reducing the shadow economy through electronic …file/report_shadoweconomy_final.pdfcontents...

Reducing the Shadow Economy through Electronic Payments

ContentsExecutive summary 1

Introduction 6

1 The shadow economy and its types 81.1. Definitionoftheshadoweconomy 91.2. Possiblecausesandpotentialconsequencesofthe

shadow economy 111.3. Passive and committed shadow economy 13

2 Shadow economy in Central and Southern Europe 16

2.1. Ourapproachtotheestimationoftheshadoweconomy 17

2.2. Analysed countries and data sources used 202.3. Estimated size, structure and sectorial

breakdownoftheshadoweconomy 25

3 Limiting the shadow economy throughthepromotionof electronic payments 34

3.1. Identifieddeterminantsofthepassive shadow economy 35

3.2. Selected regulations and their impact on the shadow economy 373.2.1. Obligation to make an electronic

paymentofwagesandsalaries 393.2.2. Obligation to make an electronic

paymentofsocialsecuritybenefits 423.2.3. Thresholdforcashpayments 463.2.4. Obligation to possess cash registers 493.2.5. Obligation to operate POS terminals

forselectedtypesofbusinesses 523.2.6. Taxincentivesforconsumers 563.2.7. Taxincentivesformerchants 623.2.8. Receipt lotteries 67

Conclusions 70

The shadow economy and its types

• The shadow economy is a complex phenomenon that can have various causes and consequences. The European Commissiondefinesitasthenon-observedpartoftheeconomy, comprising: (1) illegal activities where the parties are willing partners in economic transactions, (2) hidden and underground activities where the transactions themselves are not against the law, but are unreported toavoidofficialscrutiny,and(3)informalactivitieswheretypicallynorecordsarekept.Underthisdefinition,theshadow economy can be approximated by unreported transactions made by both unregistered and registered entities.

• Ahighleveloftheshadoweconomyhassignificanteconomic and social implications. Its adverse consequences include: a reduced tax base, lower quantity and/or quality ofpublicgoods,distortionsinmarketcompetition,thedegradationofeconomicandsocialinstitutions,and–throughthesechannels–lowereconomicgrowth.Whilethe shadow economy may also have some advantages, it isevidentthattheyaresignificantlyoutweighedbyawiderangeofnegativeconsequencesofunreportedactivities.Therefore,itisimportanttoseektoolsandsolutionsthatmighteffectivelyreducetheshadoweconomy.

• Averyimportantcommonfactorformosttypesofshadoweconomy is that cash payments allow the seller not to report thetransaction.Withonlyafewexceptions,ifanelectronicpaymentwasusedinsteadofcash,itwouldhardlybepossible not to register the transaction. Consequently, in thisReportwefocusonmeasuringunreportedconsumercashtransactionsthatshouldapproximatethesizeoftheshadow economy.

• WeanalysetheshadoweconomyineightCentralandSouthern European countries: Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Poland, Serbia, Slovakia,andSlovenia.Wehaveadoptedaninnovativeapproachtothemeasurementoftheshadoweconomy,basedonacombinationoffourdifferentestimationmethods: currency demand analysis, labour market analysis, multiple indicators multiple causes model, and sectorial structure analysis. Our approach exploits thestrengthsandlimitstheweaknessesofeachofthese methods. In particular, we address a number ofmethodologicalissuesthatseemtohaveledtoanoverestimationoftheshadoweconomyinsomeotherstudies.

• The shadow economy related to unreported cash transactions can be divided into two categories, each requiringdifferentmeasures.Thefirstcomponentisthepartoftheshadoweconomythatcanbereducedbypromotingelectronicpaymentsandlimitingtheuseofcash in consumer transactions. Since cash payments leave no electronic trace, it is relatively easy to avoid reporting them.Cashpaymentscanthereforebethecauseofshadoweconomy activity, as they provide an incentive not to report thetransactionandevadetaxpayment.Wedefinethispartoftheshadoweconomyasthe“passiveshadoweconomy”,becauseonesideofthetransaction(theconsumer)is“passive”inthesensethathe/shedoesnotbenefitfromnot reporting the transaction, and may not even be aware thathe/sheiscontributingtotheexpansionoftheshadoweconomy through the cash payment.

• Thesecondcategoryistheremainingpartoftheshadoweconomy,whereitisnotcashpaymentsthatinfluencethe decision not to report the transaction, but rather the motivationofbothsidesofthetransactiontobenefitfromevadingtaxliabilitiesortosell/buyillegalproductsor services. In this situation, cash payments are (usually) still required to hide the transaction, but it is no longer thesource(orcause)oftheillegalactivity,butratheritsconsequence.Wedefinethispartoftheshadoweconomyasthe“committedshadoweconomy”,becauseinthiscasebothsidesofthetransactionare“committed”tousingcashinordernottoreportthistransactionandtobenefitfromalowerpricestemmingfromevadedtaxpayments.

• Since the passive shadow economy is caused by cash payments, it could be reduced either through actions promoting electronic payments, or through other measures aimedatincreasingtheshareofcashtransactionsbeingregistered.However,thepromotionofelectronicpaymentswouldnotinfluencethebehaviourofthecommittedshadow economy participants, who would continue to use cashpaymentsinordertobenefitfromnotreportingthetransaction.Therefore,thispartoftheshadoweconomyhas to be addressed with other measures, e.g.: increasing the labour inspections at building sites, introducing more restrictivepenaltysanctionsforcounterfeitingofexciseproducts, etc.

Executive summary

1Reducing the Shadow Economy through Electronic Payments |

Executive SummaryThe Shadow Economy in Central and Southern Europe

• Among the analysed countries, we estimate that in 2014 the totalshadoweconomy(thesumofunreportedconsumercashtransactions) was most prevalent in Bosnia and Herzegovina (25.5%ofGDP)andSerbia(20.7%ofGDP).Ontheotherhand,thesmallestshadoweconomiesrelativetoGDPwereintheCzechRepublic (11.3%), Poland (12.4%) and Slovenia (12.5%).

• Theanalysedcountriesdifferintermsoftheshareofpassiveandcommitted components in their shadow economy. In particular, theCzechRepublicisthecountrywithbyfarthehighestshareofthe passive (90.6% in 2014) and, consequently, the lowest share ofthecommittedcomponent(9.4%).Bycontrast,BulgariaandCroatiarecordarelativelyhighshareofthecommittedshadoweconomy (39.2% and 32.1% in 2014, respectively). Despite these differences,forallthecountriesthepassivecomponentaccountsforavastmajorityoftheirunregisteredeconomy.

• The most important role in the passive shadow economy is playedbythesectorsupplyingfood,beveragesandtobacco.Thisconclusionappliestoalloftheanalysedcountries.Onaverage,thissectoraccountsfor39.6%ofthetotalpassiveshadoweconomy.Thesectorthatrankssecond,intermsofitscontributiontothesizeofthepassiveshadoweconomy,differsamongtheanalysedcountries.ItisfuelsforvehiclesinBosniaandHerzegovina(9.4%ofthetotalpassiveshadoweconomy),Bulgaria(9.4%)andSerbia(8.6%);therestaurants,barsandcafessector in Croatia (8.7%), the Czech Republic (12.5%) and Slovakia (9.7%);andthesectorofcarsandmotorcycleswithrelatedservices and repairs in Poland (9.4%) and Slovenia (15.2%). Other sectors that have a relatively high share in the total passive shadow economy in the analysed countries comprise transport as wellasclothingandfootwear.

• The passive shadow economy may entail serious consequences, oneofthembeinglostgovernmentrevenues,whichrangefrom1.6%ofGDP(Slovenia)to4.2%ofGDP(BosniaandHerzegovina).Thisrevenueshortagedoesnotaccountforthewholetaxgapin the analysed countries. One reason is that the committed componentoftheshadoweconomyalsoincludesunreportedtransactions that otherwise would be taxed. Another reason is thatgovernmentrevenuesarealsoreducedbecauseoftaxfraud/evasionmechanismsthatoftentakeplacewithinregisteredtransactions(oneexamplebeingmissingtraderfraud),manyofwhich are even paid electronically. Still, the estimated budgetary effectsofthepassiveshadoweconomyarehighenoughtoshowthatpotentialbenefitsfromaddressingthisissuecanbesignificant.

Limiting the shadow economy through the promotion of electronic payments

• Factorsthatturnouttohaveasignificantimpactonthelevelofthepassiveshadoweconomyinclude:thepopularityofcardpayments,theratiooftaxestoGDP,andinstitutionalandtaxmoraleinagivencountry.Thesefactorsdiffersignificantlyintermsofpolicymakers’abilitytoinfluencethem.Forexample,an improvement in institutional and tax morale may require agovernmenttointroducemany,oftendifficult,reforms,which may additionally take a long time. It is also not easy tosignificantlyreducetheburdenoftaxandsocialsecuritycontributions. On the other hand, public policies leading to an increaseinthepopularityofnon-cashpaymentsseemrelativelyeasier to implement. Consequently, in this study we analyse various regulations that, by replacing cash with electronic payments,orbyincreasingtheshareofregisteredconsumercash transactions, may lead to a reduction in the shadow economy.Manyoftheconsideredsolutionsarealreadypresentinothercountriesaroundtheworld.Someofthemarebasedonenforcementorobligationmechanisms,whereasothersfocuson providing incentives, either to consumers or merchants. They include:

• Obligation to make an electronic payment of wages and salaries.Therequirementtomakeanelectronicpaymentofwages and salaries would result in a situation in which people, who previously received their remuneration in cash, would havetomakeanadditionalefforttouseit,e.g.throughATMwithdrawals.Therefore,theyshouldmoreoftenperformtheirtransactionsusingpaymentcards,andlessfrequentlyincash.This,inturn,shouldcontributetothereductionofthepassiveshadoweconomyby0.02%ofGDP(Serbia)to0.28%ofGDP(Poland).Anincreaseinthenumberofreportedactivitiesshould, in turn, lead to an improvement in government revenue by0.003%ofGDP(Serbia)upto0.051%ofGDP(Poland).

• Obligation to make an electronic payment of social security benefits.Themechanismofthisregulationisanalogoustotheobligationtomakeanelectronicpaymentofwagesandsalaries.Thepotentialreductionoftheshadoweconomyresultingfromthismeasurevariesbetween0.002%ofGDP(BosniaandHerzegovina,foraregulationlimitedtounemploymentbenefits)and0.59%ofGDP(Poland,foraregulationcoveringthepaymentofpensions).Intermsoftheimpactongovernmentrevenues,thestrongesteffecthasbeenestimatedfortheCzechRepublic–atthelevelof0.12%ofGDP(fortheelectronicpaymentofpensions).

• Threshold for consumer cash payments. This regulation introducesathresholdforasingletransactionabovewhichconsumer cash payments are not allowed. Consequently, consumer cash transactions above this level should disappear

2 | Reducing the Shadow Economy through Electronic Payments

and be replaced with additional electronic payments, thereby reducingthesizeofthepassiveshadoweconomyandincreasinggovernmentrevenues.Theeffectofthisregulationdependssignificantlyonthethresholdlevel–theloweritis,themore cash transactions would be replaced with card payments, and the more the passive shadow economy would contract by. ThestrongestimpactoftheregulationontheshadoweconomyhasbeenestimatedforBosniaandHerzegovinaandforSerbia,whiletheweakesteffecthasbeenestimatedforSlovenia.Establishinghighthresholdsforconsumercashpaymentswouldhavelittle,ifany,impactonthepassiveshadoweconomy.

• Obligation to possess cash registers. This regulation obligesawidegroupofbusinessestousecashregistersorrelatedfiscaldevicesinordertorecordeveryindividualtransaction,regardlessofthemeansofpayment.Theprocessofintroducingcashregisters,oftendescribedastheprocessoffiscalisation,isintendedtoprovideamechanismforthetax administration to supervise the records in cash turnover andtomonitoranddetectnon-compliance.IntheReport,wecalculatethepotentialbenefitsofthefiscalisationreformforthe Czech Republic and Slovenia, which had not yet introduced thismeasureatthetimeofconductingthisstudy.Forthesetwo countries, the potential reduction in the passive shadow economyamountsto0.52%and0.74%ofGDP,respectively.Anestimated increase in the Czech government revenues equals 0.13%ofGDP,slightlyexceedingtheeffectforSlovenia(0.12%ofGDP).Anadditionalanalysis(duetolimiteddataavailability,conductedforPolandonly)showsthatanincreaseintheratioofthenumberofcashregisterstothenumberofactiveenterprises by 0.1 leads, on average, to a decrease in the passiveshadoweconomyby0.326percentagepointsofGDP.

• Obligation to operate POS terminals for selected types of businesses. This regulation obliges businesses in certain sectorstooperatepointofsale(POS)terminalsthatenablecustomerstomakecardpayments.Theimpactofthisregulationonthesizeofthepassiveshadoweconomyisthehighestforrelativelylargesectorsandsectorswhere“saturation”withPOSterminalsisrelativelylow.Theestimatedeffectontheshadoweconomycontractionrangesfrom0.26%(Bulgaria)to1.14%ofGDP(theCzechRepublic).TheanalysisoftheimpactonbudgetaryrevenuesincludesthescenarioinwhichthecostoffinancingeachnewPOSterminalisincurredbythegovernment.Inthiscase,theneteffectoftheregulationongovernmentrevenuesremainspositiveforallthecountriesandvariesbetween0.01%ofGDP(Bulgaria)and0.27%ofGDP(the Czech Republic).

• Tax incentives for consumers. This regulation consists in providingfinancialincentivestoconsumers,e.g.intheformofacash-backawardedtocardpayments.Foreverycountrywefindadifferentoptimumlevelofsuchinterventiontomaximisethedifferencebetweentheadditionalrevenuesandthecostsincurredbythegovernment.Theeffectofthisregulationseemstobeparticularlypowerful,withtheimpactonthepassiveshadoweconomycontractionbetween2.2%ofGDP(forSlovenia)and6.7%ofGDP(BosniaandHerzegovina),andtheeffectonnetgovernmentrevenuesrangingfrom0.1%ofGDP(Slovenia)to0.63%ofGDP(CzechRepublic).Thiskindofconsumerincentivemaybeintroducedthroughvariousmechanisms,manyofwhichallowthegovernmenttoreduce the incurred costs, but at the same time also lower the potentialbenefitsintermsofcrowdedoutcashpayments.

• Tax incentives for merchants. Tax incentives decreasing the costofacceptingcardpaymentsbymerchantsmaystimulatethegrowthofthePOSterminalsnetworkandelectronicpayments, thus leading to a reduction in cash payments. Similarly to the regulation providing an incentive to consumers, weestimateadifferentoptimumleveloftaxreliefformerchantsforeachcountry.Theeffectofthisregulation,bothonthecontractionofthepassiveshadoweconomyandtheincreaseingovernmentrevenues,isthestrongestforSerbia(2.9%ofGDPand0.25%ofGDPrespectively).ForSlovenia,thecostsofthismeasurealwaysoutweighthebenefits,andthusthe recommended solution is not to implement the regulation in this country.

• Receipt lotteries.Theideaofreceiptlotteriesistoreducethepassive shadow economy by limiting unreported transactions throughtheincreasedissueofreceiptsinbusiness-to-consumertransactions.Specifically,consumersareprovidedwithanincentivetoaskforareceipt,asitmayalsoserveasafree-of-chargeticketinVATlotteries,thereforegivingitsholdera chance to win attractive prizes. In the longer perspective, thismeasureaimstogetconsumersusedtoaskingforfiscalreceipts.Itisoftenassumedthat,afteracertainperiodoftime, people will develop such a habit (e.g. by making asking forreceiptssociallyacceptableanddesirable,orbyraisingawarenessofthebenefitsofcombatingtheshadoweconomy),andwillthereforecontinuetodemandfiscalreceiptsevenwithout such an additional monetary incentive. In our research, wefoundthatreceiptlotteriesseemtohavesomepositiveimpact on card payments (and through that channel also on the passive shadow economy), though no quantitative conclusions onthestrengthofthisimpactcanbedrawn.


Chart 1. Summary of the impact of the analysed regulations on the passive shadow economy, compared to the passive shadow economy level (% of GDP).

2.94

6.74

1.14

0.74

5.21

0.59

0.013

0.28

9.22

0.71

2.21

0.26

0.52

2.28

0.16

0.002

0.02

0.0 2.0 4.0 6.0 8.0 10.0 20.0 22.0

Passive shadow economy level

Tax incentive for merchants- optimal tax relief

Tax incentive for consumers- optimal tax relief

Obligation to operate POS terminals -all passive shadow economy sectors

Obligation to possess cash registers

Threshold for consumer cash payments- threshold no. 3

Obligation to make an electronic paymentof pensions

Obligation to make an electronic paymentof unemployment benefits

Obligation to make an electronic paymentof wages and salaries

21.04

Minimum impact

Maximum impact

Minimum Maximum

Source: EY

Chart 2. Summary of the impact of the analysed regulations on the government VAT and CIT revenues, compared to the overall lost VAT and CIT revenues due to the passive shadow economy (% of GDP).

0.25

0.27

0.13

1.04

0.12

0.003

0.051

0.02

0.10

0.01

0.12

0.39

0.03

0.0004

0.003

0.0 0.4 0.8 1.2 1.6 2.0 4.0 4.2

Overall lost VAT and CIT revenues









Minimum impact

Maximum impact

4.191.56Minimum Maximum

0.63

Source: EY

Executive Summary


• Theeffectsoftheanalysedregulationsturnouttobehighlycountry-specificanddependonsuchfeaturesoftheanalysedmarketsastheshareofcashvs.cardpaymentsintheoverallconsumertransactions,theshareofcashlesspaymentsinGDP,thesizeofthepassiveshadoweconomyandtheeffectivetaxrates.Despitethesedifferences,wehaveshownthatforeveryanalysedcountryanincreaseinthepopularityofelectronicpaymentsmaybeanimportantmeasureinaddressingtheproblemofunreportedactivities.For example, an increase in the value card payments by 100%shouldleadtoareductionoftheshadoweconomyintheanalysedcountriesby0.6–3.7%ofGDP,andtoanincreaseingovernmentrevenuesby0.1–0.8%ofGDP.

• Eachofthepresentedmeasuresshouldberegardedasoneofmanypossiblevariantsofagiventypeofregulation.Sincethesesolutionsmaybemodifiedintermsoftheirscope,timing and other parameters, their actual impact would changeaccordinglyandwilldependonthefinaldecisionoftheregulators.Consequently,themeasuresanalysedinthis study should not be treated as recommendations, but ratherasexamplesillustratingtheeffectsofthepotentialregulations that may be considered by policymakers in theirattempttoaddresstheissueofthepassiveshadoweconomy.


