An Exploration of the Greek Shadow Economy: Can Its Transfer into the Official Economy Provide Economic Relief Amid the Crisis?

Abstract

We explore the determinants of the Greek shadow economy, its interaction with the official economy, and its relationship with corruption. In doing so, we undertake — for the first time — an interdisciplinary review of economic and political studies on the size and determinants of the shadow economy, tax evasion, undeclared work and, moreover, of their relation with corruption in Greece in order to reveal the extent and complexity of these phenomena. We estimate the size and determinants of the shadow economy via a multiple-indicators-multiple-causes (MIMIC) approach. Our findings indicate that the important determinants are factors related to macroeconomic conditions, such as unemployment and GDP growth, and institutional factors, such as tax morale and the rule of law. We also indicate that the shadow economy and corruption are complementary and that the official and the shadow economy substitute each other over the business cycle. An adoption of policy based on these findings would lead to a successful transfer of part of the shadow economy to the official economy, would boost government revenue, and would eventually lead the Greek economy out of the depression that emerged as a result of the sovereign debt crisis.

Keywords:

• corruption
• economic crisis
• Greece
• shadow economy
• sovereign debt crisis

JEL Classification Codes:

• E26
• H26
• H63
• K42
• O17

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Corrigendum

Notes

¹ The difference between MIMIC models and indirect macro-level approaches stems from the fact that they test the relationship between causes and indicators, respectively (Maloney and Saavedra-Chanduvi 2007, 34).

² Kamila Fialova and Ondrej Schneider (2011) observe that strict employment protection legislation increases the size of the shadow economy in the EU.

³ The relationship between the shadow economy and its quantifiable determinants is not that straightforward since it is influenced greatly by the quality of institutional frameworks. For example, the shadow economy depends on government choices (towards taxation, bureaucracy, etc.) that, in turn, depend on exogenous factors (historical, cultural, etc.), and altogether generate a continuum of countryspecific shadow economy equilibrium rates (Bovi and Dell’Anno 2010). Accordingly, differences of public trust in governments explain why it is possible for some countries to have higher taxes and smaller shadow economies (Elgin and Garcia 2012).

⁴ Moreover, Catalina Granda-Carvajal (2010) indicates that counter-cyclicality is positively correlated with the size of the shadow economy.

⁵ In vertical centralization, the hierarchical structure consists of a vertical dimension of differentiated levels of authority and responsibility. In horizontal centralization, the horizontal dimension of differentiated levels of authority and responsibility is determined by specialization and/or regionality.

⁶ Firms that evade taxes have larger available cash flows (for example, through VAT evasion), or lower costs (for example, from undeclared personnel), and thus they have an advantage over firms that do not participate in the shadow economy. Beyond that, corruption and bureaucratic inefficiency amount to a tax on all firms (for example, in terms of bribing). Both phenomena create barriers to entry and negative externalities to firms that do not participate in the shadow economy.

⁷ Insufficient tax collection is reflected in the sum of €67.9 billion of uncollected confirmed taxes, which is more than a third of Greece’s GDP (arrears concern the third quarter of 2013 and can be accessed in Greek at www.gsis.gr/gsis/info/gsis_site/PublicIssue/profit_np/ and www.gsis.gr/gsis/info/gsis_site/PublicIssue/profit_fp/index.html).

⁸ For instance, data from OECD and the World Bank (2015a, 2015b) (“average personal income tax and social security contribution rates on gross labor income for the average wage earner” can be accessed at http://data.worldbank.org/indicator/IC.TAX.TOTL.CP.ZS?page=1, while “total business tax rate as a percentage of commercial profits” is available at http://stats.oecd.org/) reveal that, although the tax burden in Greece has increased since 2010 (when the first bailout occurred), it is still lower than that of the eurozone’s core countries (such as France and Germany). The picture is mixed when compared to the periphery (for example, lower than Italy’s and higher than Portugal and Poland’s).

⁹ A much earlier study, focusing on tax evasion for the period from 1987 to 1996, also reaches the same conclusions, and indicates that recession encouraged the level of tax evasion in Greece and that institutional quality and the tax burden were its primary determinants (Agapetos 1999).

¹⁰ For example, small business owners perceive more opportunities in not complying with tax regulations as compared to employed taxpayers and also consider taxes as painful losses (Kamleitner, Korunka and Kirchler 2012).

