Causes and effects of shadow economy in Croatia

Transcription

1 Causes and effects of shadow economy in Croatia Bruxelles, October2013 Predrag Bejaković Vjekoslav Bratić Josip Franić Institute of Public Finance, Zagreb, Croatia

2 Contents Introduction Definition and measuring of shadow economy Shadow economy in Croatia: -discrepancy methods -labour input methods -Gutmannapproach -electricity consumption -latent variable methods Tax evasion in Croatia The shadoweconomy and economic crisis Conclusion 2

3 Introduction (1) Shadow economy is present in all societies irrespective of their dominant social and political system. There are as many noncompliant activities as there are rules to be violated. 3

4 Introduction (2) Aimofshadow economy(se): in a developed market countries -lowering production costs and prices in planned economy -compensation ofthe shortage of goods in the market or improvingthe quality of goods in developing countries-the consequence of the dual economic structure and itself the result of economic underdevelopment 4

5 Introduction (3) Neglecting the phenomenon of shadow economy leads to some serious problems: significant disproportion in certain items of the national accounts the misinterpretation of official statistic's records impropernational economic policy estimates concerning the growth of SE are more important than estimates of its volume. 5

6 Definitionand measuring(1) The definition of shadow economy is not firmly fixed but subject to change and varying criteria: 1.the legal one - illegal economy, 2. the moral one - its illegal nature and the fact that it contravenes the accepted rules of business, 3.the institutional one -income realized through this kind of operation is not included in routine record-keeping and statistics, 4.the quantitative one -those economic activities which could be measured in some way but have so far never been analysed, 5.the ideological one - depends, to a great extent, on the prevalent economic system in society and corresponding economic policy. 6

7 Definitionand measuring(2) Feige(1990) considers all economic entities as part of the official economy, providing their actions are performed according to the established institutionalized rules of the game. Only economic entities which do not operate according to institutionalized rules in the market can be considered part of the shadow economy. 7

8 Definitionand measuring(3) Informaleconomy encompasses all activities that are formally legal but ideologically suspected there is official tendency to discriminate them and give them an inferior status. 8

9 Definitionand measuring(4) Activities in hidden economy: undeclared legal production of goods and services, production of illegal goods and services, and concealed income in kind. 9

10 Definitionand measuring(5) Types of shadow economy: unreported - tax evasion and benefit fraud behaviours unrecorded - when income-producing activities are concealed and thus cannot be appropriately included in national income accounts corruption - activities involving the abuse of public office for private gain illegal - activities that violate the rules prohibiting extortion, financial fraud, smuggling, organized crime, and theft of state property 10

11 Definitionand measuring(6) Shadow economy may play (and indeed does) an important positive role as a stimulus for social development, primary as an important economic cushion, free from control and taxation, that alleviates the social consequences of transition period, struggle against inflation and economic restructuring. These consequences would be more severe without shadow economy. 11

12 Definitionand measuring(7) The shadow economy influences the successful implementation of the economic policy. The greater the shadow economy is, the greater is its influence on the economic policy. Research has shown that this economy in many countries has reached significant proportions. 12

13 Definitionand measuring(8) The scope of shadow economy canbe estimated by: monetary approach or Tanzimethod, official statistics with arbitrary estimates, calculation and analysis of the structure of shadow economy, labour input methods, discrepancy method using differences between income and consumption, 13

14 Definitionand measuring(9) using the data from national accounts, better control of taxpayers and tax obligations, examining the opinions of experts for particular part of economy, latent variable methods or method of causes, global indicators methods electricity consumption, methodology for estimate of non-exhaustiveness of national accountsetc. 14

15 Shadoweconomyin Croatia The Institute of Public Finance (Ott, 2002) in the Project The Underground Economy in Croatia have applied various approaches to the measurement of the SE: via the national accounts, monetary methods, labour force surveys, tax evasion. It was attempted to evaluate the shadow economy in individual industries, e.g., in agriculture, industry and trade, tourism, foreign trade. 15

