Shadow economy and tax evasion in the EU

Journal of Money Laundering Control Shadow economy and t ax evasion. The Achilles heel of Greek economy. Det erminant s, ef f ect s and policy proposals Georgios L. Vousinas, Article information: Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) To cite this document: Georgios L. Vousinas, (2017) "Shadow economy and tax evasion. The Achilles heel of Greek economy. Determinants, effects and policy proposals", Journal of Money Laundering Control, Vol. 20 Issue: 4, pp.386-404, https://doi.org/10.1108/JMLC-11-2016-0047 Permanent link t o t his document : https://doi.org/10.1108/JMLC-11-2016-0047 Downloaded on: 26 January 2018, At : 02: 58 (PT) Ref erences: t his document cont ains ref erences t o 25 ot her document s. 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Vousinas National Technical University of Athens, Athens, Greece Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) Abstract Purpose – This paper aims to bring into surface two major socioeconomic problems of Greece, tax evasion and shadow economy. Design/methodology/approach – It examines the determinants and the factors that led to the formation and expansion of tax evasion and subsequently of black economy. Empirical data and related research are used to provide a clearer view of the existing situation. Findings – Tax evasion and shadow economy are proved to remain two of the most severe problems that torture Greek economy. The factors that contribute the most to the formation of these phenomena are the lack of tax awareness, the tax burden, the structure of the tax system, the role of the state, the level of approvement of public authority, self-employment, unemployment and the level of organization of the economy. Except from the negative characteristics, positive ones are also identified, and certain policies are suggested so as to combat tax evasion and black economy. Originality/value – The paper highlights two major issues that constitute the deadly weakness of the Greek economy, providing a holistic view of the current situation, identifying the roots of the problem and suggesting specific measures. Keywords Financial crisis, Tax evasion, Shadow economy, Greek sovereign debt crisis Paper type Research paper Journal of Money Laundering Control Vol. 20 No. 4, 2017 pp. 386-404 © Emerald Publishing Limited 1368-5201 DOI 10.1108/JMLC-11-2016-0047 1. Introduction The shadow economy (also known by many other names such as black, grey, informal, etc.) is a common feature of countries all over the world and to a lower or greater degree exists in all societies. Its effects on socioeconomic development can be significant and farreaching, as scarce resources are wasted or used inefficiently, desirable regulations are circumvented and undermined, national statistics become inaccurate and incomplete and public finances deteriorate to the breakdown of public policy. Of course, the presence of an underground sector is simply a reflection of individuals’ incentives to conceal their economic activities, either because these activities would be less rewarding if practiced in the formal sector or else because the activities are illegal to start with. A common practice in this direction is the phenomenon of tax evasion which is the illegal evasion of taxes by individuals, corporations and trusts, an activity closely associated with the informal economy. Although shadow economy and tax evasion are often considered to be identical, the two terms are different but are very closely related. Schneider and Buehn (2012a, 2012b) argue that even though the size of the shadow economy and tax evasion JEL classification – H26, O17 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) are not congruent, activities in the shadow economy often imply the evasion of direct or indirect taxes, so that the factors affecting tax evasion will most certainly also affect the shadow economy. The main issue that arises and afflicts the research community is the fact that measuring the black economy is extremely difficult by its nature, as it requires assessment of the economic activity which derives from informal transactions. Usually, surveys underestimate the size of the shadow economy, but econometric techniques are nowadays used for better understanding of its size. The following figure depicts the size of the shadow economy in selected Organization for Economic Co-operation and Development (OECD) countries (including the seven major advanced economies as reported by the International Monetary Fund, the so-called Group of 7 or G7) as a percentage of gross domestic product (GDP), so as to emphasize the size of the problem (Figure 1). As it is made clear from the above figure, the black economy is a reality for all the countries, but the problem focuses on the so-called PIGS, a term that refers to the economies of Portugal, Italy, Greece and Spain, which were unable to refinance their government debt or to bail out over-indebted banks on their own during the recent global debt crisis. Among them, Greece holds the supremacy with the level of its underground economy in 2015 reaching the impressive 22.4 per cent of GDP, i.e. almost one quarter of the Greek economic activity. Italy follows closely with 20.1 per cent, while the Spanish black economy is 18.2 per cent and the Portuguese one 17.6 per cent. An interesting fact is that the biggest European economy, Germany, is at the level of 12.2 per cent which is identical with the average of the selected OECD countries shown on the graph. Even more, the US economy, the largest in the world, has managed to restrict its shadow economy to 5.9 per cent, which is the smallest one among all and constitutes one quarter of the Greek one (the biggest one). In less developed countries, the informal economy is usually 25 to 40 per cent of national income and represents up to 70 per cent of nonagricultural employment. In these countries, the informal activity often occurs because of the inadequacies of legal systems to document and formalize the company registration. The main driving forces of the shadow economy are tax and social security burdens, the Shadow economy and tax evasion 387 Figure 1. Level of the shadow economy in OECD countries as of 2015 (percentage of GDP) JMLC 20,4 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 388 moral attitude to taxation, the quality of state institutions and labor market regulation. Reducing the tax burden is therefore likely to lead to a reduction in the black economy, especially if it is combined with lower tax rates, less shadow work and the potential for lower prices. Of course, a vicious circle in the other direction can also be created. The number of participants in the shadow economy globally is very large with some sectors such as the constructing, having almost half of their staff working informally. The shadow economy is pervasive and is composed of a vast number of small and scattered transactions. The policy response should be very careful concerning the mechanisms and the effort to eliminate the informal economy, particularly in terms of development and promotion of entrepreneurship and business related to illegal employment. There are also huge potential benefits from the possibility of formalizing the self-employed in small businesses. 