Insight Brief Reducing the Shadow Economy through Electronic Payments An EY Study Commissioned by MasterCard 1
Each year, many countries lose a significant part of their tax revenues due to the existence of the shadow economy. In general, activities in the shadow economy account for a considerable part of the total tax gap that individual governments suffer from. A recent EY study adopts an innovative approach to the measurement of the shadow economy, including its development in time, its structure and sectorial breakdown. The study, commissioned by MasterCard, covers eight countries in Central and Southern Europe Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Poland, Serbia, Slovakia and Slovenia. A critical contribution of the research consists in investigating the potential of different regulatory measures to reduce the shadow economy through the promotion of electronic payments. What is the Shadow Economy? The shadow economy may be defined as the non-observed part of the economic activities. Such activity might be conducted informally so that no records exist, or it might be unreported to avoid taxes and/or official scrutiny. It might also be illegal. In 2014, the total shadow economy ranged from 11.3% of GDP in the Czech Republic to 25.5% of GDP in Bosnia and Herzegovina. Significant Adverse Consequences of the Shadow Economy Reduced tax base because of the unreported income Lower quantity/quality of public goods due to reduced government revenue Distortions in market competition Degradation of economic and social institutions And lower economic growth due to all of the above In the countries under study, it is estimated that governments lost between 1.6% and 4.2% of GDP in 2014 due to the passive shadow economy. 2
The Shadow Economy: Committed vs. Passive The study distinguishes between two categories of the shadow economy committed and passive. In the committed shadow economy both sides of the transaction benefit from using cash which enables them to evade tax liabilities or to sell/buy illegal products and services. In the passive shadow economy, one party (the consumer) pays in cash while only the other party (the seller) reaps the benefits by taking the opportunity to hide the income. Here, cash payments provide an opportunity as well as an incentive not to report the transaction and evade tax payment by the seller. The study examines how this part of the shadow economy can be reduced through electronic payments. The sector supplying food, beverages, and tobacco accounts for the largest share of the passive shadow economy in the countries under study, on average 39.6%. 3
An increase in the value of card payments by 100% should lead to a reduction in the shadow economy by 0.6 3.7% of GDP and to an increase in government revenues by 0.1 0.8% of GDP, in the analysed countries. How the Shadow Economy Impacts Tax Revenue For all the countries analysed, the passive component accounts for a vast majority (61 to 91%) of their unregistered economy. It entails some serious consequences, one of them being lost government VAT and CIT revenues, which range from 1.6% of GDP (Slovenia) to 4.2% of GDP (Bosnia and Herzegovina). Lost government revenues due to the existence of the passive shadow economy in 2014 4
How Electronic Payments Can Reduce the Passive Shadow Economy EY quantifies the impacts of various regulations that, by replacing cash with electronic payments, or by increasing the share of registered consumer cash transactions, lead to a reduction in the shadow economy. The effects of the analysed regulations turn out to be highly country-specific. The most effective regulations include tax incentives for consumers, e.g. in the form of a cash-back awarded to card payments, as well as introduction of a threshold for a single consumer transaction above which cash payments are not allowed. For the summary of the impact of the analysed regulations on the passive shadow economy and government revenues see Table One below. Table One. Impact of Potential Regulations promoting the use of Electronic Payments on the passive shadow economy and government revenues (Cross Country Analysis, 2014) Potential Regulation Obligation to make an electronic payment of wages and salaries Obligation to make an electronic payment of unemployment benefits Obligation to make an electronic payment of pensions Threshold for consumer cash payments impact of an exemplary threshold Obligation to possess cash registers Obligation to operate POS terminals in all passive economy sectors Tax incentive for consumers optimal tax relief Tax incentive for merchants optimal tax relief Range of Estimated Reduction in Passive Shadow Economy Activity (as % of GDP) Range of Estimated Increase in VAT and CIT revenue (as % of GDP) Potential Drawbacks or Costs.02 to.28.003 to.051 Fees associated with bank accounts or prepaid cards..002 to.013.0004 to.003 Fees associated with bank accounts or prepaid cards..16 to.59.03 to.12 Potential challenge to pensioners unfamiliar with payment cards and leery of banks. 2.28 to 5.21.39 to 1.04 Fees associated with bank accounts or prepaid cards..52 to.74.12 to.13 Cost of cash registers and related equipment.26 to 1.14.01 to 0.27 Purchase or lease of POS terminals. 2.21 to 6.74.10 to.63 Administrative costs and reduced tax revenues due to incentives..71 to 2.94.02 to.25 Administrative costs and reduced tax revenues due to tax incentives Countries that have already implemented One region of Bosnia and Herzegovina, Croatia, Slovenia Bulgaria, Croatia, Slovenia, Denmark Denmark Bulgaria, the Czech Republic, Slovakia, Slovenia (though high level for all) Bosnia and Herzegovina, Bulgaria, Croatia, Poland, Serbia, Slovakia South Korea South Korea, Brazil (Sao Paulo), Colombia South Korea, Uruguay 5
Contact: CNTR4growth@mastercard.com About Us The mission of the MasterCard Center for Inclusive Growth is to advance equitable and sustainable economic growth and financial inclusion around the world. As an independent subsidiary of MasterCard, we combine data, expertise, technology and philanthropic investments to empower a community of thinkers, leaders and innovators working on the front lines of inclusive growth. Join Our Community mastercardcenter.org @CNTR4growth MasterCard Center for Inclusive Growth For a copy of the original report: Marek Rozkrut, Ph.D. EY Poland marek.rozkrut@pl.ey.com Michal Skowronek MasterCard, Central Eastern Europe Michal.Skowronek@mastercard.com