16 ShadoweconomyinCroatiadiscrepancy methods (1) use differences between income and consumption: if consumption is bigger than income -on the level of national economy or on micro level of particular household -this part of income can be realised in shadoweconomy. 16

17 ShadoweconomyinCroatiadiscrepancy methods (2) United Nation (2003) using Imputed Unobserved Income Y IUI /(GDP) 100, estimated that in Croatia the share of undeclaredwork was 8.9% in 1998 and 8.1% in

18 ShadoweconomyinCroatialabour input methods (1) Labour input methods are based on comparing the rates of activity in longer period or among different countries. If rates of activity are decreasing, it can be due to withdrawing from formal to informal sector. 18

19 ShadoweconomyinCroatialabour input methods (2) According to Crnković Pozaić (1997): the level of the unofficial economy is 26%of total employment among the categories: 6.2% of the population surveyed is engaged in additional business activities, 10.2% are unpaid family workers, 2.3% are own-account workers and 7%are housewives, students, retired persons and usually unemployed persons 19

20 ShadoweconomyinCroatialabour input methods (3) Lovrincevic, Mikulic, Niksic-Paulic, (2002) stress that the main method for the establishment of the undeclared work derives from the failure to register subjects (in this case, employment). 20

21 ShadoweconomyinCroatialabour input methods (4) Theyestimatedthatthe gross added value created with this kind of work came to EUR1billion in 1999, or EUR 1.1billion in 1998, from which it would appear that it is this form of the undeclared work that prevails in Croatia. 21

22 ShadoweconomyinCroatia- Gutmann approach (1) The mathematical parameter k, assumed to describe the long-term behaviour of cash needed for the declared work, is equivalent to the ratio of cash and deposits in the initial period: k=c t=0 /D t=0 The percentage of cash that is used in the declared work in all subsequent periods is derived with the use of the parameter k and the amount of deposit money: Cd=kD M 1 =Cd+Cu+D. the total money supply consists of deposit money and cash, which is partially used in the declared work and partially in the undeclared work 22

23 ShadoweconomyinCroatia- Gutmann approach (2) The next step makes use of the assumption of the identical velocity of cash used in the undeclared work (Cu) and money that is used in the declared work (Cd+D). the level of the undeclared work in all subsequent periods is estimated as the multiple of the amount of cash used in the undeclared work and the derived speed of the circulation of money in the declared work. 23

24 ShadoweconomyinCroatia- Gutmann approach (3) Sosicand Faulend (2002) usedthisapproach to estimatethesize oftheunreported work in Croatia. They based their estimate on the year with which a previous study ended (Bicanic, 1997). As the starting level for the undeclared work they took25% of GDP as recorded in the official economy, i.e. an average for the period from by the previous study (Ott, 1997). 24

25 ShadoweconomyinCroatia- Gutmann approach (4) Table 2. Estimates of the size of the SEfor Croatia based on the Gutmannmethod, with the employment of domestic monetary aggregates C/M GDP UW Source: Sosic and Faulend (2002) 25

26 ShadoweconomyinCroatia- Gutmann approach (5) Sosicand Faulenddevoted more attention to criticisms of monetary methods due to the widespread dollarisationand attempted to use the problem of dollarisation constructively for a different approach to evaluating dynamics of the undeclared work. 26

27 ShadoweconomyinCroatia- They assumed that: Gutmann approach (6) 1. only local currency was used in the declared work, 2. only foreign currency is used in the undeclared work in the form of cash at that. 27