IntroductionThe shadow economy is a complex phenomenon that can have various causes and consequences. The literature uses many definitionsofnon-observedorshadoweconomy,withdifferentauthorsoftenfocusingondifferentaspectsofthisissue.TheEuropeanCommissiondefinesthenon-observedeconomyascomprising: (1) illegal activities where the parties are willing partners in an economic transaction, (2) hidden and underground activities where the transactions themselves are not against the law,butareunreportedtoavoidofficialscrutiny,and(3)informalactivitieswheretypicallynorecordsarekept.Underthisdefinition,the shadow economy can be approximated by unreported transactions made by both registered and unregistered entities.

Ahighleveloftheshadoweconomyhassignificanteconomicandsocial implications. Its adverse consequences include: a reduced tax base,lowerquantity/qualityofpublicgoods,distortionsinmarketcompetition,thedegradationofeconomicandsocialinstitutions,and–throughthesechannels–lowereconomicgrowth.Whiletheshadow economy may also have some advantages, it is evident thattheyaresignificantlyoutweighedbyawiderangeofnegativeconsequencesofunreportedactivities.Therefore,itisimportanttoseektoolsandsolutionsthatmighteffectivelyreducetheshadoweconomy. However, since there is no single measure that would addressallthecausesofthenon-observedeconomy,suchsolutionsshouldbetailoredtothespecificsofactivitiesleadingtotheexpansionofagivenpartoftheshadoweconomy.Inthisrespect,itis also recommended to distinguish between incentive mechanisms and obligation instruments.

Ourapproachisbasedontheobservationthatacommonfactorformosttypesoftheshadoweconomyactivitiesisthatitiscashpaymentsthatallowthesellernottoreportthetransaction.Withonlyafewexceptions,ifanelectronicpaymentwasmadeinsteadofcash,itwouldhardlybepossiblenottoregisterthetransaction.Nevertheless,asweshowfurtherintheReport,themotivationtousecashbyeithersideofthetransactionvarieswiththetypeofactivities,whichinturnrequiredifferentsolutions.Inthisstudy,weproposetodistinguishthe“passive”componentoftheshadow economy, where consumer cash payments are the cause ratherthantheresultofunreportedactivitiesandconsumersareoftenunawareofcontributingtotheexpansionoftheshadoweconomy.Importantly,thiscomponentofunregisteredactivitiesmaybereducedthroughthepromotionofelectronicpaymentstocrowd out consumer cash transactions. Other measures aimed at increasingtheshareofregisteredconsumercashpaymentsmayalso help to address this issue.

Whiletherelationbetweencashpaymentsandtheshadoweconomyhasbeenbroadlydiscussedintheliterature,theinfluenceofpaymentpractices(includingthepopularityofelectronicpayments)onthenon-observedeconomyhasrarelybeeninvestigatedintheempiricalresearch.OurReportaimstofillthisgap.


In this study we analyse the shadow economy in eight Central and Southern European countries: Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Poland, Serbia, Slovakia, and Slovenia. Ourcriticalcontributionconsistsininvestigatingthepotentialofdifferentregulatorymeasurestoreducethesizeoftheshadoweconomyinthesecountriesthroughthepromotionofelectronicpayments.

The Report has the following structure:

InChapter1,basedonareviewoftheliterature,webrieflydiscussthevariousdefinitionsoftheshadoweconomy,togetherwiththepossiblecausesandpotentialconsequencesofthisphenomenon.Wealsopointtothefactthattheimpactofnon-cashpaymentsonthenon-observedeconomyhasrarelybeeninvestigatedinempiricalresearch.Inordertofillthisgap,weintroduceadivisionofthenon-observedeconomyinto:(1)thepassive shadow economy (where cash payments are the cause) and (2) the committed shadow economy (where cash payments aretheconsequence).Wearguethatonlythefirstcomponentmaybereducedthroughthepromotionofelectronicpayments,whilethe latter should be addressed with other measures (e.g. labour inspections).

InChapter2,weexplainourapproachtotheestimationoftheoverallleveloftheshadoweconomy,thelevelofthepassiveshadow economy and its evolution over time. Moreover, we estimatethesectorialbreakdownofthepassivecomponent,whichis our other contribution to the shadow economy literature. Next, wediscusstheselectedcharacteristicsoftheanalysedcountriesand various data sources used in the research. Finally, we present theobtainedshadoweconomyestimatesfortheselectedcountries.

InChapter3,wefocusonthemeasuresaimedatlimitingtheshadoweconomy.First,wepresenttheeconometricallyidentifieddeterminantsofthepassiveshadoweconomyandtheirquantitativeimpact on the unreported cash transactions. In particular, we discusstherelationbetweenthevalueofcardpaymentsandthesizeofthepassiveshadoweconomy.Second,weanalysethepotentialimpactofintroducingdifferentregulatorytoolsonreplacing consumer cash payments with card payments and, throughthischannel,onthecontractionoftheshadoweconomy.Theresultingincreaseinthevalueofreportedtransactionsisthentranslatedintoadditionalgovernmentrevenues,adjustedforpotentialcoststhatagivenregulationmayentail.Thiskindofanalysis, to our knowledge, has not yet been done in the literature. Thefinalchapterconcludes.

Foreachoftheanalysedcountries,aseparatereporthasbeenprepared,providingmoreinsightintothespecificsofagivencountry,includingamoredetaileddescriptionoftheconsideredregulationsandassessmentoftheireconomicimpact.

TheresultsofvariouscalculationspresentedintheReportarediscussed in greater detail in the appendices to this study1.

This study was commissioned by MasterCard and was conducted independently by EY.

1 The Report, technical appendices and individual country reports are availableon:http://www.ey.com/pl/electronic-payments. 7Reducing the Shadow Economy through Electronic Payments |

1 The shadow economy and its types

1


1.1. Definition of the shadow economy

Theliteratureusesmanydefinitionsofthenon-observedorshadoweconomy,withdifferentauthorsfocusingonslightlydifferentaspectsofthephenomenon.Forinstance,Schneider,BuehnandMontenegro2definetheshadoweconomybyfocusingmainlyonthereasonfortheshadoweconomytoexist,i.e.thewillingnessofindividuals and businesses to avoid taxes or regulations:

“(…)theshadoweconomyincludesallmarket-basedlegalproductionofgoodsandservicesthataredeliberatelyconcealedfrompublicauthoritiesforanyofthefollowingreasons:

(1)toavoidpaymentofincome,valueaddedorothertaxes,

(2)toavoidpaymentofsocialsecuritycontributions,

(3) to avoid having to meet certain legal labour market standards, suchasminimumwages,maximumworkinghours,safetystandards, etc.; and

(4) to avoid complying with certain administrative procedures, such as completing statistical questionnaires or administrative forms.”

Thisdefinitionexcludesillegalactivities,whichisnotalwaysthecaseintheliterature.Oneofthemostimportant(andrelativelyrecent)definitionsincludingillegalactivitieshasbeenprovidedbytheEuropeanCommissioninadocumentwithguidelinesforthesystemofnationalaccountsintheEuropeanUnion(ESA2010)3. TheCommissionusesthetermnon-observedeconomy,whichcomprises:

• Illegal activities where the parties are willing partners in an economic transaction (e.g. drug selling);

• Hidden and underground activities where the transactions themselves are not against the law, but are unreported to avoid officialscrutiny(e.g.unreportedpartofrevenuestoavoidtaxation);

• ►Activitiesdescribedas‘informal’,typicallywherenorecordsarekept(e.g.householdsthatoccasionallyletrooms,non-registeredteaching assistants, etc.).

2 SchneiderF.,BuehnA.,MontenegroC.E.,“ShadowEconomiesAllovertheWorld:NewEstimatesfor162Countriesfrom1999to2007”,PolicyResearchWorkingPaper,5356,TheWorldBank,2010.

3 EuropeanCommission,“EuropeanSystemofAccounts.ESA2010”,2013.ThedefinitionprovidedbytheEuropeanCommissioninfluencesthescopeandcoverageoftheshadoweconomyestimatedbynationalstatisticaloffices.Italsoconstitutesanimportantreferencepointfortheshadoweconomydefinitionsutilisedintheresearchonthenon-observedeconomy.

Thisdefinitionexcludesthoseillegalactivitieswhereatleastoneofthepartiesisnotawillingparticipant(e.g.theft),astheyarenoteconomic transactions. It also excludes household and domestic servicesprovidedbymembersofhouseholdsfortheirownconsumption(e.g.cookingforaspouse),sinceitisdifficulttoassigntothemaspecificmonetaryvalue(theyaregenerallyexcludedfromthenationalaccountsystem,e.g.fromGDPcalculations).

ThescopeandcoverageoftheshadoweconomyanalysisinthisReportislargelyconsistentwiththequoteddefinitionoftheEuropean Commission. It is illustrated by Chart 1.1, showing that the shadow economy is approximated by unreported transactions, which are made by both registered and unregistered entities. Averyimportantcommonfactorforalltypesofshadoweconomyis that it is cash payments that allow the seller not to report the transaction.Withonlyafewexceptions(suchase-commerce,onlinebookmakersorbartering),ifanelectronicpaymentwasmadeinsteadofcash,itwouldhardlybepossiblenottoregisterthetransaction.Consequently,inourapproachwefocusonmeasuring unreported consumer cash transactions that should well approximatethesizeoftheshadoweconomy4.

Oneshouldalsonotethatiftheestimatedcashtransactionswerereported, it would translate into higher government revenues due to theimprovedtaxcollection(notleastfromCITandVAT)5. However, thisisnottosaythateliminatingthethus-definedshadoweconomywould at the same time eliminate the whole tax gap6. Chart 1.1 showsthattaxfraudortaxevasionarealsopossiblewithregisteredtransactions, paid either in cash or electronically7. One example is themissingtraderfraud,whereatransactionisreported,aninvoiceisissued,paymentismade,buttheseller“disappears”withoutpayingitsVATliability.Thefactofregisteringthetransactionmay,therefore,notsufficetoensuretaxcollection.Inordertoaddresssuch issues, additional measures have to be adopted that, however, arebeyondthescopeofthisReport.

4 Since our approach concentrates on cash transactions, it also accounts forthesocalled“blackmarket”transactions(illegalactivities).However,itdoesnotaccountforthoseshadoweconomytransactionsthatareconductedintheformofabarter(inexchangeforothergoodsandservicesratherthanformoney),orwiththeuseofelectronicpayments.

5 The only exception being illegal products and services, which are not taxed anyway.

6 Variousdefinitionsofthetaxgapandalternativemethodsofitsmeasurementarediscussed,forexample,inGemmelN.,HasseldineJ.,“TheTaxGap:AMethodologicalReview”,WorkingPaper09/2012,VictoriaBusinessSchool,andRaczkowskiK.,MrózB.,“Taxgapintheglobaleconomy”,mimeo,UniversityofSocialSciences,WarsawSchoolofEconomics, September 2015.

7 OntheVATgapsee,forexample,“StudytoquantifyandanalysetheVATGapintheEUMemberStates”,CenterforSocialandEconomicResearch,2015.


Chart 1.1. Different elements of the shadow economy.

Economic activities

Registered entities

Unregistered entities

Unreported transactions that increase the tax gap

Illegal product or service

Transactions that we measure in this Report

Illegal possession

Illegal sales

Unreported transactions that do not increase the

tax gap

Legal product or service

Illegal form of sales

Illegal source

Other unregistered sales (informal

activities)

Unregistered transactions

With benefits for one side of the

transaction

With benefits for two sides of the

transaction

Tax evasion/ tax frauds

VAT frauds (e.g. missing

trader frauds)

Reported transactions that increase the tax gap

Other tax evasion/fraud schemes

Other registered transactions*

Unregistered employment

Legend:

Notes:Unreportedtransactionsareequivalentofnon-observedeconomy,asdefinedbytheEuropeanCommission.

Source: EY

* Other registered transactions may also increase the tax gap, for example, in the case of tax avoidance, the abuse of transfer pricing, non-payment due to insolvency or differences in the legal interpretation of the rules. For more details see, for example, HM Revenue & Customs, “Measuring tax gaps 2015 edition. Tax gap estimates for 2013-14”, 2015.


1.2. Possible causes and potential consequences of the shadow economy

The shadow economy is a very complex phenomenon that can have various sources, varying over time and among countries. On the basisoftheliterature8itispossibletodividethepossiblecausesoftheshadoweconomyintothefollowingcategories:

• Taxes Avoidingthepaymentofincome,valueaddedandothertaxesisoftenconsideredasanimportantfactordrivingindividualsintothenon-observedeconomy;

• Social security contributions Both employees and employers might be interested in entering the shadow economy by paying less (or none) social security contributions, to increase take home earnings and decrease labour costs, respectively;

• Administrative Registered activity may be hindered by a high burden imposed by administrativerulesthatgeneratehighcostsforbusinessesandare costly to comply with;

• Quality of administration and justice system Asenseofprotectionbythelaw,whichcanbeunderstoodasastablelawandeffectivejudicialsystem,createsincentivestoact in the registered economy. Furthermore, increasing the risk ofdetectiondiscouragesindividualsfromenteringtheshadoweconomy.Bycontrast,alowqualityofadministrationandjusticesystemmaybeconducivetoenteringorremaininginthenon-observed economy;

• Economic institutions Theflexibilityofemploymentcontracts,minimumwagesandotherrulesdefiningtheeconomicenvironmentcaneitherencourage or discourage businesses to operate within the legal framework;

• Business cycle Aneconomicslowdownandreducedopportunityoffindingajobintheofficialsectormayencourageworkerstoenterthenon-observed economy;

• Payment practices and systems Cashiseasiertohidefromthepoliceandotherauthorities,sotransactionsthatareperformedwithcasharemorelikelytobeunregistered;

• Values and moral aspects Ahighlevelofsocialcapitalandtrustinotherpeoplediscouragescheating behaviour, such as activity in the shadow economy, and vice versa;

8 ThiessenU.,“TheShadowEconomyinInternationalComparison:OptionsforEconomicPolicyDerivedfromanOECDPanelAnalysis”,InternationalEconomicJournal,vol.24(4),2010,pages481-509.

• Other subjective factors People’sgeneralsatisfactionfrompublicgoodsandservicescanincrease tax morale and contract the shadow economy, and vice versa.

Someofthepresentedcausesaffectingthesizeoftheshadoweconomycanbedifficulttomeasure.Consequently,inordertoanalyseandquantifytheireffectonthesizeofnon-observedeconomy, it is necessary to use proper proxies, i.e. observable variables that are assumed to capture the prevalence and intensity ofaparticularcauseoftheshadoweconomy.Therefore,inthefurtherpartofouranalysis,weusenotonlytheofficialstatisticaldata,butalsotheresultsofsurveysandreportsconcerningsuchthings as public policy quality.

Theshadoweconomyhassignificanteconomicandsocialimplications. The potential adverse consequencesofa(high)shadow economy include9:

• Lower observable tax base Theshadoweconomyisassociatedwithawillingnessofindividuals and enterprises to evade taxation, so an increase in itssizemeansthatalargerpartoftheeconomyisnotcoveredbythe tax system, which leads to a decline in government revenues.

• Lower quantity and/or quality of public goods By decreasing government revenues, the shadow economy negativelyimpactstheprovisionofpublicgoods(e.g.publicinfrastructure);

• Distortions in competition Companiesoperatingintheshadoweconomybenefitfromreducing their costs and thereby increase their competitiveness comparedtocompaniesoperatingexclusivelyontheofficialmarket;

• Degradation of economic and social institutions Loweredtaxrevenuesmayforcethegovernmenttoadditionallyincrease tax rates to cover its expenses, which would mostly affectlegallyoperatingcompanies.Asaresult,manyhonestcompaniesmightbeforcedtomovetotheshadoweconomyorleave the market;

• Economic growth Theshadoweconomycanadverselyaffectlegaleconomyactivitybydegradingthequalityofeconomicandsocialinstitutions,decreasingtheavailabilityofpublicgoods,etc.

9 Forareviewoftheliteratureontheconsequencesoftheshadoweconomysee:EnsteD.H.,SchneiderF.,“ShadowEconomies:Size,Causes,andConsequences.”JournalofEconomicLiterature,vol.38(1),2000,pages77-114.


Insomeareas,theeffectsoftheshadoweconomyaresubjecttoa vigorous debate. For example, some authors present evidence that the shadow economy and corruption are complementary (the larger the shadow economy, the more prevalent is corruption)10. On the other hand, some claim that the shadow economy can mitigate government-induceddistortions11andworkasasubstituteforcorruption (decreasing its scale).

Anothercontroversialaspectoftheshadoweconomyconsequencesis related to the labour market. It is likely that some people are only abletofindjobsintheshadoweconomy,especiallyinaperiodofeconomic downturn when the unemployment rate is high12. In this context,itcouldbearguedthatajobintheshadoweconomyisbetterthannojob.Moreover,evenifapersonisemployed“offthebooks”,thereissomeevidencethatavastmajorityofhisorherincome13 is usually spent on products and services provided by legal businesses.However,suchaformofemploymententailsmanyrisksandcosts.Peoplethatareunofficiallyemployedmostoftenlacksocialandlegalprotection.Theymayalsofinditveryhardto

10 DreherA.,SchneiderF.,“Corruptionandtheshadoweconomy:anempiricalanalysis”,PublicChoice,vol.144(1),2010,pages215-238.

11 ChoiJ.P.,ThumM.,“CorruptionAndTheShadowEconomy”,InternationalEconomicReview,vol.46(3),2005,pages817-836,08.

12 BajadaCh.,SchneiderF.,“UnemploymentandtheShadowEconomyintheOECD”,Revueéconomique,PressesdeSciences-Po,vol.60(5),2009,pages1033-1067.

13 Atleasttwo-thirdsincaseofGermanyandAustria.See:EnsteandSchneider (2000), op. cit.

develop skills, be promoted, increase their earnings and get alegalemploymentcontractinthefuture,thusbeingtrappedin the shadow economy14 15.Moreover,thereducedcostofworkdue to using unregistered employment provides some companies withanunfaircompetitiveadvantageoverothercompaniesthatreport their employment and pay all required taxes and social contributions.

The above examples illustrate that, while the shadow economy may have some advantages (controversial though they may be), itisratherevidentthattheyaresignificantlyoutweighedbythewiderangeofnegativeconsequencesofthenon-observedeconomy.Therefore,itisimportanttoseektoolsandsolutionsthatmighteffectivelyreducetheshadoweconomyanditsnegativeconsequences.Suchsolutionsshouldbetailoredtothespecificsofactivitiesleadingtotheexpansionoftheshadoweconomy.Inparticular,oneshouldfirstinvestigatethesize,dynamics,structureandsectorialbreakdownoftheshadoweconomyinagivencountry.

14 BajadaandSchneider(2009),op.cit.15 ILO,“Transitioningfromtheinformaltotheformaleconomy”,2014,

pages1-86.


