The twilight zone microeconomic decision study

Transcription

1 Dr Agnieszka Jakubowska Politechnika Koszalińska The twilight zone microeconomic decision study Keywords The twilight zone, unrevealed income, seeming effect. 1. Introduction A very common phenomenon to be observed in nowadays economic reality is minimalisation of fiscal payments through the escape of entrepreneurs into so called twilight zone of economic activity. The expression twilight zone (Polish szara srefa literally the grey zone ) has long existed in the language of polish business. It is used to describe economic activity not included in official records run by entrepreneurs, i.e. people running legal business. According to the research made by tax offices in different countries it is estimated that a large portion of gross domestic product is done in an illegal way, i.e. in so called twilight zone 1. The research conducted among business people running activity in the twilight zone shows that tightening of the fiscal system would not make their activity stop or restrict it, because even after the payment of due taxes their gross profit would be bigger than reported at the moment. The hiding of real income is not connected with legal production being unprofitable, but only with a possibility to make 1 This phenomenon is estimated to be about 20 per cent of gross domestic product in Italy, 25 per cent in Spain, 30 per cent in Greece, around 13 per cent in Sweden and Belgium, 9 per cent in Germany, 8 per cent in France, 7 per cent in Great Britain and the Netherlands. The size of Polish twilight zone is estimated at about per cent of gross domestic product (depending on the definition of the phenomenon applied and methods of evaluation). (referred on ) 153

2 bigger profit. The main causes for this phenomenon should thus be linked to too high, according to entrepreneurs, tax rates and other obligatory fees, and also to a relatively low risk of such activities coming to light, which results among others from the tax law being excessively complicated and thus making avoidance of taxation easier. 2. Financial results of the twilight zone activity The analysis of fiscal aspects related to the passage of entrepreneurs into the economic twilight zone presented below is aimed at showing only the financial consequences of such acts, without taking into account the moral and social perspective of the phenomenon. The only determinant of blameworthiness of such behaviour, reflecting its quantitive weight, accepted in the analysis was the value of financial sanction corrected by the risk level related to the uncovering of such activities, which counterpoises the potential benefits of running business apart from the legally regulated zone. The analysis of numerous bankruptcy cases allows to state that under certain conditions running business in the twilight zone can bring the entrepreneur negative effects by enlarging the risk factor. The approach to the problem presented below shows that such activities are not always justified, also from strictly economic point of view. It also shows the mechanism of financial consequences arousing as a result of unrevealing some of the revenue made and taking it into the twilight zone. The primary equations of the analysis are described by the following formulae: 1. the level of total revenue - ΣR: ΣR=R L +R F (1), where: R L legal, revealed revenue, R F unrevealed revenue (twilight zone), R 2. the rate of unrevealed revenue: f= F (2), R 3. the level of revealed revenue: R L =ΣR R F =ΣR (1 f) (3), 4. the level of balance net profit: Π N =(R L C) (1 T) (4), where: C costs of generating income, T- the rate of income tax, 5. the level of unrevealed revenue: R F =f ΣR (5). 154

3 To present the decision situation in a more detailed way, the following assumptions were made: 1. Fiscal effect is examined in view of a balance year. 2. The subject is financed only from equity capital. 3. There are two income effects of running business in the twilight zone : real effect (E R ) due to tax protection resulting from unrevealing part of income, so called risk bonus connected to activities evading law; seeming effect (E S ) being a consequence of wrong estimation of financial costs connected to the passage into the twilight zone. A subject will be eager to conduct activities in the twilight zone, if potential estimated benefits, expressed as total of real and seeming effect will surpass potential cost of such activities, i.e. if the following inequality is real: E R +E S >P r where: P penalty level in case of illegal activities coming to light, r the probability of revealing the activities in the twilight zone. In order to calculate the real effect (E R ) two cases will be studied: Case I legal, revealed revenue (R L ) covers costs (C) subject comes to surplus or zero in the balance effect. Case II unrevealed income (R F ) is made on such a scale that legal revenue (R L ) does not cover costs (C) subject reaches adverse balance. Case I At a given rate of unrevealed revenue f, the following inequality is real: R L C, i.e. Π N 0. Total revenue can be thus written as: Π= Π N +R F (6). The graphic illustration of this situation is shown in Figure