2. Literature review At this point and before we proceed with the analysis of the origins and the determinants as well as the effects of black economy and tax evasion on the Greek economy, a review of both theoretical and empirical literature on these crucial issues is undertaken so as to highlight the current research results. Bitzenis et al. (2016) explore the determinants of the Greek shadow economy and its interaction with the official economy by undertaking an interdisciplinary review of economic and political studies on the size and determinants of the shadow economy, tax evasion and undeclared work in Greece to reveal the extent and complexity of these phenomena. They estimate the size and determinants of the shadow economy via the multiple-indicators-multiple-causes (MIMIC) approach and their findings indicate that the important determinants are factors related to macroeconomic conditions, such as unemployment and GDP growth, as well as institutional factors, such as tax morale and the rule of law. The overall conclusion is that an adoption of a policy based on these findings would lead to a successful transfer of part of the shadow economy to the official economy thus, boosting government revenues and eventually leading the Greek economy out of the depression that emerged as a result of the sovereign debt crisis. Artavanis et al. (2015) used a novel approach to estimate tax evasion using the adaptation of the private sector to the norms of semiformality based on the bank’s perception of the individual’s true income. They used bank data on household credit and replicated the bank model of credit capacity decision to infer the banks estimate of individuals’ true income. The authors estimate a lower bound of 28.2bn euros of unreported income for Greece, which accounts for 32 per cent of the deficit for 2009. Primary taxevading industries are found to be medicine, law, education, engineering and media. They also provide evidence that tax evasion persists not because the tax authorities are unaware, but because of a lack of paper trail and political willpower. Berger et al. (2014) present new estimates of the Greek underground economy and explore the link between the shadow economy and aggregate debt. They show that the Greek underground economy has been underestimated heavily and has been on a rising trend again, as Greece adopted the euro and also show evidence that the size of the underground economy is positively related to the debt-to-GDP ratio. Their results suggest that for a sample of eleven EMU member countries the loss of the inflation tax as an economic policy instrument had drastic consequences. While the underground economy did not have a statistically significant impact on aggregate debt before the introduction of the euro, it has pushed up the debt-to-GDP ratio in the sample ever since. Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) Remeikiene et al. (2014) point out that, in general sense, shadow economy emerges in such spheres as taxation, social security and labor aspects of undeclared work. The aim of their article is to identify what country-level determinants from these spheres have the strongest impact on the scope of shadow economy in Greece during 2005-2013. The results show that the country-level determinants that influence mostly the scope of shadow economy in Greece are the unemployment rate, GDP per capita, total labor force, domestic credit to private, tax rate and tax payment. Calculations confirmed the results of the theoretical research by showing that tax rate is the determinant having the most significant impact on shadow economy emergence and development. The authors of the article also recommend carrying out a detailed analysis of the components of current tax structure in business and other spheres so as to lead to the introduction of proper taxes which would not appear to be the fundamental motive to act in a shadow. Kaplanoglou and Rapanos (2013) highlight a number of shortcomings in the design and enforcement of the tax system in Greece, which have played a key role in the exacerbation of fiscal deficits that led to the current sovereign debt crisis. They argue that these shortcomings resulting in low tax revenue are related to the structure of the Greek economy and to the failures of formal institutions, as all available indicators point to the fact that the low and unfairly distributed tax yield is primarily due to the poor functioning of the tax administration, lax tax enforcement, inefficiency of tax collection and the lack of effective dispute resolution mechanisms. Such failures result in high tax evasion and a thriving underground economy. The authors propose a number of specific measures such as reorganizing tax offices, simplifying tax laws, rationalizing fines, improving tax audits and establishing credible dispute resolution mechanisms while emphasizing the fact that if policymakers are successful in introducing reforms that will enhance the efficiency of the tax administration, this may be the first step in restoring confidence in public institutions. Matsaganis and Flevotomou (2010) use a tax benefit model to provide preliminary estimates of the size and distribution of income tax evasion in Greece. With that method they estimate income under-reporting at 10 per cent, resulting in a 26 per cent shortfall in tax receipts. The paper finds that the effects of tax evasion are higher income inequality and poverty, as well as lower progressivity of the income tax system. Danopoulos and Znidaric (2007) highlight the fact that Greece has the highest level of tax evasion among the 15 nations that made up the European Union prior to enlargement in 2004 and also the country’s underground economic activity remains alarmingly high. They identify the major factors that prompt tax evasion which include the low level of education and the high level of tax burden among others. They also refer to the negative effects of informal economy which include damages in the reliability and trustworthiness of official government statistics, making government policy, planning and efforts to attract foreign and other forms of investment less than credible; renders government fiscal and spending policy ineffective. However, there are also benefits in not paying taxes, as it leaves more money in the hands of consumer and businesses leading to greater investment and prevents the burden of excessive taxation. Katsios (2006) highlights the interaction between the underground economy and corruption, focusing on the determinants of the Greek economy, the tax and national insurance burdens and the intensity of the relevant regulations in Greece, concluding that Greece shows profound signs of a transition country in terms of the high level of regulation leading to a large shadow economy. The taxation problems arising from high administrative-compliance costs and bribery indicate the urgent need for tax reforms designed to simplify the regulation framework. Improvement of the quality of Greek Shadow economy and tax evasion 389 JMLC 20,4 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 390 institutions and rationalization of administrative-compliance costs are a prerequisite for successful and urgently needed tax reforms in terms of reducing the overall Greek shadow economy, through the simplification of the regulatory framework. Christopoulos (2003) uses data from Greece over the period 1960-1997 to examine whether the underground economy responds asymmetrically to tax changes, both indirect and direct. Asymmetry implies that taxpayers react in a different manner to tax increases and to tax reductions. To test this hypothesis, the author specifies and estimates a vector error correction model, and the empirical evidence suggests that when indirect and direct taxes rise, taxpayers move into the underground economy as quickly as they move out of it when indirect and direct taxes decrease. Thus, the empirical results do not give support to the asymmetry hypothesis, and this has significant implications for the effectiveness of the country’s fiscal policy. 