1.3. Passive and committed shadow economy

Whileapproximatingthesizeoftheshadoweconomybyestimatingthevalueofunreportedcashtransactions,wedistinguishtwocategoriesoftheshadoweconomy,eachrequiringdifferentmeasures.Thefirstcomponentisthatpartoftheshadoweconomythat can be reduced by promoting electronic payments and limiting theuseofcash.Sincecashpaymentsleavenoelectronictrace,itis relatively easy to avoid reporting them. Cash payments can thus generate shadow economy activity, as they provide an incentive forthemerchantnottoreportatransactionandevadepayingtax.Thesecondcategoryistheremainingpartoftheshadoweconomy,whereitisnotthecashpaymentthatinfluencesthedecisionnottoreportthetransaction,butthemotivationofbothsidesofthetransactiontobenefitfromevadingtaxliabilitiesortosell/buyillegalproducts/services.Thecashformofpaymentis(usually)stillrequiredtohidethetransaction,butitisnolongerthesourceofillegal activity.

Thekeydifferentiatingfactorbetweenthesetwocomponentsisthe causal relationship between cash payments and the shadow

economy.Inthefirstcategory,cashpaymentscontributetotheexpansionoftheshadoweconomy,whileinthesecondcomponentincreasedcashpaymentsaresimplyaresultoftheshadoweconomyactivities.Wethereforedistinguishsituationswhere:

• cash is a cause(oroneofthecauses)oftheshadoweconomy

fromsituationswhere

• ►cashisaconsequenceoftheshadoweconomy

The shadow economy where cash is a cause we label as the “passive shadow economy”,becauseonesideofthetransaction–theconsumer,is“passive”inthesensethathe/shedoesnotbenefitfromnotreportingthetransaction,andmaynotevenbeawarethatheorsheiscontributingtotheexpansionoftheshadoweconomy through the cash payment. The shadow economy where cash is a consequencewedefineasthe“committed shadow economy”(seeChart1.2),becausebothsidesofthetransactionare“committed”tousingacashpaymentinordernottoreportatransaction,andtherebybenefitfromalowerpricestemmingfromevadedtaxpayments.Table1.1includesamoredetaileddescriptionandexamplesofthecommittedandpassiveshadoweconomy transactions.

Chart 1.2. Types of shadow economy with respect to the role of cash.

Committedshadow economy

Passiveshadow economy

Cash

Shadow economy

Demand for cash is the result

Availability of cash is the trigger

Source: EY

Asthisshows,theshadoweconomyisnothomogenous–therearedifferentshadesofgrey.Therefore,theconsequencesandmeasurestolimittheshadoweconomymayalsodifferdependingon its type.

Actions aimed at limiting the committed shadow economy should resultinalowerdemandforcash,andthusleadtotheincreaseduseofelectronicpayments.Nevertheless,measurestoreducethecommitted shadow economy are not related to promoting cashless

payments,andwouldratherinclude,forexample:increasingthelabour inspections at building sites, introducing more restrictive penaltysanctionsforcounterfeitingofexciseproducts,etc.

In contrast to the committed shadow economy, the passive shadow economyiscausedbycashpayments.Therefore,itcouldbereduced either through actions promoting electronic payments or throughmeasuresincreasingtheshareofcashtransactionsbeingregistered.


Table 1.1. Differences between the committed and the passive shadow economy.

Committed shadow economy Passive shadow economy

Description • Mutualagreementbetweenbothsidesofatransaction

• Eachsidedrawsbenefitsfromnotreportingthetransaction

• Associated with both illegal and legal products/services

• Onlyonesideofatransactionisinterestedinhidingincome,whereastheothersideisnotdirectlyinterestedinthefraud(andtakesnobenefitfromit)

• ►Consistsinunderreportingrevenuesfromconsumerretailtransactions by registered, legally operating entities

• ►Associatedwithlegalproducts/services

Examples ofshadoweconomy situations

• A construction worker and his client agree that the renovationofaflatwillbeconductedintheshadoweconomy,i.e.withoutinvoicingandaformalcontract.Inthiswaybothpartiescanbenefitfromnotpayingtaxes(e.g.VATinthecaseofaconsumer,PITorCITinthecaseofaservice-provider)

• An employer and an employee agree that the latter will provideservicesinformally,whichwillallowthecompany’sownertosaveonsocialsecuritycontributions,butpartofthese“savings”willbesharedwiththeemployee,whowillthus receive a higher payment in net terms

• Aconsumerpaysforaservice(forexampleinarestaurant)incash. The seller does not register the transaction and does not payVATorincometaxfortheservice

Shadow economy trigger

• Agreementbetweenbothsidesofthetransactiontobenefitfromtaxevasionorbuying/sellingillegalproducts/services.Theirbehaviourwouldnotbeinfluencedbyimprovedaccesstoelectronicpaymentsinfrastructure

• Cashpayment.Ifanelectronicpaymentwasmade,thepossibilitytonotregisterthetransactionwouldbesignificantlyreduced

Examplesofsolutions

• Labour inspections

• ►Reductionofadministrativeburdenrelatedtocompliancewith the regulations

• Promotionofelectronicpayments

• ►Receiptlotteries

• ►Informationcampaign,e.g.promotingthecollectionofreceipts

Main beneficiaries

• Twosidesofthetransaction(sellerandbuyer) • Onesideofthetransaction(seller)

Source: EY

In this Report, we concentrate on solutions related to the developmentofnon-cashpayments(e.g.throughanincreaseduseofpaymentcards)asameansofreducingthepassiveshadoweconomy.Whiletherelationofcashpaymentsandtheshadoweconomy has been broadly discussed in the literature (it constitutes, amongotherthings,abasisforthecurrencydemandanalysis–anestimationmethodofthesizeoftheshadoweconomy,seeChapter3.1),theinfluenceofpaymentpractices(e.g.thepopularityof

non-cashpayments)onthenon-observedeconomyhasrarelybeeninvestigated in the empirical research16.OurReportaimstofillthisgap.

16 Dataonelectronicpaymentswasusedine.g.:ArdizziG.,PetragliaC.,PiacenzaM.,TuratiG.,“MeasuringtheundergroundeconomywiththeCurrencyDemandApproach:Areinterpretationofthemethodology,withanapplicationtoItaly”,ReviewofIncomeandWealth,vol.60(4),2014,pages747-772.


2 Shadow economy in Central and Southern EuropeIInthissectionwebrieflydiscussourapproachto estimating the shadow economy and present theobtainedestimatesfortheeightanalysedcountries: Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Poland, Serbia, Slovakia and Slovenia. The estimates comprise theoverallleveloftheshadoweconomy,itsdecomposition into the passive and committed components, their evolution over time and the sectorialbreakdownofthepassiveshadoweconomy.

More details on the applied methodology and obtained results are presented in Appendix 1.

2


2.1. Our approach to the estimation of the shadow economy

Therearemanymethodsforestimatingtheshadoweconomy,asdiscussed in the economic literature. The most common include:

• Currency Demand Analysis (CDA),17 which is based on the idea thatthecurrencyincirculation(cash)conveysusefulinformationaboutall(notonlyofficiallyregistered)economicactivities;

• Multiple Indicators Multiple Causes Model (MIMIC),18 which allowsthechangesofunobservablevariables(suchastheshadoweconomysize)overtimetobeestimatedonthebasisoftheir observable causes and consequences;

• Energy Demand Approach,19 which assumes that electric energy isdemandedbybothofficialandshadowmarketentities.

Therearealsoother,lesscommonmethodsofestimatingtheshadoweconomy,suchasdirectsurveysoranalysesofthestructuralaspectsofthelabourmarket(forexample,acomparisonofofficialandsurvey-basedlabourstatistics)20.

17See,forexample,TanziV.“TheUndergroundEconomyintheUnitedStates:AnnualEstimates,1930-80”,StaffPapers–InternationalMonetaryFund,Vol.30,No.2,1983,pp.283-305andArdizziG.,PetragliaC.,PiacenzaM.,TuratiG.,“MeasuringtheundergroundeconomywiththeCurrencyDemandApproach:Areinterpretationofthemethodology,withanapplicationtoItaly”,ReviewofIncomeandWealth,vol.60(4),2014,pages747-772.

18See,forexample,SchneiderF.(editor),“HandbookontheShadowEconomy”,Cheltenham(UK):EdwardElgarPublishingCompany,2011andBuehnA.,“TheShadowEconomyinGermanRegions:AnEmpiricalAssessment”,GermanEconomicReviewVol.13,No.3,2010,pp.275–290.

19See,forexample,LackoM.,“HiddenEconomy–anUnknownQuantity?ComparativeAnalysisofHiddenEconomiesinTransitionCountries,1989-95”,EconomicsofTransition,Volume8,No.1,2000,pp.117–149.

20Theprosandconsofthevariousmethodsofestimatingtheshadoweconomy are discussed in greater detail in Appendix 1.

Weadoptacombinedandinnovativeapproachthatexploitsthestrengthsandaddressestheweaknessesofthemethodsoutlinedabove, as applied in various studies. Our approach comprises the followingsteps:

Step 1 Estimatingtheoverallleveloftheshadoweconomy(i.e.totalunregistered cash transactions) using the currency demand analysis (CDA).

Step 2

Splitting the shadow economy into its committed and passive components with the labour market analysis (LMA), based on the assumptionthattheoutputofthecommittedshadoweconomyiscorrelatedwithandmirroredbyshadowlabourforceinputs.

Step 3Estimatingtheevolutionofthepassiveshadoweconomyovertime,andidentifyingitsdeterminantsusingthe MIMIC model.

Step 4Assessing how the passive shadow economy volumes were spread between various sectors using the sectorial structure analysis (SSA).

Ourfour-stepapproachisillustratedinFrame2.1.Fortechnicaldetails see Appendix 1.


Frame 2.1. Estimation and decomposition of the shadow economy – an EY approach.

Overall level of

the shadow

economy

CDA

LMA

LMA

Level of the passive

shadow economy

Level of the

committed shadow

economy

MIMIC

Evolution of the

passive shadow

economy

SSA

Sectorial breakdown

of the passive shadow

economy

Evolution of the committed shadow economy

By-product

of MIMIC

Notes: Currency Demand Analysis (CDA), Labour Market Analysis (LMA), Multiple Indicators Multiple Causes model (MIMIC), Sectorial Structure Analysis (SSA).

Source: EY

Our contribution to the literature includes:

• thebreakdownoftheshadoweconomyintoitspassiveandcommitted components;

• aformalisedcalculationofthesectorialstructureofthepassiveshadow economy;

• addressinganumberofmethodologicalissues,oftenleadingtotheoverestimationoftheshadoweconomyinotherstudies.

Whilemanypubliclyavailableanalysesoftheshadoweconomydo not provide methodological insights, the methodology applied in this study is described in detail (see Appendix 1). Since it is impossible to avoid adopting certain assumptions in the procedure ofestimatingtheshadoweconomy,ourapproachcanalsobequestioned on some grounds. Nevertheless, we would not seek to avoid criticism by limiting our transparency, and think openness is crucial. Importantly, we have improved some methodologies appliedintheshadoweconomyliteraturesofar,whichhasallowedustosignificantlyreducethenumberofrequiredassumptionsand discretionary steps to be taken in the estimation procedure. Consequently,webelievethatourestimatesoftheshadoweconomyshouldbemoreobjective,andthusmorereliable,thantheresultsofmanyotherstudiesbasedontheCDAand/orMIMICapproaches.Moreover,wetesttherobustnessofourconclusionsbysubjectingourassumptionstosensitivityanalysis.


Appendix1andAppendix2includeadiscussionofthemethodologicalissuesthatwehaveidentifiedinotherstudiesoftheshadoweconomy.Inparticular,wearguethatsomeoftenquotedestimatesoftheshadoweconomyseemtobeinflatedandbasedontoomanyarbitrary assumptions. Importantly, in the appendices we present in detail how we have addressed these methodological issues. In particular:

1 WerejectsomequestionableassumptionsappliedintheCDAliterature (e.g. that with no taxes the shadow economy would totally disappear),whichseemtoleadtoanoverestimationoftheshadoweconomy.

2 In the MIMIC modelling, we do not use external estimates oftheshadoweconomylevelfromdubiousandoftenoutdatedsources,whichseemstohaveresultedinanoverestimationofthe shadow economy in some studies.

3 WedonotapplyarbitrarydatatransformationintheMIMICmodel,whichmaysignificantlyaffecttheobtainedestimates,butinsteadweuseatransformationdevelopedbyEYthatisfullyobjectiveandthusnotinfluencedbyanydiscretionary decisions.

4 In the CDA, we use more reliable assumptions regarding theso-calledvelocityofmoney,whichallowsustoavoidtheproblemofoverestimatingthesizeoftheshadoweconomy.Moreover,wedonotneedtoassumethatthevelocityofmoneyis constant.

5 WehaveintroducedthetransformationoftheparametersoftheMIMICmodelthatallowustointerpretthestrengthofeconomic relationships between variables entering the MIMIC analysis(asfarasweareaware,inpreviousstudiesusingtheMIMIC model, it was only possible to analyse the direction oftheserelationships).This,inturn,enablesustoassessthestrengthoftheimpactofthedevelopmentofelectronicpaymentsonthesizeofthepassiveshadoweconomy.


Map 2.1. Analysed countries.

Source: EY

Wetakeintoaccountthecomplexityofthepossiblecausesoftheshadoweconomyanddifficultiesrelatedtotheirmeasurement(seeChapter 1). To address these issues we have created a vast dataset based on various sources, including (among other things):

• Eurostatandstatisticalofficesoftheinvestigatedcountries;

• Databasesofnationalcentralbanks;

• Databasesofinternationalorganisations(e.g.WorldBank,International Monetary Fund, International Labour Organization);

• Datafromeconomicreports(e.g.WorldCompetitivenessReport,Doing Business);

• Data provided by MasterCard.

Basedontheexistingliterature,andwiththeuseofstatisticaltesting(whereappropriate),wehavechosenasetofmajorcausesandindicatorsoftheshadoweconomythathavelaterbeenusedtoestimatethesize,structureandsectorialbreakdownoftheshadoweconomy(seeTable2.1forthesummaryofmaingroupsofthesevariables,andAppendix1forfurtherdetails).

2.2. Analysed countries and data sources used

OuranalysisfocusesoneightcountriesinCentralandEasternEurope, namely: Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Poland, Serbia, Slovakia, and Slovenia (see map 2.1).Thetimescopeoftheanalysisisdeterminedbytheavailabilityofdataforeachofthosecountries(themaximumtimerangeis2000–2014).Insomepartsofouranalysis,wealsoincludeadditionalcountriesinordertoincreasethesizeofthedatasetandmaximisethepotentialoftheeconometricestimation21.

21Includingadditionalcountriesincreasestheavailableinformationsetandimprovesthequalityofeconometricestimates.Thesecountriescomprise:Hungary,Denmark,Norway,Sweden,theUnitedKingdom,Austria,Finland,Germany,Italy,PortugalandSpain.


Map 2.1. Analysed countries.

Source: EY

Wetakeintoaccountthecomplexityofthepossiblecausesoftheshadoweconomyanddifficultiesrelatedtotheirmeasurement(seeChapter 1). To address these issues we have created a vast dataset based on various sources, including (among other things):

• Eurostatandstatisticalofficesoftheinvestigatedcountries;

• Databasesofnationalcentralbanks;

• Databasesofinternationalorganisations(e.g.WorldBank,International Monetary Fund, International Labour Organization);

• Datafromeconomicreports(e.g.WorldCompetitivenessReport,Doing Business);

• Data provided by MasterCard.

Basedontheexistingliterature,andwiththeuseofstatisticaltesting(whereappropriate),wehavechosenasetofmajorcausesandindicatorsoftheshadoweconomythathavelaterbeenusedtoestimatethesize,structureandsectorialbreakdownoftheshadoweconomy(seeTable2.1forthesummaryofmaingroupsofthesevariables,andAppendix1forfurtherdetails).

Table 2.1. Types and sources of variables used in the analyses.

Group Description Sources

Monetary aggregates Variablesrelatedtothequantityofcashandtotalamountofmoneyusedfortransactionalpurposes(e.g.cashincirculation,M1monetaryaggregate)

EcoWin(InternationalMonetaryFund),nationalcentral banks, European Central Bank

Non-cashtransactionsindicators

Indicatorsrelatedtothedevelopmentofnon-cashtransactionsystems(e.g.numberofpaymentcards,numberofpaymentterminals,valueofcardtransactions,etc.)

MasterCard, European Central Bank, national central banks

Macroeconomic indicators

Macroeconomicindicators(e.g.GDP,consumptionexpenditureofhouseholds, etc.)

Eurostat,EcoWin,nationalcentralbanks,nationalstatisticaloffices

Labour market Variablesrelatedtothelabourmarket(e.g.totalemployment,unemployment rates, etc.)

Eurostat,localstatisticaloffices,EcoWin,International Labour Organization

Tax burden variables Variablesdescribingtheleveloftaxationandsocialsecuritycontributions(e.g.taxesandsocialcontributionsas%ofGDP)

EcoWin,nationalstatisticaloffices,Eurostat,WorldBank

Institutional and tax morale variables

Qualitativevariablesallowingacomparisonoftheanalysedcountriesintermsoftheirinstitutionaldevelopment,governanceandtaxmorale(e.g.ruleoflawindex

WorldBank,HeritageFoundation

Socio-demographicvariables

Variablesrelatedtosocio-demographicfactors(e.g.thesizeofthepopulation,theshareofpopulationwithinternetaccess,etc.)

Eurostat,EcoWin,InternationalTelecommunication Union (United Nations)

Auxiliaryindicatorsofthepassive shadow economy

VariablesusedintheMIMICmodelasauxiliaryindicatorsoftheevolutionintimeofthepassiveshadoweconomy(e.g.thedifferencebetweenthestandardVATrateandtheratiooftheactualVATrevenues to the domestic demand)

EYcalculationsbasedonEurostat,OECD,WorldBank and additional data sources, including nationalministriesoffinance

Sectorial variables Variablesusedinthesectorialbreakdownofthepassiveshadoweconomy(e.g.sectorialhouseholdconsumptionstructure,valueofsectorial card transactions)

Nationalstatisticaloffices,Eurostat,MasterCard

Source: EY

Theeightanalysedcountriesdiffersignificantlywithrespecttothe variables considered in Table 2.1. It applies not only to the paymentinfrastructure,whichisthecentralfocusofthisstudy,butalsotoothervariables.Weaccountforallthesedifferencesinourcalculations.Inparticular,weaccountfortheinstitutionalandtaxmorale(motivationtopaytaxes,otherthanlegal)differencesthroughtheuseoftheWorldBank’sruleoflawindex22.

