Fighting the Shadow Economy in Italy: dilemmas and policies effectiveness Laura Castellucci Abstract: It is commonly thought that the underground economy is so difficult to measure that we can only have an approximate idea of its size. Thanks to several studies that have been carried out, to the great and successful effort by ISTAT to comply with exhaustiveness, to the enlarged availability of data collected by different sources and for different purposes, we are now in a position of concentrating more both on its feature and on the shaping of effective instruments to combat it, rather than on the problem of how to measure it. It emerges an underground economy of a more or less stable size (different sources produce very close estimates) and rather resistant to policies introduced to combat it. In addition to equity reasons, more than sufficient in themselves, a true commitment of fighting it is necessary for the country to regain its high productivity of the past. A due consideration of the structure of our economy, shows the need for firms to innovate more and for public administration to keep up with information technology. No help for this comes from the shadow economy. JEL 017, E60, H26 Paper prepared for the Conference on: Undeclared Work, Tax Evasion and Avoidance: a Momentum for Change in Belgium and Europe Bruxelles, 20-22 June 2007 Professor of Economic Policy, faculty of Economics,University of Rome Tor Vergata Via Columbia 2, 00133 Rome, Italy Laura.Castellucci@uniroma2.it ++39 06 72595924 (dir)- 725959 15 (dpt) Fax ++ 06 2040219 1
PROVISIONAL and INCOMPLETE DRAFT Fighting the Shadow Economy in Italy: dilemmas and policies effectiveness. Content: 1. Efforts in producing definitions of SE, methods of measuring it and actual size. 2. Regular and irregular workers and their cyclical behaviour 3. A decomposition by sectors and by geographical area (Center-north vs South). 4. European Union Value Added Tax provisional regime as a means to boost Shadow Economy (SE). 5. Tax amnesties effects. 6. Trends in labour productivity. 7. Assessment and remarks on policies effectiveness. References 1. The debate over the shadow economy, the way of measure it and of understanding its contribution to a country economy performance (under certain respects it may be judgeted as a positive one), has been characterized by periods of great interest giving ways to periods of indifference. This is so not only with respect to research, theoretical and empirical studies, but also with respect to the political agenda and even with respect to the general public concern of the problem which goes hand in hand with the more known and discussed one, that is tax evasion. To effectively combat the underground economy those three components should be in place at the same time. This is to say that good researches on its size, dynamic, features, sector s characteristic ecc., should be provided to politicians determined to combat it on the basis of equity and efficiency considerations and pushed by the general public (their voters) who think that the very existence of a shadow economy (and tax evasion and illegal activities in particular) is indeed a government failure. At present it seems to me quite possible that the three components work in the same direction, although it is probably true that the so called tax morale is not so high and it cannot be gained, or re-gained, so quickly. For sure more good researchers are now available and a sort of (implicit) agreement over the size of our SE is now reached in the sense that, from various methods of estimation and from different data sources, a percentage between 15 17% comes out as the average one (notwithstanding fluctuations over time and regional differences). Furthermore even the controversy about the methods of measuring it, that is about indirect and aggregate methods of the Tanzi type and of energy consumption type, as opposed to direct estimation of tax 2
evasion (either direct taxes or value added taxes) seems rather over 1. The remarkable effort produced by ISTAT, not only to comply with SEC93, ESA95 and with OECD 2002 manual, but to provide a method of calculating a true exhausistive GDP 2 has reached the point of regularly releasing official estimates of shadow GDP and of regular and irregular workers. Adding to the ISTAT figures those coming from Tax Authorities as well as from Social Security Agencies, one can have a confident base from which to start going deeper inside the phenomenon in order to understand it better and to figure out which kinds of policy instruments would be effective in reducing it. Finally, definitions are also agreed upon or at least we may safely compare countries figures by checking the definitions used (for example, illegal activities are in general excluded because every country has its own list of illegal activities). In the case of Italy, a distinction is made by Istat between economic and statistical shadow economy. Estimates of economic shadow GDP are provided with respect to a minimum (the so called certain shadow) hypothesis and to a maximum one (the so called presumed ). Table 1 and 2 show, respectively, economic shadow GDP and economic shadow GDP by sectors. Figure 1 shows the shadow employment in terms of full-time equivalent units of labor and 2 gives additional information concerning regular and regular self-employed. 