Underground Economy Leaves Tax Collectors Empty Handed

April 15, 2009 03:00 PM
by Anne Szustek
The gray, or underground, economy is flourishing amid the recession as underemployed workers seek one-off jobs free of taxes.

Gray Economy’s Silver Lining Leaves Public Coffers Rusty

A lack of formal employment opportunities on the job market and a subsequent cash crunch on the consumer market has bolstered “off-the-books” business transactions around the world. For example, research by Edgar Feige, an economics professor emeritus at the University of Wisconsin suggested that unreported income from the so-called “underground,” or “gray,” economy in the United States totals as much as $2.25 trillion, meaning some $600 billion in potential taxes is staying out of the revenue system.

A potential upside to the numbers: “the recession, as captured by the official statistics, may not be as severe as it appears,” Feige was quoted as saying by Bloomberg.

At the same time, however, this creates “an unsustainable situation for the public coffers,” Armando Fernandez Steinko, a sociology professor at Madrid’s Computense University, told Bloomberg, as companies in various countries that are looking to cut costs pay less in taxes in a bid to pass on the savings to consumers. Carlos Cruz, who runs a painting business in Madrid, was quoted as saying by Bloomberg, “I’m declaring half as much as I used to … Prices have fallen by 30 percent and customers will choose you for a difference of as little as 50 euros ($67.70).”

Background: Turning the spotlight on the shadow economy

Underground economies, also known as “parallel,” “shadow” or “gray” economies, encompass illegal activities such as smuggling, prostitution or underreporting employee income to evade paying social security, as well as “off-the-books” jobs such as those often taken by illegal immigrants.

By definition, calculating the currency flow in underground economies is at best an educated estimation. They skew official statistics such as per-capita GDP and unemployment figures.

In turn, given that such activities fall outside of government record-keeping, they mean less revenue for the state—thus giving way to more corruption. For example, police officers in developing countries may seek bribes from known tax evaders to bolster their already-paltry salaries. Public schools might not get the funding they need. And granting contracts for public infrastructure projects may be contingent on a kickback to public servants.

The current recession may exacerbate gray economic cycles in emerging market economies such as Turkey or South Africa, which are already suffering from diminishing tax revenue due to a loss of jobs and decreased demand for exports.

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Related Topic: Switzerland in tiff over banking secrecy laws

In response to calls by the G20 group of developed and emerging market nations and the Organization for Economic Cooperation and Development, Switzerland announced on March 13 that it would take steps to lessen longstanding rules on banking secrecy.

Switzerland is not on the OECD’s list of countries deemed to be “uncooperative tax havens,” as Agence France-Presse put it. Despite the measures the country took in March, it may soon join those others on the list, however.

Switzerland is the world’s largest center for offshore banking. Roughly one-third of the world’s cross-border wealth filters through the Alpine country’s financial institutions. The Swiss banking sector has suffered somewhat due to the current recession, as well as from other countries’ tax amnesties and stricter regulations on offshore accounts.

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