22TheWorldBank’sruleoflawindexreflectsperceptionsoftheextenttowhichagentshaveconfidenceinandabidebytherulesofsociety,andinparticularthequalityofcontractenforcement,propertyrights,thepolice,andthecourts,aswellasthelikelihoodofcrimeandviolence.Thisvariableisalsoagoodproxyfortaxmorale(see,forexample,FreyB.S.,TorglerB.,“TaxMoraleandConditionalCooperation”,IEW–WorkingPapers286,InstituteforEmpiricalResearchinEconomics–UniversityofZurich, 2006).

Inoureconometricestimations,wealsoaccountfortheincomedifferencesbetweencountries(seeFrame2.2),whichaffect,forexample,thedemandforcurrency.Moreover,weaccountforthefactthatSlovakiaandSloveniajoinedtheeuroareaintheanalysedperiod, which entailed substantial changes in monetary aggregates inthesecountries(i.e.agradualdecreaseofcashincirculationinthe months preceding the euro cash changeover).


Frame 2.2. Comparison of the economic development and card payment infrastructure in selected European countries

Considerabledifferencesinincomepercapitaadjustedforpurchasingpowerstandards(PPS,differentpricelevelsamongthecountries) that can be observed across the analysed economies (seeChart2.1)areoneofthefactorsaffectingthelevelofcardinfrastructuredevelopment,thatinturndecreasesthewillingnessofindividualsandbusinessentitiestooperateintheshadoweconomy.Inthegroupofanalysedcountries,theCzechRepublicandSloveniahavethehighestlevelofGDPpercapita(inPPS),which is almost three times as large as in Bosnia and Herzegovina.

Intheanalysedgroupofcountries,thelargestnumberofcardsper capita is recorded in Croatia and Slovenia (see Chart 2.2). Interestingly, Croatia, with 2.2 cards per capita, is in the top group ofEuropeancountries,nextonlytoNorway,Luxemburg,theUnitedKingdomandSweden.Ontheotherhand,inBulgaria,theCzechRepublic,Poland,SlovakiaandSerbia,thenumberofcardspercapita is among the lowest in Europe and amounts to approximately 1,andinmostcasesevenbelowthisvalue.Thisratioisbyfarthelowest in Bosnia and Herzegovina (0.5).

Chart 2.1. GDP per capita in the analysed countries in 2014 (Purchasing Power Standards, current prices).

0 10 20 30 40 50 60 70 80

LuxembourgNorway

SwitzerlandIreland

NetherlandsAustriaSweden

GermanyDenmark

IcelandBelgiumFinland

United KingdomFrance

ItalySpain

CyprusMalta

Czech RepublicSloveniaPortugalSlovakiaEstonia

LithuaniaGreece

HungaryPolandLatvia

CroatiaRomaniaBulgaria

Serbia

Bosnia and Herzegovina

in thousands

Source: Eurostat, World Bank, CIA (the World Factbook).


Chart 2.2. Number of cards per capita in selected European countries.


0 1 2 3 4

Norway

Luxembourg

United Kingdom

Sweden

Croatia

Malta

Portugal

Netherlands

Belgium

Germany

Slovenia

Denmark

Spain

Finland

Austria

Ireland

Estonia

Cyprus

Greece

France

Italy

Lithuania

Latvia

Bulgaria

Czech Republic

Poland

Hungary

Slovakia

Serbia

Romania

Source: ECB, MasterCard, National Bank of Serbia, Central Bank of Bosnia and Herzegovina, Eurostat.

CroatiaandSloveniaalsohavethemostdevelopednetworkofPOS terminals among the analysed countries, although they no longerrankthathigh(asbasedonthenumberofcardspercapitacriterion) when compared to other European countries with the mostdevelopedcardpaymentsinfrastructure(seeChart2.3).Onceagain,theremainingsixoutoftheeightanalysedcountriesturnout to be among the least developed European economies in terms ofavailablepaymentinfrastructure.

Chart 2.3. Number of terminals per 1000 people in selected European countries.


0 10 20 30 40

Finland

Ireland

Italy

United Kingdom

Denmark

Greece

Portugal

Spain

Sweden

Luxembourg

Croatia

Estonia

France

Slovenia

Netherlands

Austria

Latvia

Norway

Lithuania

Bulgaria

Hungary

Czech Republic

Germany

Poland

Slovakia

Serbia

Romania

Source: ECB, MasterCard, National Bank of Serbia, Central Bank of Bosnia and Herzegovina, Eurostat.


Since the most extensive card networks among the eight countries analysedinthisprojectareavailableinCroatiaandSlovenia,itisperhapsunsurprisingthatthevalueofcardtransactions23 (as % ofGDP)isthehighestinthosecountries(seeChart2.4).PolandandtheCzechRepublicrecordarelativelyhighvalueofcardtransactions in comparison with Bulgaria and Slovakia that have achievedasimilardevelopmentofcardpaymentinfrastructure.This indicates that Slovakia and, in particular, Bulgaria have the potential to expand the card payments market by increasing theutilisationoftheexistinginfrastructure.Furthermore,thereseemstobesignificantroomforimprovementinthecardnetworkinfrastructureinallthecountriesanalysedinthisproject.This,inturn,shouldresultinanincreasedpopularityofelectronicpayments,whichinturn–throughcrowdingoutcashpayments–shouldleadtoadecreaseintheleveloftheshadoweconomy (see Chapter 3).

23Ouranalysistakesintoaccountpoint-of-sale(POS)cardpaymentsperformedinagivencountrybyresidentsandnon-residents.OurmainsourcesofdataaretheEuropeanCentralBank(ECB),publicationsoftheNationalbankofSerbiaandtheMasterCarddata.Thevalueofcardpayments in Bosnia and Herzegovina has been estimated on the basis ofthedataprovidedbyMasterCardandpublicationsoftheCentralBankofBosniaandHerzegovina.Ourfocusonthecardpaymentsinsteadofa broader measure, such as electronic payments in general, is a result ofdataavailabilityandthefactthatPOScardpaymentsconstitutemostconsumerelectronicpayments.Inaddition,wefocusonconsumerface-to-facetransactionsbecausethesearethenearestsubstitutetoconsumercashtransactionsthatarerelatedtotheproblemofthepassiveshadow economy.

Chart 2.4. Card transaction value (% of GDP) in selected European countries.

0% 10% 20% 30% 40%

Portugal

United Kingdom

Denmark

Estonia

Finland

France

Sweden

Croatia

Netherlands

Cyprus

Belgium

Slovenia

Latvia

Spain

Austria

Poland

Italy

Czech Republic

Germany

Lithuania

Hungary

Slovakia

Serbia

Greece


Bulgaria

Romania

Source: ECB, MasterCard, National Bank of Serbia, Central Bank of Bosnia and Herzegovina, Eurostat


2.3. Estimated size, structure and sectorial breakdown of the shadow economy

Overall level of the shadow economyIngeneral,intheperiodprecedingtheglobalfinancialturmoil,theleveloftheshadoweconomy(expressedas%ofGDP24) in theanalysedcountrieswasdeclining(seeChart3).Aftertheoutburstofthecrisis,however,thistendencyeitherreversedorcame to a halt. Moreover, our estimates suggest that in 2014 the shadow economy contracted in all the analysed countries, with aparticularlysignificantdeclineinSerbia.

Currently, among the analysed countries, the largest shadow economies(inrelationtoGDP)areinthesouthofEurope(seeChart2.5).Weestimatethatin2014theshadoweconomywasthemostprevalentinBosniaandHerzegovina(25.5%ofGDP)andSerbia (20.7%). On the other hand, the smallest shadow economies were in the Czech Republic (11.3%), Poland (12.4%) and Slovenia (12.5%).

24Inourelaboration,wepresentourestimatesoftheshadoweconomyas“%ofGDP”,whichshouldbeunderstoodasapercentageofofficialGDP(GDPthatisofficiallyreportedbynationalstatisticaloffices).Weusethisapproach,sinceitisconsistentwiththewayofpresentingshadoweconomyestimatesintheliterature.However,thisexpressionisnotfullyequivalentto“theshareoftheshadoweconomyinthetotaleconomy”,becausetheofficialGDPdataalreadyincludessomeshadoweconomyestimates,asconductedbythenationalstatisticaloffice.Whetherthe applied approach results in a higher or lower shadow economy figuresthanintermsof“theshareoftheshadoweconomyinthetotaleconomy”,dependsontheratiooftheobtainedshadoweconomyestimatestotheshadoweconomyestimatesofthestatisticaloffices.Still,thecomparisonoftheresultsforthetwoapproachesshowsthat,fortheanalysedcountries,thedifferencesareratherminor(lessthan1.8percentage points).

Chart 2.5. Overall levels of the shadow economy in the analysed countries (% of GDP).

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

Bosnia andHerzegovina

Serbia

Bulgaria

Croatia

Slovakia

Slovenia

Poland

Czech Republic

Shadow economy figures for 2014 are based on the estimates/forecasts of some of the explanatory variables (shadow economy determinants)25. Source: EY

25Descriptionoftheestimates/forecastsofsomeoftheshadoweconomydeterminantsfor2014ispresentedinAppendix1.


Passive and committed shadow economiesSplitting the shadow economy into its passive and committed components provides a more detailed insight intothesituationofindividualcountries.Tothebestofourknowledge, no such breakdown has been done in other research,andthusconstitutesacontributionofthisstudyto the literature. As discussed in Chapter 1, the passive componentisthatpartoftheshadoweconomythatcanbereduced by promoting electronic payments, and so limiting theuseofcashthatotherwisefacilitatesunregisteredtransactions. The committed shadow economy is the remainingpartofthenon-observedeconomyandshouldbedealt with using other tools.

Our approach to distinguishing the two components is based ontheassumptionthattheoutputofthecommittedshadoweconomy is correlated with and mirrored by shadow labour forceinputs(foradetailedestimationmethodologyseeAppendix 1). It should be noted, however, that unreported employment is also possible in the registered companies that are not involved in the committed shadow economy (see Chart1.1).Therefore,fromthisperspective,ourassumptioncanresultinanoverestimationofthecommittedandanunderestimationofthepassivecomponent.Ontheotherhand,however,wedonotaccountforthefactthatsomecompanieswithnounreportedlabourforcemayalsobeinvolved in the committed shadow economy.

Chart2.6showsthatanincreaseintheleveloftheshadoweconomyafterthecrisisoutbreakwasoftentheeffectoftheriseinitscommittedcomponent,whichinturnreflectedthereboundinunregisteredemploymentintheperiodofeconomicslowdown.Thepatternofthepassiveshadoweconomy development among the analysed countries is, however, less clear. In Poland, Bulgaria, Serbia and Slovakia, itwasinthedeclineoverthelastyearsofthesampleperiod,in the Czech Republic its level was rather stable, while Bosnia and Herzegovina, Croatia and Slovenia recorded an increase in the passive shadow economy.


Chart 2.6. The overall level of the shadow economy in the analysed countries (% of GDP).

Bosnia and Herzegovina Bulgaria

20.0 21.4 22.0 22.1 21.5 21.0

4.75.2 4.9 4.4 4.2 4.5

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

16.8 16.214.3 13.5 13.0 11.7 11.4 11.0 11.1 11.3 11.2 10.8 10.4

4.53.6

4.54.2 3.8

4.1 3.8 3.95.3 5.4 6.1 7.0 6.7

0

5

10

15

20

25

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

16.8 16.214.3 13.5 13.0 11.7 11.4 11.0 11.1 11.3 11.2 10.8 10.4

4.53.6

4.54.2 3.8

4.1 3.8 3.9 5.3 5.4 6.1 7.0 6.7

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

Croatia Czech Republic

11.4 11.7 11.9 11.8 12.2 12.2 11.5

2.8 2.4 2.9 3.64.5 5.0 5.4

0

2

4

6

8

10

12

14

16

18

20

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

11.4 11.7 11.9 11.8 12.2 12.2 11.5

2.8 2.4 2.9 3.6 4.5 5.0 5.4

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

10.9 11.2 10.7 10.6 10.8 10.3

0.7 0.70.8 0.9 1.0 1.1

13.813.1

12.611.7

11.0

0

2

4

6

8

10

12

14

16

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

10.9 11.2 10.7 10.6 10.8 10.3

0.7 0.7 0.8 0.9 1.0 1.1

13.8 13.1 12.611.7 11.0

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

Poland Serbia

15.5 15.3 15.0 14.5 14.1 13.4 12.7 11.6 11.8 11.5 11.3 11.1 10.6

3.2 3.6 4.0 4.03.0

1.70.5

1.3 1.5 1.5 1.9 1.9 1.8

0

2

4

6

8

10

12

14

16

18

20

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

15.5 15.3 15.0 14.5 14.1 13.4 12.7 11.6 11.8 11.5 11.3 11.1 10.6

3.2 3.6 4.0 4.0 3.01.7 0.5

1.3 1.5 1.5 1.9 1.9 1.8

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

16.9 16.6 15.6 15.6

6.3 7.67.2

5.2

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

Slovakia Slovenia

15.5 14.3 13.1 12.5 12.2 12.1 12.0 11.5 11.9 11.5

0.80.4

0.80.2 1.8 2.6 2.3 3.5 3.4 3.3

19.3 19.4 19.118.1 17.4

0

5

10

15

20

25

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

15.5 14.3 13.1 12.5 12.2 12.1 12.0 11.5 11.9 11.5

0.80.4 0.8 0.2 1.8 2.6 2.3 3.5 3.4 3.3

19.3 19.4 19.118.1 17.4

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

10.6 10.0 9.28.0 7.4 8.0 8.6 8.9 9.1 9.2

1.21.6

1.72.1 3.1

3.3 2.93.2 3.6 3.3

11.6 11.5 11.6 11.5 11.4

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

0

5

10

15

20

25

30

10.6 10.0 9.2 8.0 7.4 8.0 8.6 8.9 9.1 9.2

1.2 1.6 1.7 2.1 3.1 3.3 2.9 3.2 3.6 3.311.6 11.5 11.6 11.5 11.4

0

5

10

15

20

25

30

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

e

Passive shadow economy Committed shadow economy Overall shadow economyNotes:Shadoweconomyfiguresfor2014arebasedontheestimates/forecastsofsomeoftheshadoweconomydeterminants.Source: EY


Theanalysedcountriesdifferintermsoftheshareofthepassiveand committed components in the total shadow economy (see Chart 2.7.).Inparticular,theCzechRepublicisthecountrywithbyfarthehighestshareofthepassive(90.6%in2014)and,consequently,thelowestshareofthecommittedcomponent(9.4%).Bycontrast,

BulgariaandCroatiarecordarelativelyhighshareofthecommittedshadow economy (39.2% and 32.1% in 2014, respectively). Still, the commonfactorforallthecountriesconsideredisthatthepassivecomponentaccountsforamajorityoftheirunregisteredeconomy.

Chart 2.7. Structure of the shadow economy in 2014 across the analysed countries.

Passive shadow economy Committed shadow economy

90.6% 85.8% 82.4% 77.7% 75.2% 73.9%67.9%

60.8%

9.4% 14.2% 17.6% 22.3% 24.8% 26.1%32.1%

39.2%

0%

20%

40%

60%

80%

100%

Czech Republic Poland Bosnia andHerzegovina

Slovakia Serbia Slovenia Croatia Bulgaria

Notes:Shadoweconomyfiguresfor2014arebasedontheestimates/forecastsofsomeoftheshadoweconomydeterminants. Source: EY

Sectorial breakdown of the passive shadow economyAdditional insight into the passive shadow economy in the analysed countriesisprovidedbythesectorialbreakdownofthiscomponent,basedonourinnovativeandformalisedapproach(seeAppendix1).

Mostoftheavailableestimatesofthesectorialstructureoftheshadow economy in the literature are based on the sectorial breakdownofunregisteredemployment.Forexample,anOECD2014statisticalbrief26showsahighshareofunregisteredemployment in the construction sector in selected countries (including Poland and the Czech Republic). Another analysis, performedforCroatiaandSlovenia,indicatesthatthehighestshareofunregisteredlabourforcecanbefoundinconstruction,hotelsand restaurants, as well as in the transport services27. However, thesectorialbreakdownofunregisteredemploymentprovideslittle,ifany,informationonthesectorswhereretailsalesareoften26OECD,“TheNon-ObservedEconomyintheSystemofNationalAccounts”,

OECDStatisticsBrief,No.18,2014.27See:BojanN.,ŠtefanB.,“TheShadowEconomyinBosniaand

Herzegovina,Croatia,andSlovenia:TheLaborApproach”,EasternEuropean Economics, 2007.

unregisteredandthatshouldthereforebetargetedwithmeasuresaimedatincreasingtheshareofreportedconsumertransactions(e.g.throughthepromotionofelectronicpayments).Unfortunately,there are not too many studies that would investigate the sectorial structureofunregisteredconsumertransactions.Still,wheresuchestimatesareprovided,themethodofobtainingtheseresults–tothebestofourknowledge–remainsunexplained28.WeaimtofillthisgapandpresentadetaileddescriptionofourapproachinAppendix1.Moreover,asalreadyemphasised,thenaturesofthecommittedandpassivecomponentsoftheshadoweconomyaredifferent,andeachneedtobeaddressedwithdifferentsolutions.Therefore,weconcentrateonthesectorialbreakdownofthepassiveshadoweconomy,whichseemstobethefirstsuchattemptintheliterature,andwhichshouldbeofparticularinterestinthecontextoftheroleofcashvs.electronicpayments.

Since the passive shadow economy is driven by mechanisms prevailingintheretailsalesofgoodsandservices,itcanbedisaggregatedeitherfromthebuyers’perspective(onthebasisoftheconsumptionexpenditurestructure)orthatofthesellers

28See,forexample,ATKearney,SchneiderF.,“TheShadowEconomyinEurope,2013”,2013.


(dependingonthetypeofthepointofsale).Giventheavailabledata,wehavedevelopedaclassificationof17sectorsthatallowsustomatchthesetwoperspectivesforourdistinctdatasources–HarmonisedIndexofConsumerPricesdataonconsumptionstructure(buyers)andcardpaymentsdatafordifferenttypesofretailers (sellers), the latter provided by MasterCard29 30.

Inourapproachtotheestimationofthesectorialbreakdownofthepassiveshadoweconomy,theshareofagivensectorinthepassivecomponentofunreportedactivitiesinananalysedcountryis proportional to:

• ►theshareofthissectorinthetotalconsumptionspending(thisnumberisaproxyforthesizeofthesectorinconsumertransactions);

• ►theshareofcashspendinginthetotalconsumptionspendingthathasbeenestimatedwiththeuseofMasterCarddata(thisnumberisaproxyforthe“cashsaturation”ofthetransactionsconducted in the sector).

Therefore,inourapproach,thelargerthesectorandthemoresaturated with cash payments, the higher share in the total passive shadow it has. For more details on our methodology see Appendix 1.

