I found a very intersting article on the World Bank’s website that was written by the Korea Institute of Public Finance.
One of the big subjects that has been talked about here in Finland is the underground economy or “harmaa talous”. One of the arguments used for having public tax records (“transparency”) is to reduce the amount of the underground economy. There was a even a huge attempt at a crackdown on the underground economy in the mid to late 1990′s, in an attempt to bring the level down. Lately, there hasn’t been much talk about it due to other, more pressing news.
What is the underground economy?
It is the unreported exchange of money. This can happen through illegal activites, such as drug trafficking, prostitution, and human trafficking, or it can happen through legal activities, such as bartering goods, unreported work, wages from self employment, employee discounts, payment without a receipt, etc.
In Norway, according to the government tax authority’s web site, 45% of people over 18 years old have purchased unreported labour. It was described as “underground economy” labour. There are probably similar levels in Sweden and Finland as well.
Why is it a problem ?
People may go underground to escape tax and social security burdens. As a result, this can weaken the tax and social security bases. As a result of this, there can be an increase in the budget deficit and tax rates. As a result of this, there can be further growth in the underground economy, and finally there is a weakening in the system, or the country, as a whole.
Growth of the underground economy
The article showed that there was, among all the European countries featured, the most dramatic growth of underground economic activity in the Scandinavian countries between the years 1960-1995. (Denmark, Norway, Sweden) Finland wasn’t included in the paper, but we can assume that Finland has very similar scores. The growth in Scandinavia was much higher than that in Germany, Austria, Switzerland and the US. Norway had the most dramatic increase of all the European and Western countries featured in the article.
Causes of Underground Economy
- Higher tax rates and social security contributions
- Increased regulation
- Forced reduction of weekly working hours
- Earlier retirement
- Decline of civic virtue and loyalty towards public institutions
I take the liberty to define another cause here, because I believe it is a factor. These countries that have had the highest increase in underground economic activity also have or have had public (published) tax records. The published information is name, salary, capital income, and municipality in the case of Finland, and until recently included wealth. In Finland’s case, the information has been published in tax calendars, newspapers, and other publications which sole purpose is to publish this information. In Sweden in recent years, quite detailed information could be looked up online, but anonymous lookups were stopped during this past Summer. Norway has had press heydays when it has opened its records up for 3 weeks a year. In all these countries, it is toted as some sort of noble democratic ideal and called “transparency”, but it ends up basically being a feeding frenzy for the press and tabloid type entertainment.
There seems to be a psychological factor, a desire of people to take what is their own, that is the money they have worked hard for, and put it in a safe place away from prying eyes. When even peoples’ wealth is published, it should come as no surprise when the government finds that there are billions in Finnish money in the Cayman Islands and other tax paradises where the governments don’t reveal the identity of the owner of the money.
I might also add “fear of the tax official” in the case of Scandinavia, and wanting to avoid dealings with the tax collector because of an unclear definition of one’s rights and responsibilities as a taxpayer. There is an expression “the tax collector is always right” in Finnish. “Verottaja on aina oikeassa.” Noone is comfortable dealing with a boss, for example, who is “always right”.
Methods of Estimating the Size of the Underground Economy
A number of different approaches were used to estimate the size of the underground economy. There were indirect approaches like taking surveys, looking at discrepancies between the national expenditure and income statistics, discrepancies between the official and actual labour force, currency demand approach and physical input. The currency demand approach looks at the demand for cash currency which points to underground payments, because cash is often used with underground payment. The physical input looks at the demand for electricity, since electrical consumption goes hand in hand with economic development. If a country is using more electricity than is accounted for in its GDP, then the rest can be suspected as being used for the underground economy. (read the article)
Most studies try to associate the tax burden with the underground economy, which certainly must be a factor in the case of Scandinavia, due to the high taxes. However, the tax burden in Scandinavia is pretty similar with that in other EU countries, such as France, Belgium, Germany, Italy, etc. But one differing factor is certainly the pubicizing of peoples’ tax and income records from the tax officials. I maintain that this causes people to want to hide their money and their money transactions away from prying eyes.
The conclusion: The use public tax records to reduce the underground economy in Scandinavia has failed quite quite miserably. Or then, I might add, it was always just an excuse used by people who are addicted to “peeping” at other peoples’ private economic affairs and is perhaps the actual cause of this dramatic, disproportional increase in the underground economy in this region.