¹¹ If undeclared workers are registered as unemployed, a realistic figure representing the extremely high levels of unemployment in Greece amid economic depression would be less than the official figure due to undeclared work. Nevertheless, the income from this type of work would be below the poverty threshold.

¹² As such, the discussion concerns exclusively the phenomena of clientelism and rent-seeking and not the elements that contributed to the Greek crisis. (For the latter the reader should turn to Yiannis Kitromilides 2013 and Vasileios Vlachos 2013).

¹³ An interpretation of the pre-crisis Greek paradox of rapid economic growth can also be reached by the following notion: Since citizens have to accept some corruption and government inefficiency, “how much?” depends on the quality of political institutions and on economic conditions (Aidt, Dutta and Sena 2008). As such, it can be assumed that corruption was more acceptable during Greece’s economic growth of the “cheap credit” pre-crisis euro-era (and, moreover, allowed individuals to circumvent institutional deficiencies).

¹⁴ It should be noted that the validity and reliability of corruption measurement techniques based on perception are argued to be completely unrelated to actual corruption once other relevant factors are controlled for (Mocan 2008).

¹⁵ Another theoretical dimension is the recession-push hypothesis where, in times of high unemployment, individuals are pushed into self-employment for lack of alternative sources of income, such as paid employment. Emilio Congregado, Antonio Golpe, and André van Stel (2012) find that the effect is disproportionally stronger when economic conditions worsen.

¹⁶ Policies reducing the size of the shadow economy lead to a less procyclical fiscal response to shocks (Çiçek and Elgin 2011). Moreover, the findings that the size of the shadow economy is a significant determinant of financial instability, sovereign default risk, and public indebtedness (Elgin and Uras 2013), generate expectations for something more than a temporary relief.

¹⁷ Tax amnesties and debt settlements may improve government revenue, but have a negative impact on tax morale.

¹⁸ Jorge Martinez-Vazquez and Benno Torgler (2009) argue that the success of tax reforms and tax administration modernizations in Spain (a country with cultural similarities to Greece) had a lot to do with improvements in tax morale.

¹⁹ The political dimensions of the Greek crisis (see clientelism and rent-seeking), which are deeply rooted in the inefficient use of public resources, greatly affect the level of tax morale (for an example about Italy, see Barone and Mocetti 2011). Citizens’ perceptions of this phenomenon require time (and effort) to improve.

Additional information

Notes on contributors

Aristidis Bitzenis

Aristidis Bitzenis is an associate professor at the University of Macedonia (Thessaloniki, Greece) and coordinator of the research project TALIS, titled “The Shadow (Informal Sector) in Greece: Size, Causes, and Consequences.” Vasileios Vlachos is a research associate for the same project. Friedrich Schneider is a professor of economics at the Johannes Kepler University (Linz, Austria) and a collaborator on the same project. The above-mentioned research is implemented through the Operational Program “Education and Lifelong Learning” and co-financed by the European Union (European Social Fund) and Greek national funds. This paper is part of the research in question.

Vasileios Vlachos

Aristidis Bitzenis is an associate professor at the University of Macedonia (Thessaloniki, Greece) and coordinator of the research project TALIS, titled “The Shadow (Informal Sector) in Greece: Size, Causes, and Consequences.” Vasileios Vlachos is a research associate for the same project. Friedrich Schneider is a professor of economics at the Johannes Kepler University (Linz, Austria) and a collaborator on the same project. The above-mentioned research is implemented through the Operational Program “Education and Lifelong Learning” and co-financed by the European Union (European Social Fund) and Greek national funds. This paper is part of the research in question.

Friedrich Schneider

Aristidis Bitzenis is an associate professor at the University of Macedonia (Thessaloniki, Greece) and coordinator of the research project TALIS, titled “The Shadow (Informal Sector) in Greece: Size, Causes, and Consequences.” Vasileios Vlachos is a research associate for the same project. Friedrich Schneider is a professor of economics at the Johannes Kepler University (Linz, Austria) and a collaborator on the same project. The above-mentioned research is implemented through the Operational Program “Education and Lifelong Learning” and co-financed by the European Union (European Social Fund) and Greek national funds. This paper is part of the research in question.