4 The level of revenue and costs R F Π ΣR R L Π N C The rate of unrevealed revenue (f) Figure 1. Case I legal, revealed revenue covers costs. Source: personal elaboration The real effect of the twilight zone is in this case additional income, being a difference between the income reached within the zone and a hypothetical income, which could be made by the subject in a totally legal way. If we describe the hypothetical income from the legal activities by a formula: Π H =(ΣR C) (1 T) (7), then the real effect of doing business in the twilight zone can be described as: E RI = Π Π H (8). Using the equities (3), (4), (5) and (6) the above formula comes to: E R I =[ΣR (1 f) C)] (1-T)+f ΣR (ΣR C) (1 T) (9). After transformation we get the following equity: E R I =f T ΣR (10). So, the size of the real effect of conducting activities in the twilight zone is in the assumed case proportional to its value f and to the rate of income tax T paid by the subject. Case II What we have here is such an enlargement of the twilight zone that with a given rate of illegal income f, the following inequality is true: R L <C<ΣR, i.e. Π N <0, but Π H >0. The graphic illustration of this situation is shown in Figure

5 The level of revenue and costs R F C ΣR R L The rate of unrevealed revenue (f) Figure 2. Case II - legal revenue does not cover costs Source: personal elaboration In this case we have a balance loss V N which minimizes total income of the subject, i.e.: Π=R F -V N =f ΣR [C (1 f) ΣR] (11). After transformation we get the following equity: Π=ΣR C (12). When legal revenue is not big enough to cover the subject s costs, tah is in the case of a balance loss, subject s total income is equal to the amount of the surplus of earnings over costs. The real effect of doing business in the twilight zone is thus: E RII = Π-Π H =ΣR C (ΣR C) (1 T) (13). After transformation we get the following equity: E RII =T (ΣR C) (14). The real effect of the presented case is thus equal to the value of tax to be paid, if the subject conducted legal business activities only and is inversely proportional to the rate of income tax T. It must be realized that the value of the real effect does not depend on the degree, in which the subject conducts activities in the twilight zone - f. From the economy point of view it is not profitable to enlarge the proportion of the twilight zone to the point where it causes balance loss, because in this case the income from the twilight zone would not be bigger than legally obtained earnings. 157

6 The subject gets so called risk bonus connected to conducting activities in the twilight zone only if it does not create loss. This dependence is illustrated by the following formula: E R = f T ΣR T (ΣR C) gdy (1 f) ΣR C>0 gdy (1 f) ΣR C<0 (15). To obtain the risk bonus related to conducting activities in the twilight zone it is necessary to limit its size to the surplus of profit over costs, that is: f ΣR<ΣR C. After surpassing the size of the twilight zone above the value [ΣR C], the subject does not get any additional bonus for the risk connected to illegal business, because the real effect of its enlarging does not increase. The balance loss should thus be a signal for the subject making part of its earnings in the twilight zone, showing that these activities should be restricted or stopped. In reality, however, adverse balance makes the entrepreneurs rather enlarge the twilight zone as a way to compensate for the loss. Exercise 1. Using formula (15) analyse how the value of the real effect changes according to the relation [ΣR-C] shown by the indicator of profitableness d described by an equation: d = R C (16). R Study the following cases: 1. If f<d it means that the subject realizes a profit, so the real effect of enlarging the twilight zone is calculated by a formula: E R I =f T ΣR. 2. If f=d it means that the subject has a zero profit, so the surplus [ΣR C] was transferred to the twilight zone. If f>d it means that the subject has a zero profit, so so the real effect of enlarging the twilight zone is calculated by a formula: E R I I =T (ΣR C). Present on a diagram the level of the real effect of the twilight zone depending on the value of indicator f and d with a given level of income ΣR=PLN and the rate of income tax T=19%. 158

7 Solution: The level of the real effect of the twilight zone (in thousands PLN) % 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% The rate of unrevealed revenue (f) dla d=10% dla d= 20% dla d= 30% dla d= 40% Diagram 1. The level of the real effect of the twilight zone depending on the value of indicator f and d with a given level of income ΣR=PLN and the rate of income tax T=19%. Source: personal elaboration From the above diagram it can be assumed that the enlargement of unrevealed income level f after surpassing the profitableness d, does not give any additional effects, so from an effectiveness point of view is unjustified, causing only the rise of potential risk costs. The limiting level of the twilight zone real effect, which maximizes potential benefits of its usage, can be described as a relation: f =d= R C (17). R The formula describing the real effect of the twilight zone (15) also proves that in both cases the level of real effect is connected directly to the income tax rate T so with the decrease of tax rate the real effect of activities in the twilight zone will also 159

8 fall and the other way round, both when the subject realizes profit and loss. Exercise 2. Analyse and show on a diagram the influence of parameter T change on potential benefits of conducting activities in the twilight zone for the situation described in exercise 1, taking the profitableness indicator for 20%, 15%, 10%, 5%. Solution. 25 The level of the real effect of the twilight zone (i thousands PLN) % 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% The rate of income tax (T) dla f=20% i f>20% dla f=15% dla f=10% dla f=5% Diagram 2. The influence of parameter T change on potential benefits of conducting activities in the twilight zone taking the profitableness indicator for with a given level of indicator f. Source: personal elaboration As results from the above diagram the potential benefits of the twilight zone increase with the rise of tax rate applied to legal income, while the increase of unrevealed income f above the limit rate f =d=20% makes further rise of real effect level stop. The diagram also shows that potential tax rate T=100% would equal the value of real effect to the value of illegal income R F, and with the rate T=0% it would be reduces to zero. The analysis of market behaviour proves that decisions in case of hiding part of income in the twilight zone are made not 160