3. Causes of informal economy and driving factors For the black economy to exist, the following two conditions must be met: (1) Those involved in the informal economy must have an incentive in order to decide to take action in this area. In other words, the benefits they expect from expanding their activities in the informal sector have to be larger than the suspected cost of their revelation. (2) The adequate opportunities should be provided, i.e. there exist employment opportunities in the informal economy. The most important factors, as identified by the literature, that lead people to become active in the shadow economy are as follows. 3.1 The level of the tax burden The level of tax burden and the high tax rates largely explain the existence and growth of the shadow economy. Individuals and companies, by keeping hidden a part of their economic activity, they manage to achieve lower tax burden. Especially in the case of indirect taxes, there are benefits for all the parties involved, for example, buyers and sellers. This mutual interest leads to cooperation between them to hide all or part of their trading. A recent research published by the Institute of Economic Affairs (British Institute of Economic Affairs, 2013) reveals that high tax rates have led to an underground economy equivalent to a staggering 10 per cent of Britain’s GDP, with its worth been over £150bn. High levels of public spending and tax increases led both individuals and enterprises to illegal employment, thus creating a vicious cycle. The underground economy has as a direct consequence the loss of tax revenues, and this in turn leads to an increase in tax rates, and thus to the reinforcement of employment in the black market. Recent findings highlight the fact that the punitive tax regimes have led to the exacerbation of the shadow economy, resulting in more than 30 million people across the European Union been employed illegally. Especially in Greece, a country among the most affected by the crisis in the Eurozone, illegal activity accounts for over 20 per cent of national income. 3.2 The degree of acceptance of state power A person will be more willing to develop activities in the black economy if it considers the state as a power that seeks to limit the fruits of his labors compared to a person who believes that the role of the state increases prosperity and promotes the common good. This ideological attitude of people is expressed by the term tax consciousness or tax morality. Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 3.3 The level of unemployment The level of unemployment is a feature of the economic and social structure of a country. The degree of interaction between the two variables, unemployment and undeclared work, is not easy to determine. According to a widespread perception, in an economic downturn, especially in economies characterized by high inflation and rigidities in the labor market, an increase in the level of unemployment is a reinforcing factor of undeclared employment. As the recession periods are particularly relevant for the violation of institutional constraints which weigh heavily on labor costs, unemployment appears to act as a reinforcing demand factor, and hence supply, of undeclared employment. According to data published by the Hellenic Statistical Authority, the unemployment rate in Greece in April 2016 stood at 23.3 per cent, versus 25.3 per cent in April 2015 and 27.1 per cent in 2014. The highest unemployment rate for 2016 was recorded in Western Macedonia (27.6 per cent) and the lowest in the Aegean (15.4). In 15-24 age group, unemployment increased to 47.4 per cent. A further important aspect of the unemployment phenomenon is the evolution of the percentage of long-term unemployed that is both impressive and disturbing. This group of the workforce, which remains for a long time excluded from the formal labor market and is inevitably led to social exclusion, is according to all estimates a significant undeclared labor supply tank. 3.4 The degree of state intervention The degree of state intervention may be measured in the number of laws and regulations, including the laws change. In Greece, the laws, reforms and regulations are numerous as well as the non-stop alterations every now and then, such as the liberalization of closed professions that require a professional license (e.g. taxi, etc.), market regulations and restrictions on the job market. The degree of intensity of state rules and regulations are major factors which lead Greek citizens straight to the black economy. This is directly related to the burden of social security contributions as regulations lead to an increase in labor costs in the formal sector which in turn leads to an increase in unemployment (as occurs in many OECD countries). All of the above provide an incentive for workers to be used in the shadow economy, especially when labor costs are passed on to the same. Thus, the unemployed are a double burden for the state, as they continue to receive social benefits and if these activities, which are undertaken in the black economy, became official then employers and employees would have payed less tax. Of course, the percentage change in real labor cost per unit were 2.9 per cent in 2011, 7.4 per cent in 2012 and 1.1 per cent in 2013. This decrease reflects the significant decline in turnover in almost all sectors of the Greek economy and the existence of significant employment rate in informal or unofficial forms of employment. There was also a reduction in the average gross earnings in the whole economy by 4.6 per cent in 2010, 1.7 per cent in 2011, 6.6 per cent in 2012 and 7.7 per cent in 2013 as the efforts made by the government under the agreed memorandum for the country’s exit from the crisis intensify. There is a general rule that the greater the number of rules and regulations which exist in an economy, the greater share of total GDP is occupied by the informal sector. Indeed it has been found that an increase of one percentage point of government regulations is related with an increase of 8.1 percentage points to that share. Therefore, many studies suggest that the Greek government should give more emphasis on the enforcement of laws and regulations rather than increasing their number. 3.5 The social security scheme Social security charges are considered to be a very influential factor of the extent of the black economy because, like high taxation, so the contributions paid by employers and Shadow economy and tax evasion 391 JMLC 20,4 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 392 employees contribute to the development of the shadow economy. Also, the fact that the government provides various kinds of social benefits to poor, unemployed and generally to people who have low incomes, motivates many people to be virtually presented as beneficiaries of social benefits, without actually entitled to. Consequently, a number of citizens have an incentive to operate in the black economy and to declare a lower income to take advantage of such benefits thus, depriving valuable resources of the state and social welfare. 