Key Takeaways
- Digital payment growth is paradoxically deepening the informal economy by creating a high-volume, low-visibility transaction layer that traditional tax systems, built for an analog world, cannot penetrate.
- Current policy focuses on digitizing tax *filing*, not tax *collection*, a fundamental mismatch that addresses administrative convenience for the already compliant, but completely fails to capture the estimated NPR 2 trillion-plus digital gray market.
- A retail Central Bank Digital Currency (CBDC) is not about replacing cash but about formalizing digital flows, offering a structural solution to widen the tax base by making digital transactions inherently traceable in a way that private e-wallets, by design, are not.
Introduction
In a bustling alley in Kathmandu’s Asan market, a vegetable vendor accepts payment. There is no fumbling for change; her customer scans a QR code, a silent, instantaneous transfer of funds. This scene, replicated millions of times a day across Nepal, is the poster child for the nation’s digital revolution. It signals progress, efficiency, and financial inclusion. Yet, beneath this veneer of modernity lies a profound and dangerous economic paradox: the very digital tools celebrated for modernizing Nepal are simultaneously creating a vast, untaxable shadow economy that our fiscal infrastructure is utterly unprepared for.
The numbers are staggering. In the fiscal year 2022/23, transactions via QR codes alone surpassed NPR 2.1 trillion, a near 300% increase year-on-year. This is merely one slice of a digital payments ecosystem that processes tens of trillions of rupees. While the government and the Nepal Rastra Bank (NRB) rightfully champion this growth, the Inland Revenue Department (IRD) remains stuck in an analog-era paradigm. Its mechanisms are built on voluntary PAN/VAT registration, physical audits, and self-reported income—tools designed to tax a handful of large corporations, not a million digital micro-transactions. This creates a fundamental tension: a 21st-century digital transaction reality colliding with a 20th-century tax collection bureaucracy.
This is not a minor leak in the system; it is a structural hemorrhage. A significant portion of this digital volume, especially in the customer-to-business (C2B) space, occurs in a gray zone—from a customer’s bank account to a merchant’s *personal* bank account. For a tax system that cannot see it, this income does not exist. The result is a crippling erosion of the tax base, forcing the government into a cycle of increasing reliance on volatile import duties and levying higher tax rates on an ever-shrinking pool of compliant businesses. This article argues that patching this system with more regulations is futile. The missing link in Nepal’s economic reform is not a new policy, but new plumbing. The only viable path to widening the tax net without strangling the formal economy is a strategic pilot of a Central Bank Digital Currency (CBDC).
The QR Code Paradox: How Digitization Fuels the Shadow Economy
The core of the problem lies in a concept we term the “QR Code Paradox.” The technology is designed for seamlessness, but this very seamlessness allows for the ‘obfuscation of economic identity’. When a customer pays a small business, from a local eatery to a social media influencer selling apparel, the transaction should, in theory, be a C2B (Customer-to-Business) payment. This would classify the incoming funds as revenue, subject to taxation. In reality, the vast majority of these payments are technically P2P (Person-to-Person) transfers. The merchant presents a QR code linked not to a registered business PAN, but to their personal bank account.
The consequences of this subtle switch are enormous. From the perspective of the payment service provider (PSP) like Fonepay or a bank, the transaction is indistinguishable from one friend repaying another for lunch. There is no “flag” to denote it as business income. For the IRD, which lacks automated, real-time access to this granular banking data, the transaction is invisible. Multiply this by the millions of daily occurrences, and you have a parallel digital economy operating in plain sight. An estimated 30-40% of the burgeoning retail digital transaction volume, potentially exceeding NPR 2 trillion annually, flows through this gray channel, completely untaxed.
This behavior is not born of malice, but of rational economic calculation. For a small entrepreneur, the perceived cost and complexity of formal registration, bookkeeping, and tax filing far outweigh the perceived risk of being caught. The traditional system creates a high barrier to formality. Why register for a PAN, maintain records, and file returns when accepting payments into a personal account is frictionless and, until now, devoid of consequence? The government’s own push for digitization, without a concurrent reform of the tax collection mechanism, has inadvertently made being “informally digital” the most logical business decision for hundreds of thousands of micro-enterprises. They have adopted the modern tool (digital payments) but have shed the modern obligation (taxation). This is not just tax evasion; it is a systemic flaw where the path of least resistance, enabled by new technology, is the one that bypasses the fiscal state.
The IRD’s Analog War on a Digital Problem
The response from Nepal’s fiscal authorities to this digital hemorrhage has been tragically inadequate, akin to bringing a bow and arrow to a drone fight. The IRD’s strategy is fundamentally rooted in a world of paperwork, physical supply chains, and large, easily identifiable economic actors. Its flagship initiatives, while well-intentioned, entirely miss the point of the new digital informal economy.
p>Consider a key policy push: the mandatory digital invoicing for businesses above a certain turnover. While a step forward, this policy only targets businesses that are already registered, already in the formal system. It is an exercise in improving the administrative efficiency of taxing the taxed. It does absolutely nothing to bring the freelance graphic designer, the Instagram thrift store, or the corner `chiya pasal` with a personal QR code into the tax net. Similarly, the Vehicle & Consignment Tracking System (VCTS) is a powerful tool for monitoring the physical movement of goods between large, formal B2B entities. It is, however, completely blind to the digital services economy or the final C2B sale of goods that have already entered the retail environment. These are solutions for a 1990s problem, not a 2020s reality.