29FurtherinformationconcerningtheutiliseddataandmethodologycanbefoundinAppendix1.Detailsonthesectorialmatchingofthedataarepresented in Appendix 3.

30Thedatausedaccountsalsofortheconsumptionexpenditureandcardpaymentsofnon-residents(mainlytourists).

It turns out that the most important role in the passive shadow economyisplayedbythesectorsupplyingfood,beveragesandtobacco(seeChart2.8).Thisconclusionappliestoalloftheanalysedcountries.Onaverage,thissectoraccountsfor39.6%ofthetotalpassiveshadoweconomy.Thisismainlytheresultofits large share in the total consumption expenditure. The sector thatrankssecond,intermsofitscontributiontothesizeofthepassiveshadoweconomy,differsamongtheanalysedcountries.ItisfuelsforvehiclesinBosniaandHerzegovina(9.4%ofthetotalpassive shadow economy), Bulgaria (9.4%) and Serbia (8.6%); the restaurants,barsandcafessectorinCroatia(8.7%),theCzechRepublic(12.5%)andSlovakia(9.7%);andthesectorofcarsandmotorcycles with related services and repairs in Poland (9.4%) and Slovenia (15.2%). Other sectors that have a relatively high share in the total passive shadow economy in the analysed countries comprisetransportaswellasclothingandfootwear.

Thereisasignificantdifferencebetweenourapproachtothesectorialanalysisofthepassiveshadoweconomyandotherapproachesbasedonananalysisofunregisteredemployment.Whilewetendtoagreewiththeviewthatinmanycountriesitistheconstructionsectorwheretheshareofunregisteredemploymentisparticularlyhigh,thiscategoryoftheshadoweconomyshouldbedealtwithusingtoolsotherthan,forexample,thepromotionofelectronicpayments.Bycontrast,inourapproachwefocusonthesectorialbreakdownofthepassiveshadoweconomyactivitiesinretailsales,whereconsumercashpaymentsarethesourceofunreported transactions.


Chart 2.8. Shares of sectors in the passive shadow economy (% of total passive shadow economy, long-term averages).

41.9% 43.3%

35.9%39.6%

44.4% 43.2%

35.9%32.8%

8.3%8.1%

8.7%

12.5% 3.9%8.0%

9.7%12.4%

7.5%7.4%

6.9%

8.6%

9.4%

7.7%

5,4%

15.2%

9.4%9.4%

5.6%

1.6%5.9%

8.6% 6.9%

7.7%7.7%

4.7%

3,3%2,5%

8.0%

4.9%

2.1%

4.0%3.5%

4.3%

3.9%6.1%

3.5%

6.6%

4.1%

1.7% 1.8%

3.0%

5.7%

5.7%

1.9%

9.5%

3.5%

4.7% 4.6%

4.1%

5.0%2.8%

4.7%

4.6%

1.4%

3.5% 3.3%

4.8%

2.6%4.0%

3.5%

5.2%4.7%

2.3% 2.3%

4.4%

4.2%

6.1%

2.4%

3.4% 2.4%

1.6% 1,6%

2.0%

4.9%

1.7% 1.6%

3.6%5.6%

2.9% 2.6%

7.2%

3.6%1.4%

2.9%

0.4%

1.6%

1.5% 1.5%

3.8%

1.5%3.3%

1.5%

4.5%

2.0%

1.5% 1.5%3.2% 1.3% 2.5% 1.5%

3.7% 2.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Toys, hobbies, sport

Repair of appliances

Garden and flowers

Education

Newspapers, books and stationery

Accommodation

Pets and veterinary services

Recreation and culture

Healthcare

Furniture and furnishings with repairs and related services

Personal care (hairdressing, health and beauty, spas, etc.)

Clothing and footwear

Transport (private and public)

Fuels for vehicles

Cars and motorcycles with relatedservices and repairs

Restaurants, bars and cafes

Food, beverages and tobacco (grocery stores, markets, etc.)


Bulgaria Croatia CzechRepublic

Poland Serbia Slovakia Slovenia

Source: EY

Our sectorial estimates are based on the assumption that each cash unit spent in a given country is equally likely to trigger a shadow economytransactionregardlessofthesectorinwhichitisspent.Whilethisassumptionmaynotbetrue,limiteddataavailability

doesnotallowustoadoptadifferentapproach.However,totestthisassumptionandtakemoreinsightintothecross-sectorialdifferences,wehaveconductedanadditionaleconometricanalysiswhose results are presented in Frame 2.3.


Frame 2.3. Testing the validity of assumptions underlying the sectorial structure analysis.

In order to test assumptions underlying our approach to the sectorialbreakdownofthepassiveshadoweconomy,webuiltan additional econometric model to investigate the relationship between the passive shadow economy and changes in the value ofcardpaymentsindifferentsectors.Ifthetotalpassiveshadoweconomyismore(less)sensitivetothevalueofcardpaymentsina given sector than in other sectors, this means that the passive shadow economy within this sector constitutes a higher (lower) shareofcashtransactionsthanisthecase,onaverage,forothersectors.Thisanalysisallowsustodrawthefollowingconclusions.Forthemostofthesectorsandcountries,ourassumptionthateach cash unit spent is equally likely to trigger a shadow economy

transactionissatisfied(sectorsincountrieswithout“+”or“-”signs). However, in the analysed countries there are some sectors in which the cash unit spent leads, on average, to a stronger or a weaker increase in the shadow economy than in other sectors. Consequently, the values presented in Chart 2.8 might, to some extent,behigher(“+”)orlower(“-”),respectively.Unfortunately,the available data and applied econometric analysis does not allowustopreciselyconcludeonthescaleofthedifference.Still,theresultspresentedinTable2.2.maybehelpfulinguidingtheselectionofsectorsthatonemightwanttofocuson.Formoredetails on our methodological approach, see Appendix 1.

Table 2.2. Results of the econometric estimation showing that in some countries shares of individual sectors in the total passive shadow economy may to some extent be higher (“+”) or lower (“-”) than presented on Chart 2.8.

Bos

nia

and

Her

zego

vina

Bul

gari

a

Croa

tia

Czec

h R

epub

lic

Pola

nd

Serb

ia

Slov

akia

Slov

enia

Food, beverages and tobacco (grocery stores, markets, etc.) - - +

Restaurants,barsandcafes + +Cars and motorcycles with related services and repairs + - - +Fuelsforvehicles - + +Transport (private and public) +Clothingandfootwear + + - -Personal care (hairdressing, health and beauty, spas, etc.) - + +Furnitureandfurnishingswithrepairsandrelatedservices + + +Healthcare + - - -Recreation and culture + - -Pets and veterinary services + - -Accommodation + + -Newspapers, books and stationery + - -Education + - - -Gardenandflowers - + -Repairofappliances + -Toys, hobbies, sport + +

Source: EY


Passive shadow economy and lost government revenuesThe passive shadow economy may entail serious consequences, manyofwhichhavebeendiscussedinChapter1.Here,wepresentestimatesofadditionalgovernmentrevenuesthatwouldbecollectedifallthepassiveshadoweconomycashtransactionswere reported. This allows us to illustrate the potential budgetary benefitsfromaddressingthisissue.

ThecategoriesofgovernmentrevenuesthatweconsiderinouranalysisareVATandCITrevenues.Ifaconsumertransactionisnotregistered,thentheVAT,despitebeingincludedintheconsumerprice,willnotbepaidbytheseller.Moreover,themerchant’srevenuefromthistransactionwouldnotbereportedeither.Consequently, it would translate into lower than otherwise CIT revenues collected by the government31.

31Weareawareofthefactthatsomemerchants(dependingonthecountryandthesectorconsidered)maynotbeCITpayers,but,forexample,PIToranothercategoryoftaxpayers.However,hereweassumethatallthepassive shadow economy transactions are made by CIT payers.

ThedetailsofhowwehavecalculatedtheVATandCITrevenueshortfallduetothepassiveshadoweconomyactivitiesarepresentedinAppendix6.HerewejustindicatethatwedonotapplythestandardVATorCITratesinourcalculations,sinceitwouldleadtoanoverestimationofthebudgetaryeffect.Inourapproach,wetakeintoaccounthowVATratesdifferamongsectorsinvariouscountries,andwhattheeffectiveCITrateisrelativetogross operating surpluses recorded by companies. This is consistent withourpreferencetobeontheconservativesideratherthanpresentingbiased,overestimatedfiguresthatcouldweakenthecredibilityofourconclusions.

Chart 2.9. Lost government revenues due to the existence of the passive shadow economy in 2014.

1.6

2.02.2

2.6 2.6 2.7

3.2

4.2

0

1

2

3

4

5

Slovenia Poland Bulgaria Czech Republic Croatia Slovakia Serbia Bosnia andHerzegovina

VAT revenues lost (% of GDP) CIT revenues lost (% of GDP)

Source: EY

The obtained results show that the game is worth the candle, sincepotentialgovernmentrevenuesfromeliminatingthepassiveshadoweconomystemfrom1.6%ofGDPtoasmuchas4.2%ofGDP32. Consequently, even a partial success in dealing with this categoryofunregisteredtransactionscansignificantlyimprovethepublicfinancesituationintheanalysedcountries.Itthereforeleadsto a question about the measures that could be adopted in order to addressthepassivecomponentoftheshadoweconomy.Thisistheissue that we investigate in the next chapter.

32Ouranalysisdoesnottakeintoaccountthefactthatsomemerchantswhoseactivityhassofarbeenbasedontheunfaircompetitionbynotdeclaringpartoftheirprofits,maybecomeworse-offasaresultofbeingforcedtoregisteralloftheirprofitsandpaymoretaxes,accordingly.Inordertodefendtheirpreviouslevelofnetdisposableincome,somemerchants might try to increase prices, which should be limited by the marketcompetition,ortodecreasethewagesoftheiremployees,whichshould be tempered by competition on the labour market, or might simply accept lower margins.


3 Limiting the shadow economy through thepromotionofelectronic paymentsHavingestimatedthesizeandstructureoftheshadow economy, and the sectorial breakdown ofitspassivecomponent,inthischapterwefocusonmeasuresthat,ifimplemented,couldreduce the shadow economy. However, prior to discussingdistinctregulatorysolutions,wefirstpresenttheidentifieddeterminantsoftheshadoweconomy and their quantitative impact on the passive component. In particular, we analyse the relationshipbetweenthevalueofcardpaymentsandthelevelofcash-drivenunregisteredtransactions. The obtained results allow us to verifyourhypothesisthattheshadoweconomymaybereducedthroughthepromotionofelectronic payments. Next, we conduct an impact assessmentofvariousregulatorytoolsforeachofthe eight analysed countries. The considered tools may (1) promote electronic payments and thereby reducethevalueofcashpayments,or(2)increasetheshareofreportedconsumercashtransactions,andthroughthesechannelsdecreasethesizeofthe passive shadow economy. In our assessment, where possible, we show the quantitative impact oftheconsideredregulationsonthecontractionofthe passive shadow economy, and on the resulting growthingovernmentrevenues.Wediscusstheeffectonpublicfinanceinnetterms,sincewealsoaccountforsomepotentialcoststhatagivenregulationmayentailforthegovernment.

3


3.1. Identified determinants of the passive shadow economy

In our econometric analyses (see Chapter 2), we have estimated thesizeoftheoverallshadoweconomy(totalunregisteredconsumer cash transactions) using the CDA approach, as well as thepassivecomponentofthenon-observedeconomyusingtheMIMICapproach.Bothapproachesrequiredtheidentificationofkeyfactorsthatdeterminethelevelorchangesintheshadoweconomyandanestimationoftheimpactthateachofthosedeterminantshas on the shadow economy (or its passive component). Since the mainfocusoftheregulatoryanalysisisthereductionofthepassiveshadoweconomy,inthissubchapterwefocusondeterminantsobtained in the MIMIC approach only (see Table 3.1)33.

Table 3.1. Impact of the identified determinants on the passive shadow economy (MIMIC model).

Determinant Impact of the determinant on the passive shadow economy

Theratioofthetotalvalueofcardpaymentsat physical terminals toGDP

• Anincreaseinthetotalvalueofcardpayments at physical terminals in relation toGDPby1%led,onaverageintheanalysed sample period, to a decrease in the passive shadow economy by 0.037 percentagepointsofGDP

Theratiooftaxesand social security contributionstoGDP

• Anincreaseinthetotalvalueoftaxesandsocialsecuritycontributionsby1%ofGDPled, on average in the analysed sample period,toagrowthofthepassiveshadoweconomyby0.272percentagepointsofGDP

WorldBank’sruleoflaw index (ranges fromapproximately-2.5(weakruleoflaw)to 2.5(strongruleoflaw))

• Anincrease(improvement)intheWorldBank’sruleoflawindexby1led,onaverage in the analysed sample period, to a decrease in the passive shadow economyby1.583percentagepointsofGDP

Notes:Thepresentedimpactofagivendeterminantisvalidwhenitisnotaccompaniedby any other changes in the remaining listed determinants.

Source: EY

33 For more details see Appendix 1, which also includes estimation results forthetotalshadoweconomy(totalunregisteredconsumercashtransactions), based on the currency demand analysis.

According to the MIMIC analysis, an increase in the card payments toGDPratio34 reduces the passive shadow economy. Moreover, adeclineintheratiooftaxestoGDPturnsouttoreduceshadoweconomyactivities.Anotherfactorpositivelyinfluencingthemerchants’propensitytoregistertransactionsistheirinstitutionalandtaxmorale,approximatedbytheWorldBank’sruleoflawindex35.

Forpolicymakers,itmaybeeasiertoinfluencesomeoftheidentifieddeterminantsoftheshadoweconomy,whileitmaybedifficulttoaffectothers.Forexample,changesintheruleoflawindexseemveryrelevantfortheoverallandpassiveshadoweconomylevels.However,asignificantimprovementinthisareamayrequireintroducingmany,oftendifficult,reformsbya government, which may additionally take a long time. It is also not easytosignificantlyreducetheburdenoftaxandsocialsecuritycontributions,notleastinlightofthefiscalchallengesinmanycountriesintheaftermathoftheeconomiccrisis.Ontheotherhand,publicpoliciesleadingtoanincreaseinthepopularityofnon-cash payments (especially card payments, which have been proven inthemodeltohaveasignificantimpactonthecontractionoftheshadow economy) seem relatively easier to implement.

Inthiscontext,wecalculatetheimpactoftheobservedchangesindeterminantvaluesin2010–2014ontheevolutionofthepassiveshadoweconomy.Inthisperiod,thegrowingvalueofcardpayments in the analysed countries led, on average, to a decrease inthepassiveshadoweconomyby1.17percentagepointsofGDP.Thiseffectfortheruleoflawindexamountedtojust0.09percentagepointsofGDP,whiletheobservedchangesintaxesandsocial contributions were associated, on average, with an increase inthepassiveshadoweconomyby0.27percentagepointsofGDP.Thisshowsthattherecentchangesinthevalueofcardpaymentsinthe analysed countries have already had a relatively strong impact onthereductionofthepassiveshadoweconomy.

34Thetotalvalueofcardpaymentswasnotappropriatefortheestimationprocessofthecurrencydemandequation(theoverallleveloftheshadoweconomy)duetocertaintechnicalreasons(the“endogeneityissue”,seeAppendix 1).

35IntheMIMICmodelwehaveincludedalsoothervariables,suchasGDPin PPS per capita or regulatory measures applied by particular countries. For more details see Appendix 1.


It should be emphasised, however, that we do not use the estimation results presented in Table 3.1 to analyse theimpactoftheconsideredregulations–throughthechannelofanincreasedusageofelectronicpayments–onthepassiveshadoweconomy.Ifwedid,wewouldlikelyobtain biased results, because the estimated parameters describetheaverageimpactofselecteddeterminantsonthe passive shadow economy based on their historical developments. Most importantly, one should note that it is not so much a given percentage increase in card payments,buttheresultingproportionofcrowdedoutconsumer cash payments that determines the contraction ofthepassiveshadoweconomy.Andagivenregulation-induced percentage increase in card payments leads toadifferentpercentagedeclineinconsumercashpayments, with the latter depending on the current ratio ofcardtocashtransactionsvalue36. That ratio, in turn, variesamongcountriesandovertime.Weaccountforthesefactorsinourapproachtotheregulatoryanalysis,which is discussed in the next section.

36Forexample,inacountrywith60%ofcardand40%ofcashconsumer payments, a 10% increase in card payments (to 66% oftotalconsumertransactions)leadstoa15%declineincashpayments(from40%to34%oftotalconsumertransactions).Inanothercountrywith20%ofcardand80%ofcashconsumer payments, a 10% increase in card payments (to 22% oftotalconsumertransactions)leadstoamere2.5%decreaseincashpayments(from80%to78%oftotalconsumertransactions).


3.2. Selected regulations and their impact on the shadow economy

Ourestimationresultsshowthatanincreasedpopularityofcashlesspaymentshadasignificantimpactonthereductionofthepassiveshadoweconomyinthesampleperiod.Intheremainderofthis chapter, we discuss selected policy measures that are aimed mainly at replacing cash with electronic payments, or increasing theshareofregisteredconsumercashtransactionsintheanalysedcountries.Wefirstbrieflydescribethemechanismofeachregulationanddiscussthepotentialchannelsofitsimpact.Nextwedemonstratetheestimatedeffectofagiventoolonthepassiveshadoweconomyandgovernmentrevenues(formethodologicaldetails,seeAppendix5andAppendix6).Whenaconsideredregulationpositivelyaffectsthevalueofcardpayments37, we assumethattheresultingreductioninthevalueofconsumercashtransactions leads to a proportional decline in the passive shadow economy in the analysed country38.If,inturn,aregulationisfocusedonincreasingtheshareofregisteredcashtransactionsintotal consumer cash payments, its impact on the passive shadow

37 Thisimpactonthevalueofcardpaymentsiseitherestimatedorsimulated, depending on the regulation considered.

38 Consider an example country in which the passive shadow economy equals20%ofGDP.Ifagivenpolicytoolleadstoadecreaseinconsumercash payments by 25%, the passive shadow economy contracts by 20%x25%=5p.p.,tothelevelof15%ofGDP.Thereare,however,somesituations when this assumption may not hold. In such circumstances, we makeanexplicitdisclaimeranddescribetheconsequencesofmodifyingthis assumption.

economyismuchmorestraightforwardandproportionaltoadeclineintheshareofunreportedcashtransactions(seeChart3.1).Calculatingtheimpactoftheregulationonthepassive shadow economy allows us to estimate the resulting changeingovernmentrevenues(formethodologicaldetails,seeAppendix6).Inaddition,forsomeregulationswepresentthecost-benefitanalysisthataccountsnotonlyforadditionalrevenues,butalsoforthecoststhatthegovernmentmayincurduetotheintroductionoftheregulation.