1 Tanzi method is no more viable in the Euro era and debatable any way; energy consumption, problems of parameter ecc.; cross checking of different data sources is more promising as there are many offices/ authorities/agencies responsible for the data collection and analysis on tax fraud and evasion. The most important being: Central Statistical Office; Tax Authorities; Revenue Guard Corps; Health Authorities; Chambers of Commerce; Local Government, for real estate evasion; Labour Market Authorities (INAIL); Trade Unions; Social Securities Institutions: INPS,.). If there is a shortcoming is the insufficient cooperation, and some times even the lack of understanding each others, among those entities. 2 I am not a profound expert in the subject but I know that ISTAT method has been suggested as a benchmark for other OECD countries. 3
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2. An interesting feature of the labour market to analyse in some details, comes from the behaviour of the different components of the labour market, namely the shadow employment, the regular employment and the regular self-employment, over the cycle. Actually I take as very convincing the idea of Bovi (2005) who considers that for (every?) firms there are two types of labour input: one regular and one black or shadow. While the black one is, of course, untaxed, it may also be less productive but also more flexible. If this were case, it should be possible to capture those feature trough empirical investigation and econometric tests. Actually looking at Fig. 3 one grasps the different behaviour of the various components. At first glance it seems that all the inputs by and large follow a procyclical behaviour. Correlation coefficients are positive, confirming the impression. There is some quantitative difference, supporting the presumed effects linked to the qualitative peculiarities of the production factors. The correlation between GDP and shadow employment is 57%, self employment scores 44% and private sector regular employees records a rigid 21%. The reduction in the volatility of self employment may be tentatively associated with the introduction, in the course of 1996, of free lance coordinated workers (Co.Co.Co. in Italian, that is coordinate and continual collaboration). In fact they are classified as self employed in the national accounts; firms exploited this opportunity to hire workers repeatedly as CoCoCo. In practice firms use them as sort of low-cost permanent employment. 3 Actually, as one would expect, irregular workers are more flexible and therefore used as a buffer during the cycle 4. 3 Bovi M., The dark and independent side of the italian labour market in Labour, 19 (4), 2005 4 The same function of the underground economy of smoothing the cycle has been found by Chiarini-Marzano, (2007, Agenzia delle Entrate, Documenti di discussione, n.1). By using the undeclared tax base of Value Added Tax, due in turn to Marigliani-Pisani (2006, n. 1. Documenti di lavoro, Agenzia delle entrate, Le basi imponibili dell IVA. Aspetti generali e principali risultati per il periodo 1982-2002) as a proxy for the shadow GDP they found this income smoothing effect: they found a standard deviation of (real) GDP over the period of 1.4% while the standard deviation of regular GDP, that is total GDP netted out for the undeclared tax base of Value Added Tax, over the same period was of 2%. There are reasons to believe, and empirical studies to confirm, that the shadow economy does play a sort of buffer role during the cycle. 6
3. Furthermore a brief glance at shadow employment by sectors as it appears from figura 4., shed some light in the importance of considering not only the aggregate labour market but it also raises some puzzling (dilemma?) questions. While it is by and large true that after 1998 in all sectors the shadow employment, calculated in terms of irregular workers over total, tends to clearly decrease in two sectors this was not the case. The two sectors are Agriculture&fishing and Transport&communication. For the first one we may think that the effect is actually due to the reduction in the number of the regular ones; even a small increase in the number of irregular combined with the reduction in the number of regular workers, may produce such a great increase, and against the stream, pictured in the corresponding figure. More difficult is to interpret the trend in the transport and communication sector. Finally we can tentatively, and probably from a somehow optimistic position, interpret the last sharp decrease in the trend of irregular employment in the building sector (incidentally the general wisdom considers this sector to be greatly characterized by black workers both in the past and at present, with more immigrant in recent years) as a response to the introduction of the income tax incentive for households in terms of deduction (within a ceiling of 41% when first introduced in year 2000 and now shrank at 36%) of maintenance/renovation expenses for houses. (But it does not explain the by now famous mistery concerning year1998). 7
