Transparency vs. underground economy, another myth busted?
@ 11:48 pm 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
- Unemployment
- 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.
It couldn’t be more true. People do indeed use all opportunities to harbor capital offshore, because having one’s income and wealth published is a major liability for those who have international business or personal dealings. One might conclude that it’s good that the wealth stays somewhere else, because it keeps the illusion of egalitarianism alive LOL!
Seriously though, the sloppy handling of personal financial data even affects non-wealthy people who come for purposes of work. Imagine you go back home (perhaps to the US) for a visit and get into a car accident. The American lawyers would have a blast inspecting your financial worth. They can just call Finland and get all the information they need to give themselves an advantage over you!
And divource cases anyone? Automatically, you lose!
What’s done in the Scandinavian/Nordic countries is unbelievably foolish, especially during a time when protecting oneself against sophisticated international criminal activity is paramount. I believe it’s a result of being isolated from the world for so long. No reality checks and no concept of what is proper versus improper legal behavior—not to mention what is moral versus immoral, or safe versus unsafe.
Same goes for income based fines. Can anyone outside of Finland imagine that cops can pull you over for speeding, and then ogle your income and finances? Are traffic cops the right people to be handling your sensitive data, especailly since they can get your info BEFORE they pull you over?! No chance of prejudiced decision making there. Right.
And what about foreign visitors vs. residents? No other countries in the world give out their residents’ financial information; they have strict laws against it, and rightly so! In practice, it means that only residents can get income based fines—no one else. Isn’t this discrimination by nationality according to both, the UN’s Universal Declaration of Human Rights and the European Convention on Human Rights?
From what it might appear, both the United Nations and European Union have a completely different standard, concerning the handling of people’s information. Maybe it’s time for people to start sending complaints?
Comment by Kristian — Fri, Nov 23rd, 2007 @ 12:10 am
There is exactly one solution to the gray economy:
Discontinue direct taxation completely and collect all state revenues via VAT.
As the old saying goes, the simplest way to tax crime is to tax the Mercedes these mafioso buy by the dozen.
Comment by Martin-Éric — Fri, Nov 23rd, 2007 @ 12:19 am
boooooring
Comment by suv — Fri, Nov 23rd, 2007 @ 1:22 am
Three main reasons for ‘dark money’:
1. Ulosottovirasto - your employer has to pay off your bad debts on your behalf and then deduct the amount from your salary. Your employer is legally obliged to do so and the amount deducted is usually 30%. So the lower the ‘officiial’ salary the lower the repayments. Also nearly all loans in Finland are joint loans so after divorce etc both parties have to pay outstanding debts (or rather their employers do).
2. Union agreed overtime rates - companies can start losing money if they officially pay union sanctioned overtime rates.
3. Cost of hiring an employee is expensive and increases dramatically if official pay increases. Employers have to pay 20% of the workers salary as pension plus the employer pays insurance for the worker and pays 4% of total salaries into the unemployment fund.
Basically the cost of hiring workers is high. Worker-based benefits and overtime are costly and taxes for the worker can reach 40% if higher salaries are paid.
So there is an incentive by employers and employees to pay ‘dark money’
I would go so far as to say that the economy would be in serious trouble if ‘dark money’ was stopped being paid. And also in every European country there is a significant ‘dark side’ and informal economy. It helps the economy if the economy isn’t so tightly regulated.
Comment by Andy Campbell — Fri, Nov 23rd, 2007 @ 2:18 am
Clown is a one-cause man
Comment by anon — Fri, Nov 23rd, 2007 @ 12:58 pm
Not being a economist, I do not understand how Mr. No-Wook Park has estimated the underground economy for different countries, but I think something must be amiss there. For example for the year 1960 he gives the size of “hidden economy relative to GNP” for various countries in the scale of 1% to 4,5%. To me, these numbers seem absurdly low, even if the governments at the time had some mystical abilities for keeping an eye on their citizens.
“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.”
As the author seems to link the growth of the economy in general to the growth of the underground economy, this seems like a almost too easy a conclusion: it was the Nordics that did, arguably, have the best overall growth rates for European countries during this period.
“The conclusion: The use public tax records to reduce the underground economy in Scandinavia has failed quite quite miserably.”
Some people could call this an unfalsifiable argument, directed by preconceived notions. We can not know how prevalent the underground economy in the Nordics would be, if we did not have public tax records. It is certainly not the only difference to other countries economic policies. Only if we could disentangle the effects caused by it especially from those caused by all other reasons could we say if it, as a policy, has failed in this regard.
We can, of course, make estimates based on other countries. Also other recently prosperous ones, in Asia especially, have quite high rates of underground economy. How have they used their tax records?
Comment by Drakon — Fri, Nov 23rd, 2007 @ 2:11 pm
Who the hell wants to read the same 2000 word essay every single day?! Take a break, reevaluate and come up with a fresh angle, please. The same also goes for the other half of the Ambiguously Gay Duo, Kristian, who always sees it fit to continue the clown’s novel in the comments section.
Comment by disposable — Fri, Nov 23rd, 2007 @ 2:58 pm
It’s still November, the month of the press feeding frenzy with peoples’ personal tax data in Finland, so I am going to have my say. Things should quiet down soon.
Look at this from this article. When I see these sorts of things being said, I of course want to give a strong rebuttal.
Professor Heikki Patomäki would bring more transparency into taxation by bringing back the wealth tax, preferrably higher than before. He would also make all the dividend and capital income taxable, and the money invested in tax paradises included.
“In a democratic society, the division of income is a public political issue and is not in any way any persons’ private issue”, the professor adds.
Comment by Sirkuspelle — Fri, Nov 23rd, 2007 @ 3:58 pm
Kristian: “Imagine you go back home (perhaps to the US) for a visit and get into a car accident. The American lawyers would have a blast inspecting your financial worth. They can just call Finland and get all the information they need to give themselves an advantage over you!
And divource cases anyone? Automatically, you lose!”
So, let me get this straight: The only way you can win a court case in the US is to lie and cheat, and doubly so if it has anything to do with your finances? Say it ain’t so!
Comment by Fat Bastard — Mon, Nov 26th, 2007 @ 12:05 pm
Fat Bastard,
Yes, Finland’s public tax record system is like walking around a big city with a pile of cash hanging out of your back pocket.
It’s just a matter of time before something bad happens.
Comment by Kristian — Fri, Nov 30th, 2007 @ 2:18 am