Inmostoftheregulations,weuseourestimateoftheshareofcash transactions in the overall consumer transactions (and the correspondingshareofcardtransactionsintheoverallconsumertransactions;fordetailsseeAppendix4).Asensitivityanalysisoftheresultswithrespecttothestructureofconsumerpaymentsispresented in Appendix 7.

Introduction of a given regulation

Crowding out of consumer cash payments by

electronic payments

Decrease in the size of the passive shadow economy

Increase in the government VAT and CIT

revenues

Change in the government balance

Cost of the regulation incurred by the government

Increasing the share of registered

transactions in consumer cash

payments

Chart 3.1. Considered mechanisms of the impact of regulations aimed at combating the passive shadow economy.

Source: EY


Table3.2.givesexamplesofsuchregulationsalreadyintroducedinselectedcountries.Someofthepresentedsolutionsarebasedonenforcementorobligationmechanisms,whereasothersfocusonproviding incentives either to consumers or merchants. Moreover, similarregulationsinvariouscountriesoftendifferintermsoftheirscopeandotherparametersthatmayplayacriticalrolefortheultimateimpactoftheconsideredinstrument.Therefore,ouranalysesoftheeffectsofdifferentregulationsshouldberegardedasexamplesoftheimpactthatvarioussolutionsmayhaveontheshadoweconomyandpublicfinance.Sincethesesolutionsmaybemodifiedintermsoftheirscope,timingandotherparameters,theiractualeffectwouldchangeaccordinglyandwoulddependonthefinaldecisionofregulators.

Table 3.2. Examples of regulations implemented in different countries.

Regulation Countries of implementation

Obligationtomakeanelectronicpaymentofwagesandsalaries

Croatia, Slovenia, Bosnia and Herzegovina (Republika Srpska), Uruguay

Obligationtomakeanelectronicpaymentofsocialsecuritybenefits

Bulgaria, Croatia, Slovenia, Italy, Denmark, Sweden, Uruguay

Thresholdforconsumercashpayments Bulgaria, Slovakia, Czech Republic, Slovakia and Slovenia (though in all countries at relatively high levels*)

Obligation to possess and use cash registers Bulgaria, Poland, Croatia, Serbia, Slovakia, Bosnia and Herzegovina, Italy, Sweden, Hungary

Obligation to operate POS terminals SouthKorea

Receipt lotteries Bulgaria,Slovakia,Croatia,Poland,SouthKorea,Brazil,Taiwan,Malta,Portugal

Taxincentivesforconsumers SouthKorea,Brazil(SaoPaulo),Colombia

Taxincentivesformerchants SouthKorea,Uruguay

*Insomeofthesecountries,consumercashpaymentsaboveagiventhresholdmaybeaccepted,butgeneratealotofadministrativeobligationsforamerchant.

Source: EY

Whenanalysingtheimpactofregulationsonthepassiveshadoweconomy and government revenues, it is important to remember thatthetotalimpactofagivenregulatorypackagewillusuallybelowerthanthesumoftheeffectsofeachregulationthatthispackage comprises.


3.2.1. Obligation to make an electronic payment of wages and salaries

This regulation introduces the obligation to make an electronic (non-cash)paymentofwagesandsalaries.Initsbasicform,theregulationrequiresthatthiskindofpaymentbeperformedviaabanktransfer,thoughitispossibletoallowpaymentalsointheformofprepaidcards39.

Obligation to make an electronic payment of wages and salaries – examples

This regulation is already in force in Croatia, Slovenia and in one region of Bosnia and Herzegovina (Republika Srpska). In those countries, employers are obliged to pay remunerations via bank transfers. Consequently, some employees have had to open bank accounts in order to receive their salaries.

39 The employer can load prepaid payment cards with the net salary or wage andgivethemtoemployeeswhocanusethecardfortheireverydaypayment transactions in the same way as a regular debit or credit card. Weassumethattheeffectsdiscussedherearesimilarforwageandsalarypaymentswhetherpaidbybanktransfersorasprepaidcards.

AccordingtotheWorldBankdata(GlobalFindexDatabase),in2014morethan70%ofthewagerecipientsintheanalysedcountriesreceivedtheirwagesintotheiraccountsatfinancialinstitutions(e.g. 74.6% in Bulgaria, 77.5% in Bosnia and Herzegovina, and the highestshareof97.0%inSlovenia).Thissuggeststhat,atleastinsomecountries,asignificantamountofwagesandsalariesisstillpaidincash.Itisverylikelythatmostofthismoneyislaterspentalsoincash,partofwhichmaycontributetopassiveshadoweconomytransactions.Theintroductionoftheconsideredregulationshouldshiftallormostofthewagesandsalariesthatweresofarpaidincashtobankaccounts(orprepaidcards)40. Thisshouldnaturallyincreasethevolumeofelectronicpayments(especiallyofpaymentsperformedwithcardsofferedwithmostbank accounts), thereby replacing cash transactions, which in turn, asshowninChapter3.2,shouldleadtoadecreaseinthesizeofthepassive shadow economy (see Chart 3.2).

SincethediscussedregulationisalreadyinforceinCroatiaandSlovenia,wedonotestimateitseffectforthesecountries.InBosniaandHerzegovinathiskindoflawisbindingintheRepublikaSrpska,butisnotpresentintheFederationofBosniaandHerzegovina.WethereforeestimatetheeffectofthisregulationonthevalueofcardpaymentsforBosniaandHerzegovinaasifthesolutionwasabsent,andthenconsideronlypartoftheeffect,correspondingtothepopulationshareoftheFederationofBosniaandHerzegovinainthepopulationofthewholecountry.

40Weaccountforthefactthatthisregulationwillnotinfluencetheformofcompensation received by unregistered employees, who will continue to receivetheirremunerationincash–formoredetailsseeAppendix5.

Obligation to pay wages into bank

account

Larger share of

income paid into bank accounts

Additional effort for

consumers needed to

withdraw cash from ATM

Crowding out of consumer

cash payments by electronic transactions

Decrease in the size of the

passive shadow economy


revenues

Chart 3.2. Mechanism of the regulation - Obligation to make an electronic payment of wages and salaries.Source: EY


Impact of the regulation on the passive shadow economyTheelectronicpaymentofwagesmeansthatpeoplewhopreviouslyreceived their remuneration in cash would have to make an additionalefforttousecash,e.g.throughATMwithdrawals,iftheywouldliketocontinuetousecash.Therefore,theyshouldmoreoftenperformtheirtransactionswithpaymentcardsand,consequently, make less cash payments. This, in turn, should contributetothereductionofthepassiveshadoweconomy(seeChapter 3.1).

Weestimatetheimpactofthisregulationonthevalueofcashpaymentsreplacedwithcardpaymentsinafewsteps.First,weusetheWorldBank’ssurveydata(GlobalFindexDatabase)tocalculatethenumberofpeoplereceivingtheirwagesincashin2014.Second, we assume that all unregistered employees receive their remuneration in cash. Third, we conservatively assume that cash recipientsarepaid,onaverage,theminimumwagefortheirwork.Finally,withtheuseofdataonhouseholdsavingsrateandthepaymentbehaviourofatypicalcardholder,weestimatethevalueofcashexpenditurereplacedwithcardpaymentsinthesituationwhen all registered employees receive their wages in an electronic form.FormoredetailsontheappliedapproachandcalculationsseeAppendix 5.

Themostsignificantdeclineinthepassiveshadoweconomyfortheconsideredregulation(seeChart3.3)hasbeenestimatedforPoland(0.28%ofGDP),followedbyBosniaandHerzegovina(0.16%ofGDP)andtheCzechRepublic(0.13%ofGDP).ArelativelyloweffectforSerbia(e.g.incomparisonwithBosniaandHerzegovina)ismainlyduetothelargeshareofunregisteredemployeesinthetotalemploymentinthiscountry.ThisimpliesthatasignificantshareofwagespaidincashinSerbiaareremunerationsobtainedbyunregisteredemployees,whowouldnotbeinfluencedbytheregulationandwouldcontinuetoreceivetheirwagesintheformofcash.

Chart 3.3. Obligation to make an electronic payment of wages and salaries – impact on the passive shadow economy (% of GDP).

-0.02

-0.10 -0.10

-0.13

-0.16

-0.28-0.3

-0.2

-0.1

0.0Serbia Slovakia Bulgaria

Czech Republic

Bosnia andHerzegovina Poland

Source: EY


Chart 3.4. Obligation to make an electronic payment of wages and salaries – impact on government revenues.

0.002

0.0150.014 0.022 0.019

0.029

0.002

0.006 0.009

0.010 0.014

0.022

1.28.9

17.4

4.4

50.2

210.0

0

60

120

180

240

0.00

0.02

0.04

0.06

0.08

Serbia Bulgaria Slovakia Bosnia andHerzegovina

Czech Republic Poland

Increase in CIT revenues (% of GDP, left axis) Increase in VAT revenues (% of GDP, left axis) Total increase in government revenues (m EUR, right axis)

Source: EY

Impact of the regulation on government revenuesInlinewiththeestimatedeffectsforthepassiveshadoweconomy,Poland, the Czech Republic and Bosnia and Herzegovina can expect the highest increase in government revenues due to the implementationoftheregulation–0.051%,0.032%and0.032%ofGDP,respectively(whichisequivalenttoEUR210.0m,EUR50.2mand EUR 4.4 m, respectively, see Chart 3.4).

Potential costs of the regulation Theintroductionofobligatoryelectronicpaymentsforwagesandsalariesshouldnotgeneratesignificantcosts.Thelikelycostsareassociatedwiththefeesrelatedtomaintainingadditionalbankaccounts(orrelatedtotheuseofprepaidcards).Thesecosts, depending on the legislation, may be covered either by the employer, employee or the government (or shared among them). However, it is worth noting that in 2014 the European Parliament passed legislation41aimedatincreasingtheavailabilityoffinancialaccountsforalltypesofconsumers.ItstatesthatallMember

41 Article46ofDIRECTIVE2014/92/EUof23July2014onthecomparabilityoffeesrelatedtopaymentaccounts,paymentaccountswitchingandaccesstopaymentaccountswithbasicfeatures. http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32014L0092(accessed:20.08.2015).

Statesmustintroducelawsthatobligebanksandotherfinancialinstitutionstoofferaccountswithbasicfeaturesfreeofchargeorat a reasonable cost42.

Estimated timing of the impact of the regulationThemajorityoftheestimatedimpactshouldtakeplacealmostimmediatelyaftertheintroductionoftheregulation.Theremaindershouldmaterialisewithin1–2years,whenthebehaviourofnewcardholderswillconvergetothebehaviourofatypicalcardholder(e.g.intermsofthefrequencyofcardpaymentsandATMwithdrawals).Someoftheestimatedeffectsmayoccurevenbeforetheintroductionoftheregulation(butafteritsannouncement),since some entities will start acting in compliance with the regulation already in the transition period.

42 ThesefeaturesarenotdefinedintheEUlegislationandshouldbedetermined at a national level.


3.2.2. Obligation to make an electronic payment of social security benefits

This regulation obliges the government to pay at least some kinds ofsocialsecuritybenefitsintheformofelectronicpayments,e.g.throughbanktransfersand/orprepaidcards.Themechanismofthis regulation is analogous to the obligation to make an electronic paymentofwagesandsalaries(seeChart3.5andChapter3.2.1).

Themaindifferenceisthetargetedgroupandthefactthatsocialbenefitspaymentsareperformedonlybypublicinstitutions(notby private businesses), so once the regulation has been introduced, thereshouldbenoviolationsofthelaw(whichmaysometimestakeplaceinthecaseoflegislationconcerningwagesandsalaries).

Obligation to make an electronic payment of social security benefits – examples

The payment of unemployment and sickness benefits via bank transfer is already obligatory in Bulgaria, Croatia and Slovenia. In Italy, all social aid disbursements are made using prepaid cards. In addition, all social security benefits (including pensions) are paid electronically in Denmark, while in Sweden they are paid electronically or using prepaid cards. A law on mandatory electronic payments of social security benefits has also recently been approved in Uruguay.

Sincetheregulationisalreadyinforceforunemploymentbenefitsin Bulgaria, Croatia and Slovenia, we have not considered this scenarioforthesecountries.

Impact of the regulation on the passive shadow economyWeconsiderthisregulationfortwokindsofsocialsecuritybenefits:(1)unemploymentbenefits,whichconstitutearelativelysmallcategoryofgovernmentsocialexpenditureintheanalysedcountries,and(2)pensions,whichaccountforasignificantshareofthetotalsocialexpenditure.Thereasonwhyweinvestigateonlythesetwokindsofbenefitsisthatcomparabledata(amongtheanalysedcountries)forothercategoriesofsocialspendingwasnotavailable.However,theresultsofouranalysismayeasilyberescaledforotherkindsofsocialsecuritybenefits,ifoneassumesthattheseremainingcategoriesofsocialtransfersarecurrentlypaidincashasoftenasunemploymentbenefitsandpensions.

Theestimationoftheimpactofthisregulationonthevalueofcash payments replaced with electronic payments is similar to the approachappliedtoobligationtomakeanelectronicpaymentsofwagesandsalaries.FirstweobtaindataonthetotalnetvalueoftheconsideredbenefitsfortheanalysedcountriesusingdatabasesandpublicationsofOECD,Eurostat,EcoWinandnationalsources.

Obligation to pay social security benefits into bank account

Larger share of

income paid into bank accounts

Additional effort for

consumers needed to

withdraw cash from ATM






revenues

Chart 3.5. Mechanism of the regulation – Obligation to make an electronic payment of social security benefits.

Source: EY


ThenweusetheWorldBank’ssurveydata(GlobalFindexDatabase)onthepercentageofrecipientsofgovernmenttransfersintheanalysedcountriesthatreceivedthesetransfersincashin2014.Weassumethatthesefiguresarealsoapplicabletounemploymentbenefitsandpensionsrecipients.Inthelaststep,wetakeintoaccountthehouseholdsavingrateandthepaymentbehaviourofa typical card holder in the analysed countries in order to estimate thevalueofcashpaymentsreplacedwithcardtransactionsduetotheintroductionoftheregulation.Formoredetailsontheappliedapproach and calculations see Appendix 5. The potential decrease ofthepassiveshadoweconomycausedbytheobligatorypaymentofunemploymentbenefitstobankaccounts(oronprepaidcards)ismuchsmallerthaninthecaseoftheconsideredregulationforpensions (see Chart 3.6. and Chart 3.7). In the latter, Poland can reducethepassiveshadoweconomybyasmuchas0.59%ofGDP.OnecanalsoobserveconsiderableeffectsfortheCzechRepublic(0.47%), Slovakia (0.45%), Serbia (0.37%), Bosnia and Herzegovina (0.33%) and Croatia (0.31%).

Chart 3.6. Obligation to make an electronic payment of unemployment benefits – impact on the passive shadow economy (% of GDP).

-0.002

-0.007-0.008

-0.011

-0.013

-0.020

-0.016

-0.012

-0.008

-0.004

0.000

Bosnia andHerzegovina Poland Serbia

CzechRepublic Slovakia

Source: EY

Chart 3.7. Obligation to make an electronic payment of pensions – impact on the passive shadow economy (% of GDP).

-0.16-0.18

-0.31-0.33

-0.37

-0.45-0.47

-0.59

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0.0Bulgaria Slovenia Croatia

Bosnia andHerzegovina Serbia Slovakia Czech Republic Poland

Source: EY


Impact of the regulation on government revenues

Chart 3.8. Obligation to make an electronic payment of unemployment benefits – impact on government revenues.

0.0003

0.00080.0009

0.00150.0019

0.0001

0.0006

0.0008

0.0011

0.0012

0.1

5.4

0,6

4.1

2.3

0.0

1.6

3.2

4.8

6.4

0.0000

0.0008

0.0016

0.0024

0.0032

0.0040

Bosnia and Herzegovina Poland Serbia Czech Republic Slovakia

Increase in CIT revenues (% of GDP, left axis) Increase in VAT revenues (% of GDP, left axis) Total increase in government revenues (m EUR, right axis)

Source: EY

Chart 3.9. Obligation to make an electronic payment of pensions – impact on government revenues.

0.020 0.025

0.046 0.040 0.042

0.064 0.0630.069

0.0110.010

0.020 0.0300.035

0.043 0.046

0.051

11.3 14.6 9.130.0 25.8

80.5

446.8

186.0

0

100

200

300

400

500

0.00

0.03

0.06

0.09

0.12

0.15

Slovenia Bulgaria Bosnia andHerzegovina

Croatia Serbia Slovakia Poland Czech Republic

Increase in CIT revenues (% of GDP, left axis)

Increase in VAT revenues (% of GDP, left axis)

Total increase in governmentrevenues (m EUR, right axis)

Source: EY

Similarlytotheimpactontheshadoweconomy,theeffectofobligatoryelectronicpaymentsofunemploymentbenefitsongovernmentrevenuesismuchsmallerthantheimpactofthatregulationforpensiontransfers(seeChart3.8andChart3.9).

The latter increases government revenues the most in the Czech Republic(by0.12%ofGDPorEUR186.0m),whileinPolandandSlovakia the additional revenues amount to approximately 0.11% ofGDP.


Potential costs of the regulation Thecostsofthesemeasuresareanalogoustothecaseoftheelectronicpaymentofwagesandsalaries,comprisingmainlythecostsofmaintainingadditionalbankaccounts(seeChapter3.2.1).Yet, as it has already been mentioned, in EU countries the new directiveenforcestheintroductionofbasicaccountsthatmustbeofferedbyallfinancialinstitutionsfreeofchargeoratreasonablecost,asdefinedbytheMemberStates.

Itisalsoworthnotingthattraditionalmethodsofpayingpensions,such as delivery by post, can be relatively expensive. According to thePolishSocialInsuranceInstitution(ZUS),thedeliverycostofpensionsbypostis10timeshigherthaninthecaseofelectronicpayments to bank accounts43, which is why ZUS, together with one commercialbank,decidedtopromoteaspecialbankaccountforpensioners(bankaccountwithadditionalfeatures,suchaspaybackforpaymentsatpharmacies,andwithbankservices,suchasbanktransfersandATMcashwithdrawals,freeofchargeforthefirsttwoyears)44.Transferringpensionbenefitsdirectlytoabankaccountinsteadofadeliverybypostwouldthereforedecreasethecostsofpaying pensions incurred by the government. On the other hand, oneshouldnotforgetaboutthetechnologicalbarrierforsomeelderlypensioners,whomayhavedifficultiesinusingpaymentcards and might not be willing to use a bank account.

