoicing, blockchain, and AI are vital tools for improving compliance. It recommends a phased strategy of incentivising adoption, simplifying regulation, and building trust to unlock fiscal space and accelerate sustainable development in Pakistan.