The root of this failure is a problem of data and design. The tax system is not architected to ingest, analyze, and act upon high-frequency, low-value transactional data. The IRD’s databases, the commercial banks’ core banking systems, and the PSPs’ transaction logs are siloed. There is no ‘single source of truth’. The PAN card, which should serve as the unique identifier linking all economic activity of an individual or entity, is not systematically tagged to every bank account or digital wallet. To bridge these silos and demand bulk transaction data from private banks and PSPs would be an administrative nightmare and would raise significant privacy concerns. It would require the IRD to manually sift through billions of transactions to distinguish a family gift from business income—an impossible task. This architectural flaw leads directly to tax base erosion: a situation where the nation’s economic activity (GDP) grows, but the portion of that activity that the state can successfully tax (the tax base) stagnates or shrinks. This leaves the government with only two blunt, a blunt instrument: raising tax rates on the compliant few or increasing customs duties, both of which damage the formal and productive sectors of the economy.
The Indian Lesson: UPI’s Success and Its Formalization Blind Spot
When seeking a path forward, it is natural to look south to India, whose Unified Payments Interface (UPI) is the global benchmark for a state-driven digital payments revolution. Nepal’s own payment networks are built on a similar philosophy. However, a closer look reveals a critical lesson in what Nepal has failed to replicate. India’s success with UPI is not just a story of a user-friendly front-end; it’s a story of a deeply integrated back-end digital public infrastructure.
Over the last decade, India has painstakingly built a three-layered “stack.” At the bottom is Aadhaar, a universal biometric identity. In the middle is a bank account, mandatorily linked to Aadhaar. At the top is the PAN card (India’s tax ID) and the GSTN (Goods and Services Tax Network), which are also linked to the bank-Aadhaar nexus. When a UPI transaction occurs, it creates a data point that is, in principle, traceable across this entire stack. This architecture gives Indian tax authorities a fighting chance to cross-reference data and detect anomalies, for instance, by comparing a business’s declared turnover with the volume of funds flowing into its linked bank accounts.
Yet, even with this sophisticated infrastructure, India still grapples with formalizing its massive informal economy. Millions of small merchants using UPI continue to under-report their income, knowing that a full-scale, granular crackdown is administratively difficult. The lesson for Nepal is sobering. Nepal has enthusiastically copied the easy part of the Indian model—the slick, user-friendly payment interface. However, it has completely neglected to build the difficult, underlying institutional architecture of linked identity, banking, and tax systems. We have built the attractive shopfront of UPI without constructing the warehouse and accounting office in the back. The result is that we have inherited all of UPI’s challenges in formalizing the economy, without benefiting from any of the data infrastructure that gives India a chance to solve them. Simply trying to bolt on IRD oversight to a private, fragmented payments ecosystem is a strategy doomed to fail.
The Strategic Outlook
The current trajectory is fiscally unsustainable. As Nepal’s digital economy expands, so will the untaxed portion of it. Continuing the status quo will lead to a vicious cycle: the formal sector will bear an increasingly unjust tax burden, incentivizing more businesses to slip into the gray zone, which in turn will worsen the fiscal deficit and force the government to either make politically toxic spending cuts or take on more debt. A sudden, heavy-handed crackdown on small digital merchants is equally unviable; it would trigger a massive reversion to cash, stifling the very digital progress we have made, and would be seen as punishing small entrepreneurs.
A structural problem requires a structural solution. Instead of trying to police millions of private transactions after the fact, we must architect a system where a baseline level of tax compliance is the default. This is the strategic case for a retail Central Bank Digital Currency, or “e-NPR”. It is crucial to understand what this is and what it is not. A CBDC is not another e-wallet. An e-Sewa balance is a liability of a private company; a CBDC is a direct liability of the Nepal Rastra Bank. It is the digital equivalent of a physical rupee note, carrying the full sovereign guarantee.
Its transformative power lies in its design. As a public utility, a CBDC ledger, managed by the NRB, can be built with programmable features. The most critical feature for Nepal’s fiscal future is the ability to differentiate between a P2P transfer and a C2B (merchant) payment at the architectural level. When a transaction is designated as a merchant payment, the system could be programmed to automatically deduct a small, final “transaction tax” at the point of sale—for example, 0.5% or 1%. This amount would be instantly remitted to the IRD’s account. For the small vendor, this is a revolutionary simplification. Their tax obligation is met in real-time, with every sale. There are no complex forms to file, no accountants to hire, and no fear of punitive audits. The barrier to formality is not just lowered; it is eliminated. This shifts the paradigm from voluntary, post-facto tax declaration to automated, real-time tax collection, thereby widening the tax base to include every single digital merchant transaction.
The Hard Truth: A CBDC is not a technocratic fantasy, but it is a politically and technically complex undertaking. It will face legitimate questions about privacy, which must be addressed through robust legal frameworks and privacy-preserving designs (e.g., anonymizing small-value P2P transactions while identifying merchant payments). It will require a concerted effort in digital literacy. It will also face resistance from incumbent players in the financial ecosystem who may view it as competition. However, these challenges, while significant, are manageable design problems. The alternative—a state with declining fiscal capacity, unable to fund public services and investment because its economy has become digitally invisible—is an existential crisis. The national conversation must urgently shift from debating *if* we need a CBDC to *how* we can design and pilot a retail CBDC that respects privacy while structurally restoring the state’s fiscal foundation. Nepal’s economic reform is not waiting for a new tax code, but for new monetary plumbing. A Central Bank Digital Currency is not just an option; it is the blueprint for that future.
