Dimensions of the Shadow Economy.

• Author: SCHNEIDER, FRIEDRICH
• Position: Statistical Data Included

Shadow economic activities--employment, production, and exchange unreported to government authorities--constitute a large and growing part of all economic activity throughout the world. Although these activities, by their very nature, cannot be measured with precision, attempts have been made to estimate their magnitudes and to relate those magnitudes to tax rates and other determinants. This article summarizes the findings of some recent quantitative studies.

As table 1 shows, the shadow economy in seventeen member countries of the Organization for Economic Cooperation and Development (OECD) was large and growing between 1994 and 1998. In 1998, the year with the latest figures for these countries, Greece had the largest shadow economy, equivalent to 29 percent of its official gross domestic product (GDP), followed by Italy with 27.8 percent, Spain with 23.4 percent, and Belgium with 22.6 percent. In the middle range were Ireland with 16.3 percent, Canada with 15 percent, France with 14.9 percent, and Germany with 14.7 percent. At the lower end appeared Austria with 9.1 percent, the United States with 8.9 percent, and Switzerland with 8 percent. Between 1994 and 1998, the shadow economy increased by at least 1.6 percentage points in Greece, Italy, Sweden, Norway, Germany, and Austria and by smaller amounts in all but two of the other OECD countries listed in table 1.

Table 1: Size of the Shadow Economy in OECD Countries, 1994-1998 Percentage of GDP Attributable to Shadow Economy (based on currency demand method) Country 1994 1995 1996 1997 1998 1999 Greece 26.0 26.6 28.5 28.7 29.0 Italy 25.8 26.2 27.0 27.3 27.8 Spain 22.3 22.6 22.9 23.1 23.4 Belgium 21.4 21.6 21.9 22.4 22.6 Sweden 18.3 18.9 19.2 19.8 20.0 Norway 17.9 18.5 18.9 19.4 19.7 Denmark 17.6 18.1 18.3 18.1 18.4 Ireland 15.3 15.6 15.9 16.1 16.3 Canada 14.6 15.0 15.1 14.8 15.0 France 14.3 14.8 14.9 14.7 14.9 Germany 13.1 13.9 14.5 15.0 14.7 15.9 Netherlands 13.6 14.1 14.0 13.5 13.5 Australia 13.0 13.2 14.0 13.9 14.1 Great Britain 12.4 12.6 13.1 13.0 13.0 United States 9.4 9.0 8.8 8.8 8.9 Austria 6.7 7.3 8.3 8.9 9.1 9.6 Switzerland 6.6 6.9 7.5 8.1 8.0 8.3 Source: Author's calculations.

The figures in table 1 were calculated using the currency demand approach, which assumes that shadow (or hidden) transactions are undertaken in the form of cash payments, so as to leave no observable traces for the tax (or other) authorities. An increase in the size of the shadow economy will therefore increase the demand for currency. To isolate the resulting "excess" demand for currency to be used in the shadow economy, a currency demand equation is econometrically estimated over time, controlling for all conventional factors such as the growth of income, changes of payment habits, and so forth. In addition, variables such as the direct and indirect tax burden, government regulation, and the social security burden, which are assumed to be the major factors causing people to operate in the shadow economy, are included in the estimation equation. The "excess" increase in currency, which is the amount unexplained by the conventional factors, is then attributed to the rising tax and social security burdens and other factors inducing people to work in the shadow economy. From the excess increase in currency, the size of the shadow economy over time can be calculated by assuming that the expenditure velocity of money is equal in the shadow economy and the official economy.(1)

To facilitate consideration of a preliminary explanation of the differing sizes of the shadow economies in the OECD countries, table 2 presents data on the size of the shadow economy and the various tax burdens in those countries in 1996. With the exception of Spain (shadow economy 22.9 percent, tax and social security burden 67.2 percent), the countries that had the largest shadow economy in 1996--Greece, Italy, Belgium, and Sweden (28.5, 27, 21.9, and 19.2 percent, respectively)--also had the highest tax and social security burden (72.3, 72.9, 76, and 78.6 percent, respectively), whereas the countries with the lowest overall tax and social security burden--Switzerland and the United States (39.7 and 41.4 percent, respectively)--also had the smallest shadow economies, 7.5 and 8.8 percent, respectively. Of course, the pattern was not perfect. The United Kingdom and Austria each had a fairly high overall tax and social security burden (54.9 and 70.4 percent, respectively) and a relatively small shadow economy (13.1 and 8.3 percent, respectively). But overall...