Excellent piece on The Chorizo Chronicles about Spain’s underground economy. It’s an important, but under-appreciated aspect of the economy here, representing around 19% of GDP, according to this piece in the NY Times. Interesting, that number is essentially unchanged from pre-Crisis numbers, indicating that Spain’s large “black” economy isn’t a response to the crisis, but something endemic to the labor market.
But is Spain’s underground economy really that large compared to other countries? According to a report by the IMF in 2006, the US had an underground economy of under 10%. Russia, on the other hand, is between 40-50%. Those are pre-Crisis estimates, though. The US black economy may have increased substantially as a result of ongoing weakness in the labor market. Bloomberg reports that around 18-19% of US income goes unreported to the IRS.
I don’t find this particularly surprising. After all, the underground economy includes the massive drug trade. Although I’m sure some drug dealers go to the trouble of laundering their earnings to be able to report them to the IRS without getting in trouble, illegal drugs is a huge business in the US (good estimates of its size are hard to come by, but I’m going with “ginormous”) and a majority of that economy is going unreported. I’ve got to imagine prostitution is another sizeable black market that mostly goes unreported (although I guess high-class prostitutes could always report their income as “consultants” which, let’s face, what’s the difference?).
In addition, every waiter, host and bartender in every restaurant in the country reports only the tips they receive from credit card receipts and quietly pockets their cash tips. They may be “officially” employed according to labor statistics, but the majority of their income is still part of the underground market.
Add to that every kid that cuts someone’s lawn, every babysitter, much of the country’s domestic cleaning staff, huge chunks of the agriculture and construction market that make use of undocumented immigrants, and you’ve got a very large undocumented economy indeed.
But back to Spain. Chorizo argues that the rather high VAT of 21% (for US readers, VAT works kind of like a sales tax from the perspective of the consumer) forces a lot of transactions off the books in order to avoid payment. I think that’s part of the story, certainly, but there’s some other factors as well, I think. Employers are still disincentivized from hiring employees due to restrictive labor regulations that can make it difficult to fire workers when demand decreases. As a result, employers are incentivized to keep as much of their workforce as possible off-contract and paid in cash in order to maintain the flexibility to react to demand fluctuations. The government has started liberalizing some of these rules, but I think there’s still a ways to go.
Meanwhile ,the traditional incentive for businesses to bring employees on full-time and under contract is to keep them from leaving without notice or going to a competitor. Sadly, with unemployment at 27%, no employer is seriously worried about an employee deciding to look for a better position.
At the same time, freelancers have no incentive to create their own businesses. New business creation remains a difficult proposition with an enormous amount of paperwork and minimum capital requirements. There are few tax advantages to creating your own account.
If Spain really wants to reduce the size of its underground economy, it needs to create more incentives for employers and employees to join the real economy. Liberalizing labor laws to give employers more flexibility while providing tax incentives to businesses that increase their workforce is one way to start. Meanwhile, lowering the barriers for business creation while creating new lending facilities for startups would give entrepreneurs reason to join the ranks of documented businesses.
Increased oversight and enforcement would be a big step in the right direction as well. Unfortunately, Spain’s politicians seem to feel that they themselves don’t need to follow the rules when it comes to tax cheating and bribery. That makes it difficult to argue that normal citizens should pay their taxes when the president is taking illegal money. Until Spain’s political class learns to play fair, it can’t expect its citizens to do so.