3.6 The role of the state The black economy is related to violation of state rules and therefore the state policy makers should make serious efforts to mitigate it. In practice, however, often tolerated or supported by the state, the grey economy, whether this is because it serves the interests of individuals or social groups that have the ability to influence the institutions’ decisions or because it is thought to contribute, in short term period, to the achievement of certain objectives of economic policy as, for example, improving the balance of payments, increasing employment and stimulating economic growth. Such phenomena are observed in the case where the governmental mechanisms are loose and show a high level of tolerance on something which is clearly forbidden, as for example the illegal immigration in Greece that has skyrocketed the current period and has become a major threat for all Europe. Therefore, it is not only the level of the administrative machinery but also the political will that affect the size of the shadow economy. From all the above mentioned, several studies have concluded that the most important causes for the creation of the informal economy in many countries are the tax burden, the large number of freelancers and the government restrictions. For Greece, in particular, it is found that the three most important causes are unemployment, the large number of self-employed and social levies as part of the overall tax burden. 3.7 Workforce synthesis and the number of self-employed The synthesis of the workforce in Greece plays a vital role in creating and strengthening the informal economy. This is due to the fact that the agricultural sector and related industries, as well as the tourism sector, employ a high percentage of undeclared workers. So although these people produce work, it does not appear in official statistics of GDP and their insurance contributions are not paid despite grants and facilities offered by the state and the European Union. In addition, self-employed are those who greatly contribute to the growth of the informal economy according to a related research held by the British Institute of Economic Affairs (2013). It is also argued that self-employed constitute one of the major factors that lead to the formation of the underground economy regardless of the level of economic development. For example, it was found that the informal economic activities derived from this employment accounted for 10.6 per cent of GDP. This means that there is lot of chance that all these professionals do not declare all their work and operate in the black economy, as they have a larger number of deductible expenses, both from their tax base and the taxation of their personal income, and they are subjected to fewer internal and external controls compared to larger enterprises. Greece has the highest percentage of selfemployed in the EU according to Eurostat (2012) with 32 per cent of its employees, compared with 15.1 per cent in the Eurozone and 15.2 per cent in the EU (32.8 million selfemployed). After Greece, the highest percentage of self-employed is found in Italy (23.4 per cent), Portugal (21 per cent) and Romania (20 per cent). In Greece, according to the study, the percentage of uninsured workers stands at 37.3 per cent of the total, while the country also holds first place in the percentage of illegal immigrants working (4.4 per cent of the total) followed by the USA (3.2 per cent). 4. Determinants and causes of tax evasion Tax evasion is a global problem, but its range and effects depend on several factors, the major of which are: Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 4.1 The educational level of the population The higher the educational level the higher the grade of tax consciousness and the lower the tax evasion trend. On the contrary, when the educational level is low, tax payers are not able to understand the fact that tax revenues are the main source for the financing of public goods (health, security, etc.) which satisfy critical social needs. 4.2 The level of tax burden in comparison to the aggregate income The higher the level of the burden by a single tax, the higher the benefit for a tax payer by tax evasion. Subsequently, the higher the average tax burden, the higher the trend for tax evasion due to the restriction of the individual’s basic needs (food, clothing, etc.) that becomes more noticeable and the gain by the tax amount outweighs for the risk taken in case of tax evasion apocalypse. 4.3 The distribution way of tax burdens If the distribution of tax burdens responds to the prevailing view for social justice, then the trend for tax evasion is smaller. On the other hand, when the principle of fair distribution is violated with the implementation of tax exceptions to specific private entities, then a handful of unpleasant consequences occur:  the sense of unfairness is cultivated among the tax payers and reinforced by their will to assimilate in any possible way with those excepted from tax;  increases the level of total tax burden as the amounts to be paid by those exempted have to be given by the rest; and  creates unequal conditions of competition between favored and non-favored companies as taxes generally affect the production and business plans of private productive units. 4.4 The structure of the taxation system The type and cash significance that constitute the taxation system of a country determine the range of tax evasion. As a result, if the taxation system is dominated by direct taxes, i.e. income taxes, then the tendency for tax evasion is bigger because private entities have more opportunities to hide their tax than individuals. This can be done in the following two ways: (1) households like freelancers by declaring lower income than the real one; and (2) companies by transferring part of their profits to depreciation accounts, research expenses, etc. On the other hand, if the taxation system consists mostly of indirect taxes, the trend for tax evasion is smaller because the tax control is more effective, the related taxed units are fewer, and they are also obliged to keep accounting books from which taxation can be accrued like value-added tax (VAT). Of course, this is a general rule that does not apply in the unique Shadow economy and tax evasion 393 JMLC 20,4 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 394 case of Greece. This is justified by the fact that while indirect taxes are more important than the direct in Greek taxation system, tax evasion is very high due to the existence of an ineffective control mechanism and high levels of corruption. 4.5 The degree of market and business organization When the economy is organized in such a way that a significant proportion of transactions take place in kind, for example, the possibility of tax evasion will be greater compared with an economy where all transactions are made with money. Moreover, if companies operating in one country are numerous but small, the evasion potential is large because the accounting of these enterprises is low; thus, monitoring by the tax authorities becomes difficult or even impossible. In contrast, in countries where companies are fewer and larger their monitoring by tax authorities is easier. 4.6 The level of development and organization of the economy In well-organized economies, transactions between taxpaying units are easily recorded, and tax authorities have available more reliable stuff, e.g. transaction documents etc., so as to properly perform their work. Therefore, they can relatively easily reduce the tendency of taxpayers for tax evasion. 