Study: the percentage of shadow economy has increased in Estonia
According to the recent Shadow Economy Index for the Baltic Countries compiled by the Stockholm School of Economics in Riga (SSE Riga), the size of shadow economy in Estonia increased by 1.7% last year and formed 14.9% of GDP. Despite this increase, the percentage of shadow economy in Estonia in 2015 is still the lowest in all three Baltic Countries.
In 2015, the percentage of shadow economy in Estonia constituted 14.9%, in Lithuania 15%, and in Latvia 21.3% of GDP. An increase in shadow economy in Estonia by 1.7 percentage points and in Lithuania by 2.5 percentage points goes against the long-term trend of gradually reducing the size of the shadow economies. While the size of shadow economy in Latvia used to be relatively constant, then in 2015, it decreased by 2.2 percentage points.
According to the Shadow Economy Index, a major component of shadow economy are the unofficial “envelope” wages (approximately 60%), followed by underreporting of income and underreporting the number of employees (approximately 20% each).
The percentage of “envelope wages”, as well as underreporting of income has increased
According to the SSE Riga Shadow Economy Index 2015, Estonia is still the country with the lowest underreporting of salaries, income, and people employed without contracts. Yet, some negative tendencies can be observed that should make policy makers in Estonia cautious. For instance, underreporting of salaries or the so-called “envelope wages” accounted for 17.7% in 2015, which is a 3.1% percentage point increase from 2014. Similarly to Estonia, the percentage of “envelope wages” increased by 3 percentage points in Lithuania last year (reaching 15.2%). In Latvia, however, the level of “envelope wages” decreased by 2.4 percentage points (reaching 17.9%).
In addition, underreporting of income that is intentionally concealed from the authorities increased in Estonia from 6.7% in 2014 to 7.5% in 2015, although Estonia outperforms the other Baltic countries with regards to this indicator. Namely, the level of underreporting of income in Latvia was as high as 19.9% in 2015, whereas in Lithuania it accounted for 10.5%. In comparison with 2014, underreporting the number of employees decreased in Estonia from 7.6% to 5.4% in 2015. In Latvia and Lithuania, the figures are 9.6% and 6.6%, accordingly.
The proportion of unregistered enterprises in 2015 was slightly higher in Lithuania, compared to Estonia and Latvia (7.3%, compared to 5.8% and 5.2% of all enterprises, respectively).
Shadow economy thrives in the construction sector
The highest levels of shadow activity in all three Baltic countries are in the construction sector; however, shadow activity in the Estonian and Lithuanian construction sectors is about half that of the Latvian construction sector (i.e. approximately 20%). A relatively high level of shadow economy (nearly 17%) is also observed in the service, wholesale, and retail sectors in Estonia. Although there is a tendency for the level of shadow activity to be somewhat higher in smaller companies, a relatively high level of shadow activity occurs in the companies of all three Baltic countries that employ 51–200 employees and 200 or more employees.
Estonian entrepreneurs are not worried about being caught
The entrepreneurs in Lithuania and Latvia perceive the risk of being caught when underreporting income, salaries, or employees as relatively high. In Estonia, however, the most common answer from Estonian entrepreneurs was that the probability of being caught while underreporting income and salaries is 31–50% (26.1% and 26.9% of the respondents, accordingly). Approximately 16% of the respondents claimed that being caught while underreporting income is improbable in Estonia. 10% of the respondents agreed when asked about the probability of being caught while underreporting salaries.
Estonian entrepreneurs also stand out with regards to the lowest perceived probability of being caught if involved in paying bribes. As many as one fourth of the respondents believe that they will never be caught should they be involved in such activity. One third of Estonian entrepreneurs do not believe that anything serious can be expected if caught, whereas one fifth of the respondents (19%) believe that they would have to cease operations if this happens.
Entrepreneurs are not happy with the government’s tax policy
Entrepreneurs in all three Baltic countries continue to be relatively satisfied with the State Revenue Service but relatively dissatisfied with the government’s tax policy and support for entrepreneurs. The proportion of entrepreneurs satisfied with the State Revenue Service increased from 54.6% in 2014 to 63.0% in 2015. Yet, the level of entrepreneurs satisfied with the government’s tax policy decreased from 29.4% to 25.6%, and the proportion of entrepreneurs satisfied with the quality of business legislation: from 41.2% to 36.4%.
In comparison with 2014, the proportion of entrepreneurs satisfied with the government support for entrepreneurs decreased by 7.2 percentage points to 11.2%. Given the fact that entrepreneurs’ satisfaction with the abovementioned issues is considered a major driver of shadow economy, policy makers in Estonia should be cautious about these trends and take action to improve the situation.
SEB Pank and SSE Riga have compiled the Shadow Economy Index since 2009. It calculates the size and explores the key reasons for shadow economy in the Baltic countries, as well as provides the scope for informed policy measures to decrease shadow economy.
Arnis Sauka
Stockholm School of Economics