28 ShadoweconomyinCroatia- Gutmann approach (7) They supposed that changes in the ratio of the two components of the GDP, that is the GDP created in the declared work and that generated in the undeclared work are in proportion to changes of the ratios of the estimated amount of foreign cash in circulation and the domestic monetary aggregate M1: (FCC t / M 1t ) / (FCC t-1 / M 1t-1 ) (GDP UWt / GDP DWt ) / (GDP UWt-1 / GDP DWt-1 ) FCC = foreign currency in circulation, M1 = domestic monetary aggregate, GDP = gross domestic product, UW = the undeclared work, DW = the declared work 28

29 ShadoweconomyinCroatia- Gutmann approach (8) Table 3: Estimates of the size of the UW for Croatia based on estimations of foreign currency in circulation FCC / M GDP UW Source: Sosic and Faulend (2002) 29

30 ShadoweconomyinCroatia- Electricity consumption (1) basedon assumptionthatthe difference between the growth rate of electric consumption (a proxy for the growth rate of total economic activity) and the growth rate of measured GDP yields an approximation of the growth rate of unrecorded income. 30

31 ShadoweconomyinCroatia- Electricity consumption (2) Sosicand Faulend (2002) used the electricity consumption method with the assumption on the unitary elasticity of change in the consumption of electricity to changes in the overall GDP. They adhered to the assumption that the undeclared work came to 25% of the declared work in

32 ShadoweconomyinCroatia- Electricity consumption (3) Table 4: Estimates of the dynamics of the UW for Croatia using the electricity consumption method Rate of rise of GDP (Official economy in %) GDP Index (Official economy) Rate of rise in electricity consumption (%) Total GDP (declared and undeclared) Undeclared as percentage of declared work (%) Source: Sosic and Faulender (2002) 32

33 ShadoweconomyinCroatia- Latent variable methods (1) based on analysing reasons that stimulate the participation in the shadow economy determinants: e.g., real and perceived tax burden, the burden of regulation, tax immorality, etc. indicators: male participation rate, hours worked and growth of real GNP 33

34 ShadoweconomyinCroatia- Latent variable methods (2) Lovrincevic, Maricand Mikulic(2006) estimated the total amount of undeclared work in Croatia using: input method, DYMIMIC method, average deviations of result of other methods Eurostat method 34

35 ShadoweconomyinCroatia- Latent variable methods (3) Average share of undeclared work in total Gross Additional Value (GAV) and Gross Domestic Product (GDP) decreased during from 15.4% GAV (12.4% GDP) in 1998 year to 13.9% GAV (11.2% GDP) in

36 ShadoweconomyinCroatia- Latent variable methods (4) The economic sectors with the highest share of UW in GAV in the year 2002 were: Hotels and restaurants (34%), Real estate leases and business services (32%), Fishing (27%), Building (22%), Other community, social and personal services (20%) and Trade, repairs of motor vehicles and household goods (19%). 36

37 ShadoweconomyinCroatia- Latent variable methods (5) Total amount of undeclared work in Croatia in 2002 was EUR 2.7 billion, what is increase of 18% in comparison to The most important forms incorrect reporting EUR 1.2 billion, non-registered (hidden) producers (EUR 0.75 billion), and statistical unavailable data (EUR 0.36 billion). 37

38 ShadoweconomyinCroatia- Latent variable methods (6) Lovrincevic, Maricand Mikulic(2006) underlinedthat the most significant increase was observed in incorrect reporting, while there was a decrease in the realised amount by non-registered (hidden) producers. 38

39 Tax evasionin Croatia (1) Sanja Madzarevic-Sujster(1997) explained that in Croatia this most often involves declaring lower tax bases, the payment of wages while evading the payment of social contributions, taxes and surtax. 39

40 Tax evasionin Croatia (2) As difference between actually paid and potential contributions and income tax, evasion of contributions and income tax was 2.8% of GDP in 1994 and3.8% in

41 Tax evasionin Croatia (3) Madzarevic-Sujster(2002) carried out similar simulation and found out that evasion of taxes and contribution was: 4,3% GDP in ,9% GDP in