4.7 The structure of the national income The structure of the national income is very important to the extent of tax evasion. This is especially true for evasion of income tax because there are incomes where tax evasion is necessarily limited if not impossible, while in other cases, its inhibition is difficult. In the first case are the incomes from salaries and pensions. In the second is the income from the exercise of agricultural activities and business. 5. Size of Greek shadow economy in comparison with other Organization for Economic Co-operation and Development countries According to recent estimates by Schneider (2013), prolonged economic crisis in Greece and Spain has somehow reduced the phenomenon of the underground economy, and more specifically, the recession in the formal economy in both countries is so strong and also reductions in the income of citizens so great, having vertically further decrease even the demand for the activities of the shadow work (e.g. house-keepers etc.). As a result, the informal sector in both countries is declined substantially: while in Greece, in 2013, it accounted for 23.6 per cent of GDP, compared to 24 per cent in the past year, 25.1 per cent in the pre-crisis 2007 and 28.2 per cent in 2003, while in Spain, it estimated to have fallen to 18.6 per cent of GDP, from 19.2 per cent in 2012 and 22.2 per cent in 2003. Meanwhile, the fight against tax evasion in Greece has begun, to some extent, to pay off. More specifically, the amount of tax evasion related to indirect taxes and self-employment in Greece decreased to 4 per cent of GDP in 2010 from 5.6 per cent in 2009. In the years to follow, 2012 and 2013, the shadow economy has decreased in most of the 38 countries of the OECD, compared with 2008. However, contrary to other countries, the reason of the reduction in Greece was the prolonged economic crisis. With the official economy either recovering or growing rapidly, people have less incentive to develop further activities in the shadow economy. In the following table, the average relative impact of the main determinants of the underground economy of 38 OECD countries, for the decade 20002010, is presented (Table I). Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) Country Of shadow Personal income tax Indirect taxes Tax morale Un employment Self-employment GDP growth Business freedom 13.8 9.8 21.5 34.6 15.6 19.4 27.2 17.6 17.3 21.7 17.4 14.8 15.7 27.0 24.1 15.2 16.1 26.9 26.3 22.2 25.4 9.6 21.3 18.5 19.2 5.1 22.1 1.8 4.3 7.8 34.6 10.0 19.7 12.8 16.6 5.8 12.3 19.9 12.5 15.6 5.7 8.2 9.0 13.2 25.4 27.4 20.2 37.7 17.5 35.3 35.9 30.7 33.5 36.0 29.1 24.3 24.2 21.8 34.9 39.7 36.4 18.9 27.3 32.3 28.8 33.4 7.4 11.6 19.1 5.7 7.7 5.5 9.1 9.4 4.0 11.7 8.7 15.5 8.3 10.4 6.4 6.5 7.9 9.0 3.4 13.3 17.5 20.0 15.8 12.1 16.5 25.9 19.2 17.3 11.2 19.0 9.5 21.8 18.6 23.2 24.3 18.0 18.6 7.1 12.5 18.6 9.8 23.3 19.9 10.4 19.3 20.5 17.3 17.5 22.4 32.7 29.9 23.5 9.9 10.4 15.2 15.1 16.9 37.6 18.5 17.9 21.3 31.0 44.3 14.6 17.1 11.9 0.9 0.8 0.4 1.9 0.7 0.8 0.8 1.2 0.3 1.8 0.8 0.4 0.6 0.7 1.2 0.6 1.0 0.1 1.4 1.8 1.5 1.2 9.9 9.1 7.2 6.2 10.4 6.7 8.7 8.3 8.2 8.3 7.9 8.6 9.1 5.7 8.0 8.2 8.5 6.8 8.0 6.6 6.1 9.8 Australia Austria Belgium Bulgaria Canada Chile Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Iceland Ireland Italy Korea Latvia Lithuania Luxembourg (continued) Shadow economy and tax evasion 395 Table I. Average relative impact (in %) of the causal variables on the shadow economy of 38 OECD countries over 1999 to 2010 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 396 JMLC 20,4 Of shadow Personal income tax Indirect taxes Tax morale Un employment Self-employment GDP growth Business freedom 27.3 30.0 13.2 12.2 18.6 26.4 22.7 32.2 17.5 25.2 22.8 18.6 8.3 30.6 12.5 8.7 20.3 5.9 2.3 13.6 21.8 21.2 6.1 8.1 4.2 4.8 9.6 10.6 23.5 17.7 4.9 18.2 27.5 13.1 39.7 42.1 32.5 25.4 31.5 27.8 29.9 24.5 31.7 33.9 17.9 30.6 30.7 31.4 30.8 5.1 29.4 3.2 10.2 13.0 8.4 12.5 7.8 8.7 14.2 6.4 9.6 10.4 8.7 9.0 0.7 8.1 13.2 9.5 20.0 5.9 10.4 11.9 10.8 26.1 14.6 13.1 34.9 15.4 29.2 15.2 9.6 16.4 14.3 22.0 16.9 21.2 33.8 19.7 22.9 13.0 25.7 31.1 37.7 13.7 21.7 23.8 13.2 23.8 41.4 18.0 16.0 22.2 0.8 0.4 0.8 0.6 0.5 1.3 0.4 1.1 1.5 1.2 0.6 0.8 0.5 0.6 0.6 0.9 0.9 9.3 5.3 10.0 9.1 10.5 5.3 7.2 5.2 7.1 8.6 7.5 8.0 8.7 4.6 9.9 15.4 8.1 Table I. Country Malta Mexico The Netherlands New Zealand Norway Poland Portugal Romania Slovak Rep. Slovenia Spain Sweden Switzerland Turkey UK USA Average Sources: Schneider and Buehn (2012a, 2012b); Shadow economies in highly developed OECD countries: what are the driving forces? Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) Concerning the most critical factors which matter the most to the creation of the informal economy in 38 OECD countries for the period 1999 to 2010, indirect taxation ranks first (average 29.4 per cent) and self-employment second (22.2 per cent), while in Greece the figure is reversed. Specifically, in Greece self-employment plays by far the most crucial role in the size and growth of the shadow economy (37.6 per cent), followed by indirect taxation (21.8 per cent). Both in the 38 countries and Greece, unemployment ranks third in the list of factors with the greatest impact on the size and growth of the shadow economy, with a share “contribution” of 16.9 per cent (at 38) and 18 per cent, respectively (due to the fact that lack of work often incites the unemployed in illicit economic activity to ensure their living). Overall, in 2012, Greece ranked ninth among the 27 EU Member States, in terms of the black economy (24 per cent of GDP), significantly exceeding the EU average (18.4 per cent), as seen in the next Figure 2. In the first place is Bulgaria where the shadow economy represents 31.9 per cent of GDP, followed by Romania (29.1 per cent), Lithuania (28, 5 per cent), Estonia (28.2 per cent), Latvia (26, 1 per cent) and Cyprus (25.6 per cent). Reversing the list, the less shadow economy in the EU-27 has Austria (only 7.6 per cent), followed by Luxembourg (8, 2 per cent), The Netherlands (9.5 per cent) and the UK (10.1 per cent). The size of the shadow economy in Greece as of 2012 was estimated at e60bn of which; however, only Shadow economy and tax evasion 397 Figure 2. Size of the shadow economy of EU-27 in 2012 (percentage of GDP) JMLC 20,4 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 398 e20bn were recorded to the official GDP as derived from partially legitimate activities, while the remaining e40bn came from illegal activities. 6. Effects of the black economy and tax evasion on Greek economy 6.1 Negative effects Having identified the causes of the black economy and the factors that contribute to the systematic increase of tax evasion, at this point, we are going to refer to their direct negative impact on Greek economy. The main effects are summarized to the following:  The principle of fair distribution of the tax burden is violated.  The existence of high level of tax evasion does not allow the collection of the required revenues for the satisfactory and proper functioning of the public sector.  Fiscal policy bodies are unable to use the tax system effectively in favor of the economic development of the country, because the effectiveness of the statutory exemptions which are granted as incentives to promote this objective is weakening.  