Tuesday, September 16, 2014


Features

In Tough Times, Europe's Shadow Economy Grows

As austerity bites in Europe, many are informally selling goods and services to hide their income from the tax authorities.
As austerity bites in Europe, many are informally selling goods and services to hide their income from the tax authorities.
By Charles Recknagel
Jusuf Ahmic lives in the Bosnian city of Tuzla.

For a little over 5 dollars a meter, he lays bathroom tiles. But he only gets work when a plumber friend sometimes calls for help.

In these hard times, he can't afford the cost of registering a business. The idea of paying anything to the state, when he can barely feed his family, makes him roll his eyes.

"This state is useless; it just takes and gives nothing back," he says. "There is no incentive [for small businessmen], so I will carry on [unregistered]. If they catch me, what can I do? I can't change the situation I'm in."

Ahmic is one of a growing number of people fleeing Europe's economic crisis for the refuge of the shadow economy.

It is a world where people perform services that are legal but hide their income from the tax authorities. Where payments are in cash, receipts are not given, and earnings are under-declared if they are declared at all.

According to the latest data available from VISA Europe, the interbank credit-card service, Europe's shadow economy grew by 5 percent from 2007 to 2011. The VISA study put the total value of the shadow economy in 2011 at some 2.2 trillion euros (2.8 trillion dollars).

The shadow economy does not include typical criminal activities such as drug-dealing racketeering, or burglary.

Deterred By High Taxes And Costs

Friedrich Schneider of Johannes Kepler University in Linz, Austria, is a leading expert on shadow economies. In his opinion Europe's biggest shadow economies are in Central and Eastern Europe and the Mediterranean.

"These are the two groups that have the highest shadow economy," he says. "In Eastern Europe, it is Bulgaria and Romania with quite high values due to their systems of bad governance and high corruption, which is also a phenomenon in, for example, Greece."

The World Bank estimated in September that as much as 32 percent of the economic activity in Bulgaria this year was in the shadows, and 29 percent of the economic activity in Romania. That compares with just 7 percent in Austria.

People move to the shadow economy when they believe they cannot survive in the legal economy. Often they are escaping what they perceive as too-high taxes or regulatory costs on their business.

But if the move may temporarily help individuals to survive, it poses a major challenge for their countries.

Shadow economies deprive governments of enormous amounts of tax revenue. And it is more revenue, as well as less state spending, that many governments need to ease the sovereign debt problems behind Europe's financial crisis.

In some countries, such as Italy, the shadow economy is large enough that if taxed, it alone could solve the sovereign debt problem quickly.

Tax evasion is reported to cost Italy's treasury some $340 billion a year. If collected annually, that amount could pay back Rome's $2.6-trillion debt in less than eight years.

However, that is a windfall that Italy or any other European government is unlikely to ever see. To thoroughly tax all the hidden earnings of the shadow economy would require draconian measures -- something elected governments usually cannot impose.

Lessons To Be Learned

Instead, experts like Dalibor Rohac, an economist at the London-based Legatum Institute, maintain that governments should try to learn lessons from their hidden economies.

"The lesson for a government is not to try to crack down on the shadow economy dramatically because, after all, you want people to buy goods and services that make them better off," he says. "The correct answer is to reduce the costs of operating in the formal economy and bring these transactions to the formal sector."

Many people who work in the shadow system would, indeed, prefer to return to the formal economy if they could afford to do so.

That is because the shadow economy has some distinct disadvantages.

It is cut off from using the formal sectors' services and institutions that speed and simplify doing business.

Regulations on product standards and work safety are ignored.

And disputes between business partners must be settled out-of-court, sometimes violently.

Ahmic, the mason in Tuzla, claims he would like to register his business one day and stop working illegally. But it is not likely to be anytime soon.

"I was told by people who are in the same business that I would need a few thousand Bosnian Marks [equivalent to a few thousand dollars] and a lot of paperwork, so I cannot do it," he says. "For the time being it's just out of my reach. I can't even imagine doing it in the near future. Later on, when things get better, well maybe yes. Who knows?"

With additional reporting by RFE/RL Balkan Service correspondent Maja Nikolic in Tuzla
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