The impact of the shadow economy on the official economy is rarely discussed in any meaningful way in political and social forums. Occasionally we hear comments by political leaders hinting that the failure of certain policies is attributable to the extent of the shadow economy.
The black economy is basically “the business of not declaring income (legal and illegal) so that you pay no tax on it and using the undeclared income to pay employees cash without the deduction of income tax and without paying social security contributions”. Like most things in life the shadow economy is not all black or white. It is many shades of grey. But how big is this black economy?
Two studies confirm that Malta has one of the largest black economies in Europe and that, according to one study, there has been little change in the size of our shadow economy. According to Randstad, a Dutch human resources consulting firm quoted in an article by Margit Feher in The Wall Street Journal, Malta’s black economy in 2013 accounted for 24.3 per cent of GDP.
In a separate study by Friedrich Schneider, a professor at the Johannes Kepler University of Linz, Austria, Malta’s black economy will still amount to 24.3 per cent of our GDP in 2015. The size of Malta’s black economy is ranked slightly higher than that of Greece and Italy and much higher than that of Austria, Denmark, Holland, Sweden and other Northern European countries with enviable social security networks.
There are many who argue that the black economy has far more advantages than disadvantages. They maintain that “punitive tax regimes, increased labour market regulation and a growing lack of trust in governments are causing many Europeans to abandon formal employment and enter into the murky, illicit world of shadow economies”. Schneider argues that “rather than trying to deter the shadow economy or stamp it out, governments had to embrace the entrepreneurship it spawned and actually lower tax rates”.
Malta has one of the largest black economies in Europe
Every government depends on tax revenues to fulfil its political vision to provide a better quality of life for its people. In a country like Malta with a strong tradition of providing adequate social services in health, education and for retired people, the flow of taxes in the government’s coffers is indispensable if the more important aspects of the welfare state are to be preserved. Put simply, the continued existence of a strong social element in the government’s annual budgetary commitments is dependent on the political will to curb the black economy effectively enough to stop the substantial tax leakage that exists today.
Malta’s public finances remain fragile even if substantial progress has been achieved in recent years thanks mainly to Malta’s membership of the eurozone that brings with it relatively tough fiscal discipline. But current consensus across the political spectrum to maintain our free health and education systems brings with it an obligation of robust strategies that ensure constant and effective tax collection from all sources that are bound to pay such taxes.
Ironically, a reduction in the tax burden is likely to lead to a reduction in the size of the shadow economy. A virtuous circle can be created of lower tax rates, less shadow work, higher fiscal morality, a higher tax take and an opportunity for lower rates.
Some attempts have been made to create this virtuous cycle, for instance, by reducing income tax rates and granting favourable tax incentives for certain economic activities. But what worries me is the culture of dependence that seems so endemic in our society. As long as people believe that they can continue to work in the shadow economy and avoid paying income tax and national insurance irrespective of the level of these taxes, many will continue to risk doing so. But this is only possible if there is a lack of political will to curb tax avoidance, however unpopular this may be with the electorate.
The importance of reducing the shadow economy to a more acceptable level is not only a moral priority but a very practical, tactical initiative to ensure that the expensive social objectives that most of us take for granted remain sustainable in the long term.
The negative effects of tolerating a substantial black economy alongside the official economy are graphically clear to those who followed the recent economic and political history of Greece.
Not all shades of grey activities are acceptable in a vibrant economy.
Size of black economy as a percentage of GDP in 2013
Source: Ramdstadjohncassarwhite@yahoo.com