9 based on real effect presented above; instead business people treat as benefits from conducting illegal activity the value of income tax calculated from total unrevealed income, that is according to the formula: R F T. They are also led by so called seeming effect - E S, whose level can be calculated as a difference between the value of tax from unrevealed revenue and the value of real effect E R, which can be presented with a formula: E S = T f ΣR-f T ΣR gdy d>f T f ΣR-T (ΣR C) gdy d<f (17). Exercise 3. Using formula (17) present a simulation of the seeming effect level - E S in comparison to the calculable real effect - E R, depending from the level of indicator f and d with a given income level ΣR=PLN and the taxation rate T=19%. Solution. Table 1. Simulation of the seeming effect level - E S in comparison to the calculable real effect - E R, depending from the level of indicator f and d with a given income level ΣR=PLN and the taxation rate T=19%. The rate of unrevealed revenue (f) Unrevealed income R F=f ΣR Effect Effect Effect Effect real seem. real seem. real seem. real seem. dla d=10% dla d=20% dla d=30% dla d=40% (in thousands PLN) 0% % 2 1,9 0 1,9 0 1,9 0 1,9 0 20% 4 1,9 1,9 3,8 0 3,8 0 3,8 0 30% 6 1,9 3,8 3,8 1,9 5,7 0 5,7 0 40% 8 1,9 5,7 3,8 3,8 5,7 1,9 7,6 0 50% 10 1,9 7,6 3,8 5,7 5,7 3,8 7,6 1,9 60% 12 1,9 9,5 3,8 7,6 5,7 5,7 7,6 3,8 70% 14 1,9 11,4 3,8 9,5 5,7 7,6 7,6 5,7 80% 16 1,9 13,3 3,8 11,4 5,7 9,5 7,6 7,6 90% 18 1,9 15,2 3,8 13,3 5,7 11,4 7,6 9,5 100% 20 1,9 17,1 3,8 15,2 5,7 13,3 7,6 11,4 Source: personal elaboration Table 1 shows the size of the seeming effect estimated by the entrepreneur as a benefit from running business in the twilight 161

10 zone, which in some cases, however, does not correspond in any way with calculable financial effects of these activities. 4. Conclusion It can be stated, on the basis of the analysis conducted, that it is very dangerous to recklessly make a decision about hiding part of the revenue in the twilight zone, without prior calculation of measurable effects of such acts. The entrepreneur, who wrongly pressumes the effects of acting in the twilight zone will be much more probable to hide their earnings. A precise estimation of the twilight zone real effect wilii in many cases prove economical ineffectiveness of further enlargement of illegal activities scale, and in view of potential danger of financial penalties will prove to be irrational. 5. Comprehension check 1. On the basis of the conducted analysis of hiding part of revenue in the twilight zone, try to think about financial consequences of illegal cost increase. 2. Decide, what actions can be taken by the government in order to reduce the twilight zone size. 3. Justify the statement that lowering income tax will stimulate entrepreneurs to coming out of the twilight zone. 4. Explain, why some business people having balance loss will not achieve financial benefits from higing in the twilight zone. 6. Recommended supplementary literature Dolata St., (1999), Podstawy wiedzy o podatkach i polskim systemie podatkowym, Uniwersytet Opolski. Litwińczuk H., (2004), Prawo podatkowe przedsiębiorców, Warszawa: Wydawnictwo KiK. Machała R., (2003) Praktyczne zarządzanie finansami firmy, Warszawa: Wyd. Naukowe PWN. 162

11 Samuelson W. F., Marks St. G., (2000), Ekonomia menedżerska, Warszawa: PWE. Sokołowski J., (1995), Zarządzanie przez podatki, Wyd. Nauk. PWN, Warszawa. Szczęsny W., (1999), Wydajność fiskalna przedsiębiorstw, Warszawa: Difin. References 1. Stos D., (2002), Finansowe aspekty szarej strefy w działalności przedsiębiorcy, (w:) Zarządzanie finansami klasyczne zasady, nowoczesne narzędzia, Uniwersytet Szczeciński. 2. Gos W., (1998), Zarządzanie wynikiem finansowym i dochodem, Difin, Warszawa. 3. Kaczor T., Misięg W., Niedzielski A., Udział małych i średnich przedsiębiorstw w tworzeniu dochodów publicznych, Wyd. Polskiej Agencji Rozwoju Przedsiębiorczości, Warszawa