Czechs make progress in curtailing shadow economy

Photo: Miroslav Zimmer

At one time it’s estimated that post Velvet Revolution Czechs had at least two jobs and probably declared only a small fraction of their earnings to the tax man. Times have moved on, but how big is the gray or shadow economy in the Czech economy and marketplace right now and what steps should be framed to counter it? A recent report suggested some answers to both those questions.

Photo: Miroslav Zimmer
The Centre for Economic and Market Analysis (CETA according to its Czech acronym) is a new kid on the block of Czech think tanks and economic analysts and experts. And with the self-declared mission to shed light on parts of the Czech economy and questions that normally get little attention, it has come out with its first report on the size of and trends in the Czech gray or shadow economy.

Determining the size of the shadow economy is perhaps a bit more precise than saying how long is a piece of string, but it is nonetheless clearly a fraught business and depends a lot on what definition is used. The CETA headline news is that it sees the undeclared gray or shadow economy in the Czech Republic at 15.3 percent of the overall economy. Jonáš Rais an analyst at CETA and one of the principal authors of the shadow economy study explains how that figure was arrived at.

“We are actually using a more broader definition of the shadow economy. We are including three areas. One is what you would call the actual gray economy, which is legal activity whose proceeds are hidden from the tax authorities. The other part is the illegal economy, but for the illegal economy we are actually using a more narrower definition so we don’t include prostitution and drugs production but we are including the illegal production of alcohol and the illegal production of tobacco. Those are two topics that we look more closely at.

"A third part is basically small production in the household sector. This is, for example, the direct sale of agricultural products or, for example, taking care of the neighbour’s children and stuff like that. So those are the areas we include in the definition of the shadow economy and we are using a broader definition than is usual actually.”

“We are pushing against the cash economy.”

The 15.3 percent figure, or around 24 billion euros, might to outsiders look fairly small. According to some estimates around half of the Czech or Czechoslovak economy was in the undeclared gray or shadow zone in the immediate aftermath of the fall of Communism in 1989 and even a decade ago it’s believed that the figure stood at around a fifth of the total economy.

The 15.3 percent is higher than the estimates for some Central European countries such as Slovakia, at 14.5 percent, and some of the seemingly upstanding Western countries such as Austria, the Netherlands, Sweden, Luxembourg, and Britain which have shadow economy statistics of below 10 percent. But, on the other hand, it’s less than Poland, Hungary, Slovenia, and all of the Baltic States and more or less in the same ballpark as Denmark and Finland.

And according to some other measurements the size of the Czech shadow economy could be even smaller still. CETA analyst Jonáš Rais again.

“Actually that might even be an overstatement of the actual size because according to another method, which is used by the Czech Statistical Office, the size of the gray economy is even lower. They estimate that it is around 9 percent of gross value added, so the 15 percent might actually be an overstatement. This is according to another method which is good for international comparison but, I would say, it is not so accurate when it comes to the estimate of the Czech economy.”

Jonáš Rais,  photo: archive of CETA
One way of looking at the shadow economy is as the undeclared and untaxed areas of the economy which flourish or contract according to how high local taxes are and how time consuming and burdensome regulations are. According to this view, the shadow economy is the profit zone created by the incentives to dodge taxes, customs duties, social service payments, and the like combined with the local appreciation by the tax and payment dodgers of the risk run that they will get caught. As such, the shadow economy according to Jonáš Rais, is also a good reflection of how the legal economy as well is performing:

“We look at different areas of the shadow economy but what they all have in common is that the two most significant factors which the shadow economy can be attributed to is regulation and taxes. So if the taxes are too high and if the regulation is badly done then people are motivated to move into the shadows. So these are the two aspects that each government, not only the Czech one, in each country should focus on because those are the two features that are common in all countries and in all aspects of the shadow economy.”

One of the participants at the CETA press conference was Miroslav Lukeš, the general director of credit card company MasterCard for the Czech and Slovak Republics. MasterCard also helped fund the study into the shadow economy. I put it to Mr. Lukeš that card companies such as his had a clear and direct interest in seeing the shadow economy, often based on cash transactions, squeezed as much as possible. He was only happy to agree:

“We are pushing against the cash economy. The grey economy is actually connected with cash transactions and we believe by making transactions cashless automatically the share of the gray economy is reduced. Cashless may be Mastercard; cashless may be other forms of cashless transactions.”

MasterCard’s Miroslav Lukeš admits that there are obvious charges for using credit and debit cards, though he says they are falling. But he argues that there are costs of using cash as well, even though these are not highlighted so often.

“There will always be some kind of unofficial shadow economy, whatever you want to call it.”

“These days in the 21st century there are much easier and more secure ways of making transactions. That’s why some countries, for example in Scandinavia, are thinking of abolishing cash. And also, cash is not for free. Cash actually bears costs of fraud, costs of losses, and social costs that are implicitly borne by the economy. Cash is also not for free.”

And MasterCard hopes that such studies as CETA’s will help to create a debate in the Czech Republic about the shadow economy, which so far has been lacking, and put the pressure on the government and other stakeholders on how the shadow economy can be squeezed even more. Miroslav Lukeš outlined MasterCard’s specific aims as follows:

“I would say three areas: one is awareness that the gray economy is costly and that Czechs should pay taxes and that paying taxes is normal. Secondly, a broader discussion about how we can combat the gray economy and how this can help us do business in the Czech Republic. And last but not least, broader support for the current initiatives that are on the table, for example, sales registration, which we believe is a very efficient way of combatting the gray economy.”

Sales registers are one of the flagship policies of Czech finance minister Andrej Babiš. They would force small businesses and independent traders to declare all their transactions. But the move is facing a lot of opposition and is delayed. Miroslav Lukeš says the country should not rest on its laurels and the progress achieved so far:

“Luckily the share of the gray economy is declining, so the trend is good. Yes, we have the lowest gray economy among the Central European countries, but we should actually aspire to be better than the countries of Western Europe. So definitely the benchmarks are much lower. And take into consideration the example of Austria, Austria has one of the lowest gray economies, half that of the Czech Republic, about 7 or 8 percent, and still they do introduce certain measures to combat the gray economy such as supporting cashless transactions or by supporting cash registers.”

Photo: Hekata 5,  CC BY-SA 3.0
Whatever the specific or broader goals, most analysts and economists believe that the fight against the shadow economy is a never ending battle and, that unlike other battles, the tax dodgers and evaders will never be totally beaten. A shadow economy of a certain size, some analysts say as little as 5 percent, will always be present. Joint author of the CETA study, Jonáš Rais again.

"There can never be only an official economy, there will always be some kind of unofficial shadow economy, whatever you want to call it. According to some experts that could be between 5 and 10 percent. But it is really hard to define the exact threshold because, as I already said, it is already really difficult to measure it and define it. So to say, it’s just 5 percent, it’s just 10 percent, it’s impossible to say. But definitely, there will always be some shadow economy present.”