India’s Informal Sector Isn’t Escaping the State; It's Paying for It
For millions of small firms, bribery is less about greed than survival - a symptom of vulnerability, not moral failure
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Devlina, Madras School of Economics
Santosh Kumar Sahu: IIT Madras
SDG 8: Decent Work and Economic Growth | SDG 16: Peace, Justice and Strong Institutions
Ministry of Labour and Employment | Ministry of Micro, Small and Medium Enterprises
India’s informal economy is both its backbone and its bottleneck. Employing roughly 85 percent of the workforce and generating about half the country’s GDP, it sustains livelihoods even as its fragmented, low-capital operations keep productivity well below the formal sector’s average - a paradox central to India’s development story. Behind this vast engine of enterprise lies an invisible tax – the petty, routine bribes that small firms pay not to gain favour but to survive.
Unlike the headline-grabbing scandals, these are the daily transactions of survival - the under-the-table payments to clerks or local enforcers that allow a business to function without harassment. Most do not bribe to enter the system; they bribe to stay invisible within it. In doing so, they reveal something deeper: at the base of India’s economy, corruption is less a matter of greed than of insecurity. What they purchase isn’t privilege, but predictability in a system that rarely delivers it.
When Ignorance Costs Money
Over the past decade, India has made significant efforts to enhance its ease of doing business. Online portals have replaced paper queues, approvals have been streamlined, and rankings have climbed. However, these reforms mostly ease entry into the formal economy. They do little for those already outside it - the millions of traders, artisans, tailors, and food vendors who must still pay to remain unseen.
World Bank data from 2022, covering 1,679 informal enterprises across Assam, Uttar Pradesh and Madhya Pradesh, show that roughly one in ten firms paid bribes simply to keep operating. The shares vary – about 6 percent in Uttar Pradesh, 11 percent in Assam and 16 percent in Madhya Pradesh – but the pattern is consistent.
Those most likely to bribe aren’t tax evaders or cynics avoiding scrutiny; they are business owners struggling with procedures they don’t understand. In Madhya Pradesh, many cited the “ease-of-registration problem”: they neither knew how to obtain a GST or PAN number, nor trusted that the process would be quick or fair.
For them, a side payment is not opportunism but insurance – a crude substitute for service delivery, a small price to keep the system predictable.
The Vulnerability Trap
Ignorance deepens insecurity. 23 percent of businesses facing high, unstable sales or erratic income admitted to paying bribes to remain unregistered. Older entrepreneurs, women owners, and those with limited education or a large number of dependents face greater exposure. For them, a single day’s delay can erase a week’s income, making a side payment to keep officials at bay an act of survival.
This dynamic produces a trap. The smaller the business, the higher the price it pays to stay afloat - and the harder it becomes to grow. Informality feeds on itself, turning enterprise into endurance
Formalisation without Trust
India’s steady rise in global business rankings masks a deeper institutional problem: the gap between simplifying procedures and building trust. A trader in Lucknow can register a business online, yet fears that increased visibility will lead to more inspections. A tailor in Bhopal may struggle to navigate the GST website without guidance. Formalisation cannot be decreed; it must be earned through confidence that the state will simplify rather than suffocate. That confidence rests on two pillars: transparent institutions and capable citizens.
The first requires predictability: rules applied uniformly, processes that can be tracked, and officials who are accountable. The second requires awareness: small business owners who understand their rights, procedures, and potential benefits. Across much of India, both remain unfinished.
Rethinking Policy Priorities
Turning that trust into policy requires three shifts in focus.
First, curb corruption where it hurts most. Petty bribery thrives where discretion is unchecked – when officials can delay, deny, or demand without oversight. Digitalisation helps, but only when combined with accountability. Transparent dashboards on registration timelines, randomised inspections, and independent grievance mechanisms can do as much for productivity as tax cuts. Reducing local discretion remains the most effective way to curb everyday corruption.
Second, make formality worth it. For most small entrepreneurs, the question is not “why pay taxes?” but “what follows after?” Formalisation must open doors to low-interest credit, procurement access and social protection – rather than more red tape. The Udyam Assist platform, which simplifies registration for microenterprises, is a step forward, though awareness and follow-up support remain thin.
Third, invest in capability, not just compliance. Education and skills are the real levers of inclusion. A better-informed, better-trained workforce is less dependent on precarious self-employment and more confident in navigating official systems. Even in data, firms run by owners with secondary education or above were significantly less likely to pay bribes. Long-term investment in human capital, not just short-term incentives, will erode the roots of petty corruption far more effectively than enforcement alone.
A Reform Beyond Rankings
India’s informal sector has often been viewed as a murky zone outside the reach of tax or regulation, yet it remains the country’s largest reservoir of ingenuity and enterprise. The price of that ingenuity is paid in unofficial instalments: bribery as a tax on vulnerability.
The next wave of reform must look beyond procedural simplification to relational trust. Systems must teach before they tax, assist before they penalise, and reward transparency over endurance. Only then can the 60-million-strong informal sector shift from a symptom of underdevelopment to a springboard for equitable growth.
If India can make formalisation feel fair, and governance feel accessible, its informal workers and entrepreneurs will no longer buy peace. They will help build prosperity.
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Authors:
The discussion in this article is based on the authors’ working paper on the subject. Views are personal.