42 Tax evasionin Croatia (4) Figure 1. Tax evasion, tax burden and the share of the shadow economy (% of GDP) Informal economy, left axis Lower limit of tax evasion, right axis Tax burden on the economy, left axis Upper limit of tax evasion, right axis Source: Madzarevic-Sujster (2002). 42

43 Methodology for estimate of nonexhaustiveness of national accounts(1) The classification of non-exhaustiveness types in the national accounts is based on various characteristics of the producer, i.e. the way in which data is obtained from producers. Regardless of the mutual exclusivity of individual forms, in practice there can also be cases in which individual types of non-exhaustiveness in the national accounts overlap. 43

44 Methodology for estimate of nonexhaustiveness of national accounts(2) Lovrinčević et all. (2011) calculated that the total non-exhaustiveness adjustments in Croatia in 2000 amounted to EUR 2.21 billion with the inclusion of illegal activities, or EUR 2 billion where illegal activities are not included. In the last estimated year (2008) total unofficial economy amounted to EUR 3.2 billion without illegal activities (EUR 2.7 billion, respectively). 44

45 Methodology for estimate of nonexhaustiveness of national accounts(3) Apart from 2003, absolute values of shadow economy estimates have increased throughout the observed period. On the other hand, share of shadow economy was continuously decreasing from 8.5% in 2000 to 5.9% of GDP in

46 The shadoweconomy and economic crisis (1) Croatian economy in the pre-recession period recorded average economic growth above 4%, low inflation, decreasing unemployment rate and decreasing public deficit. On the other hand, lack of overall competitiveness resulted in rising current account deficit and foreign debt. 46

47 The shadoweconomy and economic crisis (2) The overall unemployment rate for the population aged fell from 13.1% in 2005 to 8.6% in In 2009 and 2010 the unemployment rate increased to 9.3% and to 12% respectively. While GDP growth in 2008 was significantly lower than 2007, but still positive, in 2009 GDP growth fell to -5.8%. 47

48 The shadoweconomy and economic crisis (3) The recession, acting through the demand channel had a direct negative impact not only on the official but also on the unofficial economy. Theoretical causes of the shadow economy: 1) Burdens on the official economy; 2) Public sector services; 3) Tax morality and government controls; 4) Labour market conditions; 5) Structural factors 48

49 The shadoweconomy and economic crisis (4) Table 5: Factors which influence the shadow economy according to results of various empirical studies Factors influencing the shadow economy a Influence on the shadow economy (in %) b Increase of the tax burden Quality of state institutions Transfers Specific labour market regulation Public sector services Tax morale a) Averagevaluesof12 studies b)averagevaluesofempirical resultsof22 studies. Source:FeldandSchneider,

50 The shadoweconomy and economic crisis (5) Figure 2: Relationship of real GDP growth (official economy) and real growth of unofficial economy in period , Croatia Source: Lovrinčević et all,

51 Conclusion (1) Economic policy measures seeking to reduce the shadow economy should place primary interest on the institutional sphere. It is essential to understand the relation of the state towards the economy and toward society as a whole. Official statistical data significantly overestimate economic activity during periods of growth, while underestimating activity during recessions. The trend of SE is more important than itslevel. 51

52 Conclusion (2) The state must see that among other the following goals are realized: high professional level of state services; complete independence and better organization and equipping of the judicial system and the exclusive accountability to Parliament of highly professional control and inspection services; transparency of rules and regulations and of all procedures where the possibility of rent seeking is a stimulation to the unofficial economy; possibility of truly democratic and public control by citizens and their representatives over all state institutions; high quality service from the public sector; decisive break with paternalistic capitalism; 52

53 Conclusion (3) It is more important to prevent the causes of the shadow economy than its negative consequences (penalties, introduction of new taxes, etc.) From the liberal point of view, the shadow economy will decrease: if economic growth, stabilizationand restructuring are realized and if the role of the state in the economy is reduced, if taxes are lowered. 53

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