43 http://www.zus.pl/default.asp?id=1&p=1&idk=1807(accessed17.11.2015)

44 http://www.zus.pl/default.asp?id=1&p=1&idk=2453(accessed17.11.2015)

Estimated timing of the impact of the regulationWhiletheelectronicpaymentofpensionsmayconstituteatechnologicalbarrierforsomeelderlypeople,mostoftheestimatedimpactshouldtakeplacesoonaftertheintroductionoftheregulation.Theremainderoftheeffectshouldmaterialisewhenthebehaviourofnewcardholderswillconvergetothebehaviourofatypicalcardholder(e.g.intermsofthefrequencyofcardpaymentsandATMwithdrawals),which–inthecaseofsocialbenefitsrecipients–maytakelongerthaninthecaseofemployees.


3.2.3. Threshold for cash payments

Thisregulationdefinesacertainmonetaryvalue(threshold)fora single transaction above which consumer cash payments are not allowed. Consequently, consumer cash transactions above the introduced threshold should disappear and be replaced with

additionalelectronicpayments,thusreducingthesizeofthepassive shadow economy and increasing government revenues (see Chart 3.10).

Threshold for consumer cash payments - examples

Thresholds for cash payments are already present in Bulgaria, Croatia, the Czech Republic, Slovakia and Slovenia (in some of them consumer payments above the threshold may be accepted, but generate a lot of administrative obligations for a merchant). Yet, the current thresholds are relatively high (between EUR 5 000 and 15 000) so their impact on reducing cash payments is marginal, as cash is mostly used for lower-value transactions. Moreover, as we argue in this section, such high cash payments in retailing are already reported, not least for the sake of consumer warranty, and replacing them with card payments therefore has no effect on the passive shadow economy.

Similar regulations for B2B payments are present in all of these countries, but they do not influence the passive shadow economy, since it is related to consumer transactions.

Source: EY, MasterCard.

Forthepurposeofthisanalysis,weconsiderfivedifferentcashpayment thresholds45. These thresholds have been selected basedonthedistributionofconsumercashpaymentsinPoland,providedbythecourtesyofthePolishcentralbank.Forthesakeofcomparabilityacrosstheanalysedcountries,thresholdlevels(originally round values in Polish Zloty, PLN) have been expressed inEUR.Moreover,foreachcountrytherespectivethresholdvalueshavebeenadjustedforthedifferencesinnominalGDPlevelspercapitabetweenagivencountryandPoland(formoredetailsseeAppendix5).TheresultingfiguresarepresentedinTable3.3.

45 Inanadditional,lessconservativevariantofcalculatingtheeffectsofthisregulation, presented in Appendix 5, we also consider a sixth threshold.


Introduction of the threshold for cash payments

It is illegal to pay in cash above the

defined value of transaction

Crowding out of consumer cash

payments above the threshold by electronic transactions




revenues

Chart 3.10. Mechanism of the regulation – Threshold for cash payments.Source: EY

Table 3.3. Considered thresholds for the maximum allowed value of consumer cash payment (EUR).

Threshold number


Bulgaria Serbia Poland Czech Republic

Croatia Slovenia Slovakia

1 1.6 2.5 2.1 4.7 6.5 4.5 8.0 6.1

2 4.0 6.4 5.1 11.8 16.3 11.2 20.0 15.3

3 8.0 12.7 10.3 23.6 32.6 22.4 39.9 30.7

4 12.0 19.1 15.4 35.5 48.8 33.5 59.9 46.0

5 15.9 25.5 20.6 47.3 65.1 44.7 79.9 61.4

Source: EY

It should be emphasised that the considered thresholds are presentedasnothingmorethansimplyexamplesofdifferentmaximumlevelsofallowedconsumercashpayments.Weagreethat the presented limits, especially the lowest ones, may seem unacceptableandhardlyfeasibletoimplement.Nevertheless,these thresholds have been largely determined by data availability fromtheresearchconductedbytheNationalBankofPoland.Moreover,asconfirmedbythedataonthedistributionofconsumercashpayments,abovethehighertransactionlevelsthevalueofconsumer cash payments is marginal. For example, the value above thefifththreshold(forexampleEUR47.3inPoland)accountsforonly7%ofallconsumercashtransactions.Thissharewouldfurtherdecline with an increase in the threshold level. In addition, above a(relatively)highthresholdofthetransactionvaluethereshouldbealmost no passive shadow economy, because one can expect that consumerstendtodemandreceiptsformoreexpensive,durable

goodsinordertoobtainawarranty.Obviously,therearehigh-value cash payments in the committed shadow economy. However, thesewouldremainunaffectedbytheregulation,asbothpartiesbenefitingfromthiskindofactivitywouldcontinuetousecashinorder to avoid reporting the transaction. The arguments outlined abovethusstronglysuggestthatestablishinghighthresholdsforconsumercashpaymentswouldhavelittle,ifany,impactonthepassive shadow economy.

Impact of the regulation on the passive shadow economy Toestimatetheeffectofestablishingdifferentthresholdsforconsumercashtransactionsonthevalueofcashandcardpayments,weapplyasimulationapproach(formoredetailsseeAppendix5).Theimpactoftheregulationonthechangeinsizeofthe passive shadow economy is presented in Table 3.4.

In each country, the lower the threshold level, the more cash transactions would be replaced with card payments, implying astrongerimpactoftheregulationonthepassiveshadoweconomy.Thesourceofdifferencesintheresultsobtainedfortheanalysedcountriesisthedifferentsizeoftheirpassiveshadoweconomy(in%ofGDP).Forthatreason,theimpactof,forexample,theimplementationofthresholdNo3ontheshadoweconomyisthehighestinBosniaandHerzegovina(-5.2%ofGDP)andSerbia

(-3.9%ofGDP),whilethelowesteffecthasbeenestimatedforSlovenia(-2.3%ofGDP).

It should be noted that this regulation may also encourage the purchase/leaseofPOSterminalsand,throughtheincreasedacceptanceofcardpayments,additionallystimulategrowthinthevalueofcardpaymentsbelowtheestablishedthreshold.Thiseffectwillbestronger,thelowerthethresholdforconsumercash

Table 3.4. Introducing thresholds for consumer cash payments – impact on the passive shadow economy (% of GDP).

Threshold number




1 -17.7% -8.7% -13.1% -8.9% -8.6% -9.7% -7.7% -9.7%

2 -10.6% -5.3% -7.9% -5.4% -5.2% -5.8% -4.7% -5.8%

3 -5.2% -2.6% -3.9% -2.6% -2.5% -2.8% -2.3% -2.9%

4 -2.7% -1.3% -2.0% -1.4% -1.3% -1.5% -1.2% -1.5%

5 -1.8% -0.9% -1.3% -0.9% -0.9% -1.0% -0.8% -1.0%

Source: EY


payments.However,wedonotaccountforthatadditionalimpactinourcalculations,whichmakesourresults–atleastinthiscontext–conservative.

On the other hand, we have assumed that the passive shadow economyisuniformlydistributedintheconsideredrangeofunit transaction values, while it is likely that a relatively large shareofthepassiveshadoweconomyis“concentrated”aroundlower-valuetransactions.Moreover,wedonotaccountforthefactthatsomeconsumersmightsplittheircashpaymentsintoseveraltransactions,sothatthevalueofeachcashtransactionislowerthantheimposedthreshold.Consequently,thesefactors,ifaccountedfor,wouldreducetheestimatedeffectoftheconsideredthresholds.

Impact of the regulation on government revenuesTheimpactoftheregulationongovernmentrevenuescorrespondstotheestimatedchangesinthesizeofthepassiveshadoweconomyintheanalysedcountries.Therefore,thestrongest(%ofGDP)effectofestablishingthresholdNo3ongovernmentrevenuesisobservedforBosniaandHerzegovina(1.0%ofGDPorEUR143.3m)andSerbia(0.8%ofGDPorEUR267.8m),whiletheweakestimpacthasbeenestimatedforSlovenia(0.4%ofGDPorEUR 143.5 m).

Table 3.5. Introducing thresholds for consumer cash payments – impact on government (VAT and CIT) revenues % of GDP).

Threshold number




1 3.5% 1.9% 2.7% 1.6% 2.2% 2.2% 1.3% 2.3%

2 2.1% 1.1% 1.6% 1.0% 1.3% 1.3% 0.8% 1.4%

3 1.0% 0.6% 0.8% 0.5% 0.6% 0.6% 0.4% 0.7%

4 0.5% 0.3% 0.4% 0.3% 0.3% 0.3% 0.2% 0.4%

5 0.4% 0.2% 0.3% 0.2% 0.2% 0.2% 0.1% 0.2%

Source: EY

Table 3.6. Introducing thresholds for consumer cash payments – impact on government (VAT and CIT) revenues (EUR m).

Threshold number




1 486.0 791.2 908.3 6776.6 3383.0 943.7 486.8 1726.7

2 292.8 476.7 547.3 4083.3 2038.5 568.7 293.3 1040.4

3 143.3 233.3 267.8 1998.2 997.6 278.3 143.5 509.2

4 74.8 121.7 139.7 1042.6 520.5 145.2 74.9 265.6

5 49.8 81.1 93.2 695.0 347.0 96.8 49.9 177.1

Source: EY

Potential costs of the regulation Likelycostsarelinkedtotheuseofadditionalbankaccounts(orprepaid cards) that enable conducting transactions whose value exceeds a given threshold. However, in 2014 the EU obliged financialinstitutionstoofferaccountswithbasicfeaturesfreeofchargeoratareasonablecost.Moreover,theregulationmayforcesome merchants to purchase (or lease) POS terminals and incur respective costs respective costs.

Estimated timing of the impact of the regulationTheestimatedimpactoftheregulationshouldmaterialisealmostimmediatelyafteritsintroduction.Inthelongerrun,theregulationmayalsostimulategrowthinthevalueofcardpaymentsbelowthethreshold.


Introduction of obligation to use cash registers

Merchants have to install cash

registers

Consumers are more likely to use cards due to the improved card acceptance network



Merchants are more likely to accept card payments using the

existing POS terminals and to install new POS

terminals

Merchants have to install cash

registers

Merchants are more likely to

register their (cash) transactions and to

issue receipts



Increase in government

revenues

Chart 3.11. Mechanism of the regulation - Obligation to possess cash registers.

Source: EY

3.2.4. Obligation to possess cash registers

Thisregulationobligesawidergroupofbusinesses(dependingonthetypeofbusinessactivityorthevalueoftheyearlyturnover)tousecashregistersorrelatedfiscaldevicesinordertorecordeveryindividualtransaction,regardlessofthemeansofpayment.

Theprocessofintroducingcashregisters,oftendescribedastheprocessoffiscalisation,isintendedtoprovideamechanismfortaxadministrations to supervise the records in the cash turnover and monitoranddetectnon-compliance(seeChart3.11).

Itshouldbenotedthatseveralfactorsaffecttheefficiencyofthisregulation.First,theintroductionofmandatorycashregistersisusuallyaccompaniedwithintensifiedfiscalcontrolsandaudits.Second,modernfiscalisationsolutions,suchasso-calledonlinecash registers, which have become increasingly popular over the lastfewyears,mayprovidebetterresults.Inthiscase,eachfiscaldevice is equipped with internet connectivity and appropriate softwarethatenablesthedeliveryofindividualtransactiondataona real time basis to the tax administration. In this way, every invoice isauthorisedbythetaxofficebeforebeingpresentedtothebuyer.

Obligation to possess cash registers – examples

Poland, Italy and recently Sweden – these are some of the European countries that have already obliged a wider group of businesses (with certain exceptions depending on the type of business or limits of turnover) to record every individual money transfer via fiscal devices, regardless of the means of payment. Furthermore, in the case of Bosnia and Herzegovina, Croatia, Slovakia, Serbia and Hungary, cash registers must be equipped with internet connectivity so that data on each transaction can be delivered on a regular time basis (e.g. real time, daily) to the tax administration server.

Additionally, a law on fiscalisation becomes effective in 2016 in Slovenia, and one is currently in preparation in the Czech Republic.


Impact of the regulation on the passive shadow economy Weestimatetheimpactoftheobligationtopossessandusecashregistersonthepassiveshadoweconomybasedontwokindsofeconometric analysis:

• Panel, international econometric analysis oftheimpactofthisobligationonthevalueofcardtransactions;

• Time-series econometric analysis for Poland oftheimpactofthenumberofcashregistersonthesizeofthepassiveshadoweconomy46.

In the panel econometric analysis, we use the regulatory data from17Europeanstates47. The obtained results suggest that a regulation obliging businesses to record every transaction using acashregistersignificantlyincreasesthevalueofcardpaymentspercapita.Suchfindingsconfirmthattheregulation-drivenincreasedpropensityofbusinessestoreporttransactionsnotonlyleadstoanincreasedshareofregisteredconsumercashpayments,but also promotes electronic transactions through increased card acceptance. This implies crowding out consumer cash payments with card payments, which in turn translates into the reduction ofthepassiveshadoweconomy.WeapplytheestimationresultstoassessthepotentialbenefitsofthefiscalisationreformfortheCzechRepublicandSlovenia,whichasofend-2015hadnotyetintroduced this measure. For these two countries, a potential drop inthepassiveshadoweconomyamountsto0.74%and0.52%ofGDPrespectively(seeChart3.12).

Chart 3.12. The impact of the obligatory possession of cash registers on the change in the size of the passive shadow economy (% of GDP).

-0.52

-0.74-0.80

-0.70

-0.60

-0.50

-0.40

-0.30

-0.20

-0.10

0.00Czech Republic Slovenia

Source: EY

46 For more details on both approaches see Appendix 5. 47 These countries include Poland, Croatia, Serbia, Slovenia, Slovakia, the

Czech Republic, Bosnia and Herzegovina, Hungary, Denmark, Norway, Sweden,theUnitedKingdom,Austria,Finland,Germany,PortugalandSpain.

It should be stressed, however, that we assess the expected average effectofthisreformbasedonthevarietyofcountry-specificsolutionsappliedinthepast.Therefore,theactualeffectfortheCzechRepublicandSloveniamightdifferfromthepresentedresults, depending on particular regulation characteristics and thelevelofcompliancewiththenewlaw.Moreover,itshouldberemembered that the panel econometric analysis can capture only partoftheimpactoffiscalisationonthepassiveshadoweconomy.AsitisfocusedonmeasuringtheimpactofthisregulationonthevalueofcardpaymentsatPOSterminals,itdoesnotaccountfortheeffectoftheincreasedlikelihoodofconsumercashpaymentsbeingregisteredduetofiscalisationrequirements.

Thetime-serieseconometricanalysisiscomplementarytothepanelanalysisdiscussedaboveandisintendedtoestimatetheeffectofthe“fiscalisationlevel”onthepassiveshadoweconomy,usingtheexampleofPoland.WeprovidethisanalysisforPolandduetothelackofnecessarydata(i.e.thenumberofcashregisters)forothercountries48.Thisapproachcomplementstheresultsofthepanelanalysisasittakesintoaccountnotonlytheimplementationofthereform,butalsoitsscopeandevolutionovertime.Furthermore,inthisapproachwemeasurethedirectimpactofcashregistersonthe passive shadow economy. It means that it accounts not only fortheeffectofcrowdingoutcashbycardpayments(likeinthepaneleconometricanalysis),butalsofortheeffectrelatedtoanincreasednumberofcashpaymentsreportedtothetaxauthority.

Theobtainedestimatessuggestthatanincreaseintheratioofthenumberofcashregisterstothenumberofactiveenterprisesby0.1leads, on average, to a decrease in the passive shadow economy by0.326percentagepointsofGDP.Inthefourthquarterof2013,theratioofthenumberofcashregisterstothenumberofactiveenterprises in Poland amounted to 1.07. It means that a rise by 0.1 wouldcorrespondtoa9.3%increaseinthefiscalisationlevel.

48WeareparticularlygratefultothePolishMinistryofFinanceforprovidinguswithtimeseriesonthenumberofactivecashregistersinPoland.


Impact of the regulation on government revenuesResultsofthepaneleconometricmodelsuggestthatifalawonthemandatorypossessionofcashregisterscameintoforce,government revenues in the Czech Republic and Slovenia would increaseby0.13and0.12%ofGDP,respectively(inabsoluteterms,additional revenues amount to EUR 206.0 m in the Czech Republic and EUR 46.0 m in Slovenia, see Chart 3.13).

Chart 3.13. The impact of the obligatory possession of cash registers on government revenues.

0.08

0.08

0.04 0.06

46.5

206.0

0

50

100

150

200

250

0.00

0.04

0.08

0.12

0.16

0.20




Slovenia Czech Republic

Source: EY

Potential costs of the regulation Purchasingcashregistersmayconstituteasignificantimplementationcostoftheregulation.Furthermore,duringtheimplementationphase,intensifiedfiscalcontrolsarenecessaryin order to monitor how businesses comply with the new law. In addition,inthecaseofonlinecashregisters,thecostofdedicatedequipmentandsoftwaretrackingandtransferringeachreceipttothetaxauthorityshouldbetakenintoaccount.Thisinfrastructureshould be installed both by merchants and the tax authority.

Estimated timing of the impact of the regulationThe regulation may take some time to implement, due to the needtopurchaseandinstallnewdevicesandsoftwarebothbymerchantsandthetaxauthority(dependingonthescopeoftheregulation).Mostoftheestimatedimpactwillmostlikelyhavematerialisedbytheendofthetransitionperiod.Someeffectsmayemergeevenbeforetheintroductionoftheregulation(butafteritsannouncement), since some entities will start acting in compliance with the regulation already in the transition period.


3.2.5. Obligation to operate POS terminals for selected types of businesses

Introduction of obligation to operate POS

terminals

More merchants install and use POS terminals

Consumers are more likely to make card

payments due to the

improved card acceptance

network

Crowding out of

consumer cash

payments by electronic

transactions

Decrease in the size

of the passive shadow

economy

Change in the

government balance


revenues

Costs incurred by the

government related to

financing of new POS terminals

Unwillingness of merchants

to break the law

Government financing

installation of new POS terminals by merchants

[Optional]

Chart 3.14. Mechanism of the regulation – Obligation to operate POS terminals for selected types of businesses.

Source: EY

Obligation to operate POS terminals – an example

South Korea is known for promoting electronic transactions by applying a wide range of policy tools. In 2001, card acceptance was mandated for all VAT-paying businesses in the country. Moreover, in 2002 South Korea imposed fines for card refusal.

ThisregulationobligescertaintypesofbusinessestooperatePOS(pointofsale)terminals(seeChart3.14).POSterminalsaredevicesthat enable customers to settle their payments with payment cards.Sincethedevelopmentoftheacceptancenetworkisanimportantdeterminantofthepopularityofelectronictransactions,itispossibletostimulatethegrowthofcardpayments(replacing

consumer cash payments) through the obligation to install POS terminalsinselectedsectors.Thisshouldbemosteffectiveinthesectorsaccountingforahighshareofthetotalpassiveshadoweconomy,andforbusinessactivitiesinwhichtheprevalenceofPOSterminals is currently relatively low.


