The Underground Economy and Business Tax Evasion
Statscan have produced interesting and important new estimates of the upper bound size of the “underground” or “non observed”Â economy, putting it at a seemingly modest 2.2% of GDP in 2008. (Some of this is already included in GDP which isÂ adjusted to take into account some hidden and unreported economic activity.)
The 2.2% estimate shows that we are a reasonably law-abiding country, but it is important to note that it excludes some major areas of illegal activity, such as the drug trade and prostitution.
A big chunk of the sleuthing done by Statscan to identify the underground economy consists of identifying differences between transactions reported for tax purposes, and transactions registering in reported sales of goods and services in the market. For example, the scale ofÂ under-reported construction shows up in sales of building materials.
Statscan identifies “skimming” by firms as a significant issue. This is defined as under reporting of revenue and over reporting of expenses by firms for tax purposes. On top of skimming, firms may fail to report income.
Overall, Statscan estimates that corporations made as much as $17 Billion on underground activity in 2008, about half of which was in the construction sector.
Unincorporated businesses make up a much smaller share of the economy but are much more likely to skim and not report income. The estimated maximum is $10 Billion, about one half of which comes from skimming. Underground construction and contraband sales of alcohol and tobacco also loom large for this sector.
Not to make too one-sided a moral story of it, consumers are clearly complicit in a great deal of underground economy activity, getting goods and services at lower prices than in the formal, taxed economy. The underground economy is strongest in construction and in sales of tobacco, alcohol, and domestic and child care services.
Still, you can’t help but think that more stringent auditing of businesses by the tax authorities could turn up quite a useful amount of extra revenue if there is up to $27 Billion of under and unreported business income sitting on the table.
(For some reason which escapes me, the study is not on the Statscan web site, but can be requested from Â firstname.lastname@example.org)
If drugs (or some of them were legalized) and sold through the LCBO (or equivalent organizations), the police freed up from drug squad duties could be used to tax the underground economy.
A major feature of the HST is to remove sales tax from building materials (which are easy to count) and shift it onto new-home purchases and contractor services for renovations (which are easy to under-report). This change would seem to facilitate even more tax evasion in the construction sector.