Serious social injustices are caused and an unequal redistribution of income is developed, from the moral taxpayers to the tax evaders. Because evasion belongs mainly to the higher economic classes, this redistribution of national income is not desired by the society as wealth differences become even more bigger.  The state may face cash flow problems as it happens in Greece nowadays. This has led to an increase in taxes, to state borrowing and to a reduction in government spending (e.g. education, health, etc.). This condition can also cause chronic budget deficit, continuous use of borrowings and accumulation of sovereign debt, with all the known catastrophic consequences in the economy. In Greece, the problem of non-payment of taxes has taken great dimensions and the consequences became even more intense as the economic crisis deepens in the country. According to a recent survey of the Economic Chamber of Greece on “Measurement of Tax Consciousness”, it was found out that:  eight of ten respondents believe that tax evaders are doing so because “there is little chance of detection” by tax control authorities;  one of five are prepared to take the risk of hiding their income, even if aware that it is possible to be identified by the tax authorities;  almost one in two respondents believe that “if you want to conceal income from the tax authorities, you can carry out”;  one in ten admit to having attempted to cheat the tax authorities regarding their real income;  eight of ten consider it their moral obligation to declare their real income; and  one in two citizens consider that in a highly corrupted state, tax evasion is a reasonable reaction. Conclusively, the failure to arrest tax evaders and the extent of corruption are critical factors in determining the fiscal behavior of citizens and the effectiveness of tax revenue collection by the state. Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 6.2 Positive consequences As explained before, black economy and tax evasion have severe negative consequences on the Greek economy being one of the main reasons for the ongoing fiscal and financial crisis that plagues the country. But on the other hand, there are also several positive effects which are mainly connected to employment and income creation. First, the informal sector of the economy often functions as a life vest for businesses, as it enhances their competitiveness. In the formal economy, increasing labor costs and the rise of tax burden create very often problems of competitiveness both in the international and in the internal market and encourage companies to the underground side of the economy to avoid government barriers and gain competitive advantage. Another positive effect is the fact that black economy helps in creating new job positions by absorbing workforce. If it was not for the shadow economy many people which find employment in the informal sector would be unemployed. Of course, there are also negative consequences for workers in the informal sector such as the lack of insurance. Moreover, the higher the level of the shadow economy, the greater the difference among the formal and informal economy. The informal economy has resulted in the exemption of certain individuals, while on the other side, increases the tax burden of those people employed in the formal economy. Taking for granted that persons employed by the informal sector are usually low-income people one might say that shadow economy helps improve the disposable income distribution and therefore increases the social welfare. Finally, it is estimated that approximately 66 per cent of the informal economy revenues are returned immediately in the formal economy by increasing consumption of households, mainly for durable goods and services, thereby contributing to economic growth and tax revenues. The informal sector may also help in creating markets, fostering entrepreneurship and what is very important for Greece, changing the legal, social and economic factors which are necessary so as to achieve the desired development. All of the above provide a positive image of the shadow economy that may lead someone to the conclusion that there should not be great effort to crack it down, especially in times of recession and rising unemployment. But any benefits of the black economy are uncertain and always extremely short. Furthermore, informal activities undermine long-term planning and the implementation of strategies aimed at developing the economy on sound bases. For this reason, it is more than necessary the existence and implementation of a long and rigorous policy to combat the grey economy. 7. Measures for combating tax evasion and shadow economy 7.1 Measures for tax evasion The ability of tax authorities to tackle satisfactorily the trend of taxpayers for tax evasion depends on the degree of organization of tax consulting services, the quality of tax accounting institutions, the system used for the assessment and collection of taxes, the structure of the tax system and finally the degree of accounting organization of economic units. It is obvious that if taxpayers feel that the state is able to detect tax evasion, the tendency for such action would be limited and vice versa. But it is common knowledge that tax evasion has deep roots in the Greek economy and cannot be easily eliminated. Therefore, certain measures are proposed to deal with this major problem. They are as follows. 7.1.1 Regular checks on persons and companies. These checks should be performed based on the profile of tax evaders and randomly. The control based on the profile will focus mainly on individuals and companies which have higher chances of tax evasion. On the Shadow economy and tax evasion 399 JMLC 20,4 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 400 other hand, checks on persons and businesses that do not fit the above profile will be checked randomly. Thus, tax evasion levels will be monitored continuously so as appropriate measures to be undertaken. 7.1.2 Automatic cross-check of receipts and related documents. To strengthen the role of receipts in the improvement of tax revenues collection, it can be examined the possibility to increase the tax credit for certain expenditure, even if it is done at the expense of tax revenues. That way, there will be a shift in the mentality of taxpayers and will now be considered obvious the issuing of receipts for any kind of service. The European Union, to address this phenomenon and protect member states, established in 1993 the VIES system, where firms are monitored making intracommunity trade for the proper return of VAT. In every located case, the way each invoice is paid off is checked, i.e. if there is a bank document for the collection or payment. When no such documents exist and the company claims that the transaction was made in cash and without the mediation of a bank, then the case will be considered suspicious and will be investigated in depth. 7.1.3 Professional accounts. On January 1, 2011, it has been decided that all transactions between any enterprise and the payrolls should be made mandatory through commercial bank accounts. This measure, of course, has not been yet implemented, but huge efforts are made to achieve this goal. 7.1.4 Electronic invoicing and signature certification. In conjunction with the business accounts, another measure which moves in the right direction is electronic invoicing and certification of electronic signatures, where the application will be made among businesses and between businesses and public. 