4. One aspect the EU should pay attention to, is the fact that once we come at the problem of coordination/cooperation among the various administration of the numerous countries belonging to the EU (25 or 27 by now), they are in general very slow to adapt 8
their own procedures to the social necessity of the community. Besides being a general threat to cohesion this very fact may be detrimental to every countries revenue and may also boost shadow economy when it concerns the community value added tax. This tax is a very important tax from the revenue point of view in all the countries. In Italy it contributes the 26% of total revenues and similar figures are found in the other countries. At present the VAT is subject to temporary regime that makes the tax very vulnerable to the tax fraud and evasion with respect to the intra-community exchanges. The still temporary regime is based on the destination principle, that means that the traded goods leave the country of production without having paid the tax and only in the country of destination they will be taxed according to the local rules. It is not that difficult to imagine how much VAT gap can be created through missing trader, buffer, firms. Adding to this the fact that (at least in Italy) VAT is based on self assessment and self payment, there is no scope for tax authorities to control, not to mention the impossibilities of intervening in countries of different nationalities. The threat of losing revenue is not an abstract one; just consider that some countries studies carried out on the results obtained by each country s activities to contrast such practices and transmitted to the European Commission in 2004, estimate that the missing revenue is no less than 10% of net revenue stemming from the intra-community exchange. That is to say something in between 15 and 20 billions. Tax evasion and tax fraud could be prevented; one way is the one chosen by the EU according to which the origin principle will replace the destination principle in the final regime (the problem is how long it takes the process of finishing with the temporary one!); another would be to transform the tax in a federal one or to really harmonize tax base and tax rates for which administrative cooperation is indeed necessary. 5. It does not come as a surprise the fact that tax amnesties are quite bad in terms of tax morale, tax evasion and even tax revenues in the long run. See Fig. 5. What is to be studied in more details is however the effect in terms of firms dimensions. While it comes to enquiry into the dimension of firms which evade the most, every research studies and institutions in charge of collecting data, including ISTAT, will agree on the fact that the smaller the size the easier is tax evasion. Actually from the study by Bernasconi-La Pecorella on data on tax amnesties of the last thirty years it does not emerge that small business took advantage of tax amnesties (another sort of dilemma). Everybody will agree that a constant cause of having underground economy in Italy is precise the structure of our economy mainly based on small and very small firms. In other words the small dimensions of our firms have 9
been always regarded as a source of weakness for the system under many respect: competition, innovation, and evasion. 6. Finally as I consider it very important, a glance to different types of labour productivities through the help of Fig. 6. The figure can contribute to shed some light into a debate that has equally involved Europe and US, that is the one concerning the slow down of productivity in different years. Limiting ourselves to look for possible explanation applicable to my country I consider the cyclical behaviour of the two types of labour inputs: regular and shadow. It emerges from figure 6 that except for the last two years, the shadow workers productivity is responsible for the slowdown. The finding, interested in itself, underling something that I may again call dilemma, this time a policy intervention dilemma. If a policy instrument is effective in legalizing immigrant and transforming them, so to speak, in regular workers, tax revenue and social security revenue will increase but at the same time the average productivity will be affected too. And it will not be for the good as the increase in employment will come from slow skilled workers. 10
References -Bernasconi M.-Lapecorella F., I condoni nel sistema tributario italiano, in La Finanza Pubblica Rapporto 2006, Il Mulino -Bovi M., The dark and independent side of the italian labour market in Labour, 19 (4), 2005 -Bovi M.-Castellucci L., What do we know about the size of the underground economy in Italy beyond the common wisdom. Some empirically tested proposition, WP Ceis, 1999, n.120. -Bovi-Castellucci,Cosa sappiamo dell economia sommersa in Italia?, in Economia Pubblica, 2001, n.6 -Castellucci L.,The role of the underground economy in Italy and current policies to cambat it., paper presented in 2003 at the Belgia-European Colloqium on Undeclared Work. -Chiarini-Marzano, 2007, Agenzia delle Entrate, Documenti di discussione, n.1 -Fiorio C.-Zanardi A., L evasione fiscale cosa ne pensano gli italiani?, in La Finanza Pubblica italiana. Rapporto 2006, il Mulino, 2006 -Marigliani-Pisani (2006, n. 1. Documenti di lavoro, Agenzia delle entrate, Le basi imponibili dell IVA. Aspetti generali e principali risultati per il periodo 1982-2002) 11