7.1.5 Re-organization of tax services. In this sector, the establishment of a specific service is required, which will control individuals with large incomes, using data and information collected from different areas. The mission of this specialized service would be investigation, methodology, control and detection of tax evasion in areas of illegal trade as well as its confrontation, in cooperation with other bodies. 7.1.6 Education. The area of education should be reconfigured in all its stages, from primary level up to university. It is appropriate to teach students, from the beginning of their learning activity, the correct moral principles, about how they should behave in the future, as potential entrepreneurs or employees so as to have increased tax consciousness, in all areas of the economy. 7.1.7 Active citizens. Every citizen ought to become active, but at the same time, the legislation of the country needs to be amended and the public administration to be upgraded. 7.1.8 Simplification of legislation. This measure aims to provide a simplified legislation to be understood by all citizens, regardless of age, educational level, etc. At the same time, the technical support by the related information systems, such as TAXIS, must be reinforced so as to place constant controls and crossings of tax information to better serve the fight against tax evasion. 7.1.9 Amplification of transparency. There must also be correct and effective management and distribution of taxes paid by the citizens in the state and targeted fiscal policy to reduce government spending. Achieving this will enable the reduction of tax evasion, a fact which will enhance the trust of citizens to the state. Citizens, by paying taxes corresponding to each one and seeing that the money paid to the state, are properly exploited, covering crucial public needs such as health, education, etc., then and only then shall taxpayers trust the state, as they see the society in which they live, Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) to thrive. It is therefore a more than important incentive for citizens to pay to the state what it owns and in this way, tax evasion to be avoided. 7.2 Measures for shadow economy From time to time, several measures have been proposed by the Greek Governments to find appropriate ways to deal with the phenomenon of the informal economy. Some of these propositions are in place, but even more are “frozen”, without ever to be able to be applied. The most significant of these measures as well as new ones are summarized below: 7.2.1 Incentives for voluntary compliance. Tax authorities around the world adopt increasingly in recent years, various strategies which aim to the consolidation and adoption of fiscal conscience by taxpayers. In these strategies, the continuous increase of voluntary compliance by taxpayers to the tax authorities is also provided. In this way, a gradual reduction of the cost of the tax audit will be achieved, and also violations and irregularities that have been committed will be revealed by the taxpayers themselves. 7.2.2 Regulations for young entrepreneurs. One of the most important measures is the tax authority to pay special attention to creating a climate of mutual trust with taxpayers and especially with young entrepreneurs who are new comers on the market. Experience shows that the special treatment of new traders through education and specific guidance creates a degree of benefits, as for example increased voluntary compliance with the rules of the tax authorities. 7.2.3 Incentives for disclosure of violating behavior concerning tax issues. There should be certain incentives to taxpayers to disclose cases for which there should be elements that have actually taken place, as that in these cases, the taxpayers will be exempt from fines and other kind of penalties. 7.2.4 Expenditures discounts of the tax payers’ income. In this sector what is required is whatever legitimate deductions or exemptions are provided by law for the taxpayers, not to be hidden, but to be given so as to allow taxpayers and state to build a mutual trust. 7.2.5 Fair tax burden. It is necessary to develop a fair taxation system and the tax burden to meet and be consistent with the real conditions of the economy. 7.2.6 Control mechanisms and frequent checks. A measure that would be quite effective is the strengthening of the control mechanisms and the performing of frequent checks by the relevant departments for better addressing of the problem. 7.2.7 Education. As for tax evasion, so for the underground economy, education is of great importance, where there could be tax courses at all levels of education. For those interested in expanding their knowledge of the taxation, it would be very useful to attend related courses such as financial accounting, etc. 7.2.8 Legislation simplification. Simplification of legislation should be a priority, so as to enable companies to know in a clear way, what are their tax obligations to avoid unpleasant situations. 7.2.9 Improvement of productivity. There is an urgent need to increase the productivity of the entire public sector, of the tax assessment authorities not only to improve the methods of organization and administration but also to improve quality. 7.2.10 Registration of foreigners-immigrants. There should be strict registration of foreigners, as it is generally accepted that the largest proportion of workers employed without insurance are immigrants. This is because it is profitable for entrepreneurs, as they offer relatively low wages which do not correspond to the work that can be performed by employees, or in hours that can work in the business. On the other hand, from this situation foreign immigrants also benefit because they can work without a Shadow economy and tax evasion 401 JMLC 20,4 residence permit, having secured a small income to enable them to cover the essentials (e.g. housing, food, clothing, etc.). In this sector, therefore, companies must become more sensitive, so as not to resort to illegal employment of foreigners, but to oppose, thus preventing a large part of the informal economy. Motivation and support from the state is crucial in this direction, especially nowadays that the migration flows from Syria have become a scourge and threaten the whole socioeconomic structure of Greece. Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 402 8. Conclusion Tax evasion is a serious cause for large public deficits by provoking lack of financial sources, thus making the state unable to cover its costs. This leads the government to increased external and internal borrowing. The first means less independence and freedom of economic and other options for the country and also an increase in government debt due to higher interest rates of foreign borrowing. The second is an increase in interest rates to attract private capital to meet the public deficit, but this deteriorates the circulation of money in the market and captures large private funds, resulting in the reduction of private investments, which is absolutely necessary for the development of economy. The overall result is economic stagnation and loss of competitiveness, a critical and long-lasting drawback of the Greek economy. Even more, tax evasion means creating disparities among citizens, as some professions can evade taxes and some not, which not only creates inequality of the burden on taxpayers but also taxes become onerous for non-tax evaders because of government revenue lag, which is usually covered by the burden of those who already pay taxes. Another negative consequence of tax evasion is that companies are discouraged from new investments and risk taking so as to increase their profitability, as this can be accomplished on a much easier way through not payment of taxes. Tax evasion means wasting resources in unproductive activities, as it creates high transaction costs for tax evaders. It also entails high administration and transaction costs for the government, as it has to establish and maintain an effective control mechanism that is essential for purposes of mitigation of tax evasion. On the other hand, the underground economy, whose main part and cause is tax evasion, means that many private incomes remain outside official statistics and calculations as, for example, GDP are not properly reflected to the real economic situation. Therefore, the governments do not have an accurate picture of the situation and are likely to take wrong decisions in relation to the economy and the creation of revenues, thereby imposing additional burdens on consistent and law-abiding taxpayers. Even more if we take into account that the activities of tax evaders are paid in cash, tax evasion reduces the elasticity of cash demand to changes in public interest rates which means more difficulties in implementing monetary policy. Finally, measures which should be implemented to reduce the black economy in Greece and increase the growth rate are mainly related to consistent and fair tax practices. It is also considered important to reduce the existing restrictions on product and labor markets (overregulation) in order the access to the formal economy to be easier and more attractive, while placing regular checks and sanctions where necessary to achieve compliance with tax authorities. It is the only way to start diminishing corruption of public servants and citizens, too. Last but not least, related inquires must be performed so as to identify why Greek citizens evade taxes and what they would like to receive as goods and services in exchange for preferring the formal economy. It would also be useful to consider what is it for which citizens would be willing to comply to establish an honest relationship with the state. Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) In conclusion, the measures to tackle tax evasion and the underground economy in Greece are almost identical to the measures for addressing the effects of the debt crisis which still plagues the country. As research on the topic of the informal economy remains difficult and relatively limited, due to lack of sufficient and integrated data, economic research should go even deeper in this crucial issue. Greece, a relatively developed economy with high percentage of shadow economy and tax evasion, provides a fruitful ground for study as proven by the present analysis. References Artavanis, N., Adair, M. and Margarita, T. (2015), “Tax evasion across industries: soft credit evidence from Greece”, National Bureau of Economic Research, No. w21552. Berger, W., Pickhardt, M., Pitsoulis, A., Prinz, A. and Sardà, J. (2014), “The hard shadow of the Greek economy: new estimates of the size of the underground economy and its fiscal impact”, Applied Economics, Vol. 46 No. 18, pp. 2190-2204. Bitzenis, A., Vlachos, V. and Schneider, F. (2016), “An exploration of the Greek shadow economy: can its transfer into the official economy provide economic relief amid the crisis?”, Journal of Economic Issues, Vol. 50 No. 1, pp. 165-196. British Institute of Economic Affairs (2013), “The shadow economy”, available at: www.iea.org.uk Christopoulos, D.K. (2003), “Does underground economy respond symmetrically to tax changes? Evidence from Greece”, Economic Modelling, Vol. 20 No. 3, pp. 563-570. Danopoulos, C.P. and Znidaric, B. (2007), “Informal economy, tax evasion, and poverty in a democratic setting: Greece”, Mediterranean Quarterly, Vol. 18 No. 2, pp. 67-84. Eurostat (2012), European Union Labour Force Survey, Annual Results 2012 – Issue number 14/2013, Eurostat. Kaplanoglou, G. and Rapanos, V.T. (2013), “Tax and trust: the fiscal crisis in Greece”, South European Society and Politics, Vol. 18 No. 3, pp. 283-304. Katsios, S. (2006), “The shadow economy and corruption in Greece”, South- Eastern Europe Journal of Economics, Vol. 1, pp. 61-80. Matsaganis, M. and Flevotomou, M. (2010), Distributional Implications of Tax Evasion in Greece. Remeikiene, R., Ligita, G. and Jekaterina, K. (2014), “Country-level determinants of the shadow economy during 2005-2013: the case of Greece”, Mediterranean Journal of Social Sciences, Vol. 5 No. 13, p. 454. Schneider, F. and Buehn, A. (2012a), “Shadow economies in highly developed OECD countries: what are the driving forces?”, IZA Discussion Paper no. 6891. Schneider, F. and Buehn, A. (2012b), “Size and development of tax evasion in 38 OECD countries: what do we (not) know?”, CESifo Working Paper no. 4004. Schneider, F. (2013), Size and Development of the Shadow Economy of 31 European and 5 Other OECD Countries from 2003 to 2013: A Further Decline, Johannes Kepler Universität, Linz, pp. 5-7. Further reading Dell Anno, R., Gomez-Antonia, M. and Alanon-Pardo, A. (2007), “The shadow economy in three mediterranean countries: France, Spain and Greece”, Empirical Economics, Vol. 33 No. 1, pp. 51-84. Economic Chamber & Economic University of Athens (2011), “Economic chamber & economic university of Athens, department of statistics”, Research of Tax evasion in Greece. IMF (2006), “Report on the observance of standards and codes”, Fiscal Transparency Module, WA. OECD (2009), “Tax administration in OECD and selected non-OECD countries: comparative information series”, (2008), Forum on Tax Administration, Paris. Shadow economy and tax evasion 403 JMLC 20,4 Downloaded by Mr Georgios Vousinas At 02:58 26 January 2018 (PT) 404 Schneider, F. (2002), Size and Measurement of the Informal Economy in 110 Countries Around the World, available at: rru.worldbank.org Schneider, F. (2005), Shadow Economies of 145 Countries all Over the World: What do We Really Know?, Mimeo: University of Linz. Schneider, F. (2007), “Shadow economies and corruption all over the world: new estimates for 145 countries”, Economics, the Open Access, Open Assessment e- Journal, No. 2007-9. Schneider, F. (2010), “Size and development of the shadow economy of 31 European countries from 2003 to 2010 (revised version)”, Working Paper, University of Linz. Schneider, F. (2011), “Size and development of the shadow economy of 31 European and 5 other OECD countries from 2003 to 2012: some new facts”, Consultado en, available at: www.economics. unilinz.ac.at/members/Schneider/files/publications/2012/ShadEcEurope31.pdf Tafenau, E., Herwartz, H. and Schneider, F. (2010), “Regional estimates of the underground economy in Europe”, International Economic Journal, Vol. 24 No. 4, pp. 629-636. Vousinas, G. (2016), “Greek sovereign debt & deficit: determinants, evolution and effects on the economy. an empirical study with policy aspects”, Proceedings of the International Conference on Business & Economics of the Hellenic Open University, Athens. Corresponding author Georgios L. Vousinas can be contacted at: [email protected] For instructions on how to order reprints of this article, please visit our website: www.emeraldgrouppublishing.com/licensing/reprints.htm Or contact us for further details: [email protected]