Impact of the regulation on the passive shadow economyWeevaluatetheimpactoftheconsideredregulationonthevalueofcardandcashpaymentsusingasimulationapproach.Thecrucialelementofouranalysisistheestimationofthegapbetweentheregulation-impliedandcurrentnumberofPOSterminals.Importantly, we estimate this gap and the resulting increase in the numberofterminals,takingintoaccountthesectorialbreakdownoftheeconomy.Asafurtherstep,basedontheregressionanalysis,wetranslatetheestimatedchangesinthenumberofterminalsintothegrowthinthevalueofcardpayments,whichinturnallowsustocalculatethevalueofcrowdedoutcashpaymentsandtheresultingdecreaseinthesizeofthepassiveshadoweconomy.Weassumeperfectcomplianceofmerchantswiththeregulation.Formoredetails on the applied approach and obtained results see Appendix 5.

TheestimatedimpactoftheregulationonthesizeofthepassiveshadoweconomyispresentedinTable3.7.Itisthehighestfor(1)the relatively large sectors (in which an increase in the prevalence ofPOSterminalssignificantlycontributestoagrowthinthetotalnumberofPOSterminalsintheeconomy)and(2)thesectorsinwhich“saturation”withPOSterminalsisrelativelylow.Inallthecountries,exceptSloveniaandCroatia,theestimatedeffectisthehighestforthesectoroffood,beveragesandtobacco(forSloveniaandCroatiaitisrestaurants,barsandcafes,thoughdifferenceswiththefood,beveragesandtobaccosectoraremarginal).SincethenumberofPOSterminalspercapitainBosniaandHerzegovinaisthelowestamongtheanalysedcountries,thepotentialeffectoftheregulationforthiscountryisthemostsignificant.

Table 3.7. Obligation to operate POS terminals for selected types of businesses – impact on the passive shadow economy (% of GDP).

Bos

nia

and

Her

zego

vina

Bul

gari

a

Croa

tia

Czec

h R

epub

lic

Pola

nd

Serb

ia

Slov

akia

Slov

enia

Food, beverages and tobacco (grocery stores, markets, etc.) -0.30% -0.13% -0.14% -0.48% -0.44% -0.39% -0.36% -0.20%

Restaurants -0.12% -0.04% -0.14% -0.31% -0.07% -0.15% -0.20% -0.21%

Fuelsforvehicles -0.08% -0.03% -0.01% -0.06% -0.11% -0.10% 0.00% -0.09%

Accommodation -0.04% -0.01% -0.11% -0.10% -0.04% -0.05% -0.02% -0.06%

Transport (private and public) -0.05% -0.02% -0.03% -0.04% -0.02% -0.07% -0.05% -0.01%

Recreation and culture -0.01% 0.00% -0.02% -0.02% -0.03% -0.01% -0.02% -0.01%

Top 6 sectors with the highest effects* -0.60% -0.24% -0.43% -1.01% -0.71% -0.77% -0.67% -0.58%

All passive shadow economy sectors -0.64% -0.26% -0.47% -1.14% -0.79% -0.82% -0.80% -0.63%

*Thesesectorshavebeenselectedbasedontheaverageresultsforallthecountries.

Source: EY



Table 3.8. Obligation to operate POS terminals for selected types of businesses – impact on government (VAT and CIT) revenues (% of GDP).

Bos

nia

and

Her

zego

vina

Bul

gari

a

Croa

tia

Czec

h R

epub

lic

Pola

nd

Serb

ia

Slov

akia

Slov

enia

Food, beverages and tobacco (grocery stores, markets, etc.) 0.06% 0.03% 0.03% 0.12% 0.08% 0.08% 0.09% 0.03%

Restaurants 0.02% 0.01% 0.03% 0.08% 0.01% 0.04% 0.05% 0.03%

Fuelsforvehicles 0.02% 0.01% 0.00% 0.02% 0.03% 0.02% 0.00% 0.02%

Accommodation 0.01% 0.00% 0.02% 0.02% 0.01% 0.01% 0.01% 0.01%

Transport (private and public) 0.01% 0.00% 0.01% 0.01% 0.00% 0.02% 0.01% 0.00%

Recreation and culture 0.00% 0.00% 0.00% 0.01% 0.00% 0.00% 0.00% 0.00%

Top 6 sectors with the highest effects* 0.12% 0.05% 0.09% 0.26% 0.13% 0.16% 0.17% 0.10%

All passive shadow economy sectors 0.13% 0.06% 0.10% 0.29% 0.15% 0.17% 0.20% 0.10%


Source: EY

Table 3.9. Obligation to operate POS terminals for selected types of businesses – impact on government (VAT and CIT) revenues (EUR m).

Bos

nia

and

Her

zego

vina

Bul

gari

a

Croa

tia

Czec

h R

epub

lic

Pola

nd

Serb

ia

Slov

akia

Slov

enia

Food, beverages and tobacco (grocery stores, markets, etc.) 8.6 12.6 12.4 183.7 321.4 25.6 69.3 12.1

Restaurants 3.4 4.2 12.6 131.5 46.2 12.5 39.4 11.6

Fuelsforvehicles 2.3 2.9 1.1 25.4 119.3 6.2 0.0 7.7

Accommodation 1.1 0.9 9.8 36.2 23.6 3.3 4.1 3.2

Transport (private and public) 1.4 1.6 3.5 14.5 12.2 5.6 9.6 0.6

Recreation and culture 0.2 0.2 1.4 8.5 17.3 0.4 1.3 0.5

Top 6 sectors with the highest effects* 17.0 22.4 40.7 399.9 539.9 53.5 128.0 35.6

All passive shadow economy sectors 18.1 23.6 44.3 454.3 617.3 57.5 152.6 38.7


Source: EY

ThepurchaseorleaseofPOSterminalsconstitutesamajorcostofthe considered regulation. This cost may be borne by businesses, thegovernmentorsharedbetweenthem.Weconsidertwovariants:

• ►atnocosttothegovernment,inwhichwefocusonlyontheimpactoftheregulationongovernmentrevenues;

• ►wherethegovernmentfinances100%ofthecostofinstallingnewPOS terminals, which is assumed to equal EUR 100 per device in eachcountry.Thisvariantismarkedas“Optional”inChart3.14.

Theestimatedimpactoftheregulationongovernmentrevenuesispresented in Tables 3.8 and 3.9).


Inthe“optional”variant,wehavetoaccountnotonlyforadditionalrevenues,butalsoforthecoststhatthegovernmenthastoincurduetofinancingthecostofinstallingnewPOSterminals.Theneteffectsforthegovernmentbalanceinrelative(as%ofGDP)andabsolute terms are presented in Table 3.10 and 3.11, respectively.

Theresultsshowthat,evenifthegovernmentcoversthecostofthe regulation, the net impact on the government balance remains positiveforalltheanalysedsectorsandcountries,withtheonlyexception being the accommodation sector in Bulgaria.

Table 3.10. Obligation to operate POS terminals for selected types of businesses – impact on the government balance (% of GDP).

Bos

nia

and

Her

zego

vina

Bul

gari

a

Croa

tia

Czec

h R

epub

lic

Pola

nd

Serb

ia

Slov

akia

Slov

enia

Food, beverages and tobacco (grocery stores, markets, etc.) 0.02% 0.01% 0.02% 0.11% 0.07% 0.05% 0.09% 0.03%

Restaurants 0.01% 0.00% 0.02% 0.08% 0.01% 0.03% 0.05% 0.03%

Fuelsforvehicles 0.01% 0.00% 0.00% 0.02% 0.03% 0.01% 0.00% 0.02%

Accommodation 0.00% -0.00% 0.02% 0.02% 0.00% 0.01% 0.01% 0.01%

Transport (private and public) 0.00% 0.00% 0.01% 0.01% 0.00% 0.01% 0.01% 0.00%

Recreation and culture 0.00% 0.00% 0.00% 0.01% 0.00% 0.00% 0.00% 0.00%

Top 6 sectors with the highest effects* 0.04% 0.01% 0.08% 0.24% 0.11% 0.10% 0.16% 0.09%

All passive shadow economy sectors 0.04% 0.01% 0.09% 0.27% 0.13% 0.11% 0.19% 0.09%


Source: EY

Table 3.11. Obligation to operate POS terminals for selected types of businesses – impact on the government balance (EUR m).

Bos

nia

and

Her

zego

vina

Bul

gari

a

Croa

tia

Czec

h R

epub

lic

Pola

nd

Serb

ia

Slov

akia

Slov

enia

Food, beverages and tobacco (grocery stores, markets, etc.) 2.9 2.2 10.4 171.5 276.4 15.3 63.9 10.7

Restaurants 1.1 0.7 10.5 123.8 38.7 8.6 36.4 10.2

Fuelsforvehicles 0.8 0.5 1.0 23.9 107.7 3.6 0.0 7.1

Accommodation 0.4 -0.2 8.2 33.7 19.8 1.9 3.8 2.8

Transport (private and public) 0.5 0.3 3.0 13.5 10.1 3.8 8.9 0.5

Recreation and culture 0.1 0.0 1.1 8.0 14.5 0.1 1.1 0.5

Top 6 sectors with the highest effects* 5.7 3.5 34.1 374.3 467.3 33.3 118.1 31.8

All passive shadow economy sectors 6.0 3.6 37.1 425.4 535.6 35.9 140.6 34.5


Source: EY

Estimated timing of the impact of the regulationMostoftheestimatedimpactshouldmaterialisealmostimmediatelyaftertheintroductionoftheregulation.Someeffectsmaytakeplaceevenbeforetheintroductionoftheregulation,since

some entities may start acting in compliance with the regulation soonafteritsannouncement.


3.2.6. Tax incentives for consumers

Tax incentives for consumers for electronic

payments

Consumer card payments are rewarded with a cash-back,

alternative cost related to cash

payments increases



Government cost of financing

cash-back through tax deduction

Decrease in the size of the passive

shadow economy


revenues

Change in the government

balance

Chart 3.15 Mechanism of the regulation - Tax incentives for consumers.Source: EY

Another way to promote electronic payments is to make them financiallymoreattractiveforconsumerscomparedtocashpayments. This can be achieved by providing payment card userswithspecialbenefitsdirectlyrelatedtotheircards,suchasdiscounts,cash-backorrewardpointsredeemableforprizes.Suchmethodshavebeenwidelyusedbyprivatefinancialinstitutions,andtheireffectivenesshasbeenconfirmedbyanumberofstudiesbased on survey data49.Byanalogy,suchafinancialmotivationmaybeprovidedbythegovernment,forexample,throughappropriatelydesignedtaxincentivestoreducethetaxcomponentofretail

49 See,forexample,ChingA.andF.Hayashi(2010),“PaymentCardRewardsProgramsandConsumerPaymentChoice”,JournalofBanking&Finance,Vol.34,No.8,pp.1773-1787fortheUSA,SantiagoCarbó-Valverde,JoséManuelLiñares-Zegarra(2009),“Howeffectivearerewardsprogramsinpromotingpaymentcardusage?Empiricalevidence”,ECBWorkingPaperNo.1137forSpainorCarlosA.Arango,KimP.Huynh,LeonardSabetti(2011),“HowDoYouPay?TheRoleofIncentivesatthePoint-of-Sale”,ECBWorkingPaperNo.1386forCanada.

pricessuchasVAT,providedthataconsumermakesacardpaymentatthepointofsale50. This should then lead to a reduction incashpaymentsand,asaresult,toadecreaseinthesizeofthepassive shadow economy and a resulting increase in government revenues(Chart3.15).Itshouldbestressedthatsuchincentivesforconsumers may be introduced through various mechanisms, many ofwhichallowthegovernmenttoreducetheincurredcosts,butatthesametimelowerpotentialbenefitsintermsofcrowdedoutcashpayments (see also below).

50 Asimilareffectmaybeachievedthroughtheuseofsubsidies.


Tax incentives for consumers – examples

In 1999, South Korea introduced such a programme, whereby consumers could deduct from their income tax base 10% of the amount paid through credit cards in excess of 10% of the person’s total salary. To prevent excessive tax deductions, the deduction cap was set at the lower of KRW 3 m or 10% of total annual salary. In the years that followed, both the deduction ratio and the annual total salary threshold were significantly raised. In addition, debit card payments were also included. This mechanism allows the government to react (relatively) flexibly to a changing environment and to control the level of the incurred costs, though it also means that the effectiveness of this regulation in terms of reducing the passive shadow economy is lower than in the case of direct cash-backs awarded to consumer card payments (the Korean regulation does not cover non-resident payments and requires some effort from the consumer to obtain benefits related to card payments).

Another example of this kind of regulation is Colombia, where consumers making card payments are entitled to a 2% VAT rebate.

Impact of the regulation on the passive shadow economyAlthoughdifferentvariantsoftheconsumerincentivesdiscussedhere have already been implemented in some countries, to the best ofourknowledge,noquantitativeassessmentsofsuchmeasuresare publicly available51.Duetothelackofsufficientdataforthecountries where the analysed tax incentives were introduced, we use the available research on consumer reactions to card payments rewards.Ouranalysisoftheimpactoftaxincentivesonthepopularityofcardpaymentsand,asaresult,onthepassiveshadoweconomyisbasedonthemicroeconometricstudyofArangoetal.52whousetheBankofCanada2009MethodofPaymentsurvey,containingdetaileddataatthelevelofindividualtransactions.Theauthorsestimate,amongotherthings,thattheimpactofa0.78%cash-backforcreditcardtransactionsonthechoiceofmeansofpaymentbyconsumers.Basedontheseresults,weconductnecessarytransformationsandcalculatetheeffectofagivenlevelofcash-backawardedtoallcardtransactionsonthereductioninthepopularityofcashpayments.Formoredetailsontheappliedapproach see Appendix 5.

Forillustrativepurposes,weconsideracash-backthatamountsto0.5%ofthecardtransactionvalue.Weestimatethatsucharewardwouldleadtoareductioninthevalueofcashpaymentsby9.5%53. Weassumethatthetaxreliefofthesamescale(“governmentcash-back”)wouldhaveananalogousimpactonthevalueofcashpayments.Thequickerthetaxreliefworksandthesimplertheconstructionithas,thehigherthechanceisofthisconditionbeingsatisfied.Itislikelythat,forexample,animmediatebenefitfortheconsumerintheformofaVATdeduction(correspondingtoapredefinedpercentagevalueofacardtransaction)wouldbemoreeffectiveinstimulatingcardpaymentsthancomplicatedmechanismsoftaxrefundsbasedonthecollectionofpaymentcardreceipts,ortheSouthKoreanexampleofincometaxdeduction.The latter mechanisms might allow the government to control regulation-drivencostsmoreeffectively,whichistheirgreatadvantage,butatthesametimewouldreducethenumberofcardtransactionscoveredbytheregulationandlimittheinterestofsome consumers in the implemented solution due to the additional administrative burden.

51 ForfurtherdiscussionforKorea,seethestudyofJeonB.M.(2013),“FightagainstUndergroundEconomy:Creditcardandcashreceiptincomedeductionpolicy”,KWE12thconferencepaper,Tehran(Ifsahan).

52 Arango et al. (2011), op. cit.53 See Appendix 5.


Thepotentialbenefitsoftheregulationintermsofthepassiveshadow economy contraction are higher in those countries where thelevelofthepassiveshadoweconomy(as%ofGDP),theratioofconsumercashtocardpaymentsandtheaverageeffectiveCITandVATrates54 are relatively high. The biggest reduction in the shadow

54 DefinitionsoftheeffectiveCITandVATratesarepresentedin Appendix 6.

economyasaresultofa0.5%taxreliefhasbeenestimatedforBosniaandHerzegovina(2.0%ofGDP)andSerbia(1.49%ofGDP),whiletheweakesteffecthasbeenfoundforSlovenia(0.88%ofGDP,see Chart 3.16).

Chart 3.16. The impact of a 0.5% cash-back for card payments on the passive shadow economy (% of GDP).

-0.88-0.98 -0.99 -1.01

-1.10 -1.10

-1.49

-2.00

-2.5

-2

-1.5

-1

-0.5

0Slovenia Czech Republic Bulgaria Poland Croatia Slovakia Serbia


Source: EY



Chart 3.17. The impact of a 0.5% cash-back for card payments on government revenues.




0.10 0.11

0.15

0.14

0.140.16

0.17

0.280.050.08

0.06 0.11 0.110.10

0.14

0.12

55.3

769.6

89.8

384.2

107.2

196.1

103.155.2

0

80

160

240

320

400

480

560

640

720

800

0.00

0.10

0.20

0.30

0.40

0.50

Slovenia Poland Bulgaria Czech Republic Croatia Slovakia Serbia Bosnia andHerzegovina

Source: EY

Naturally,theanalysedregulationnotonlyprovidesbenefitsintheformofthecontractionoftheshadoweconomyandtheresulting increase in government revenues, but it also entails costs intheformofreducedgovernmentrevenuesperregisteredcardtransaction,duetodeductingafractionofthetaxburden.Theactuallevelofcostsandbenefits,andtheresultingneteffectforgovernmentrevenues,ishighlycountry-specific.Consequently,theoptimumlevelofconsumerincentivevarieswiththecountryanalysed.TheillustrationoftherelationshipbetweenthetaxrelieflevelandtheassociatedcostsandbenefitsisdemonstratedinChart3.18.

Chart 3.18. The impact of tax relief for consumer card payments on the government balance – an illustrative example.

Additional VAT and CIT revenuesCosts for the government

Scale of the intervention (tax relief as % of card payment value)

The break-even scale of invervention

The optimum scale of intervention

EUR

From this moment on, there is no crowding outof the passive shadoweconomy

Source: EY

A reduction in the passive shadow economy is associated with agrowthingovernmentrevenues.Asaresultoftheregulation,thebiggest increase in government revenues should occur in Bosnia andHerzegovina(0.40%ofGDP)andSerbia(0.31%ofGDP).Ontheotherhand,thelowestgrowthoftherevenuesisexpectedinSlovenia(totalchangeintherevenuesof0.15%ofGDP)andPoland

(0.19%ofGDP).Inabsoluteterms,theadditionalgovernmentrevenues are the highest in Poland and the Czech Republic (EUR 769.6 m and EUR 384.2 m, respectively), and the lowest in Bosnia and Herzegovina and Slovenia (EUR 55.2 m and EUR 55.3 m, respectively, see Chart 3.17).


Notethatthepotentialbenefitsoftheregulationforgovernmentrevenuesareproportionaltothefallinthevalueoftheshadoweconomy transactions, which in turn is proportional to the decrease incashusagebyconsumers.Theflatbenefitlineindicatestheareawhere the passive shadow economy no longer exists, and thus there arenoadditionalbenefitsfromafurtherincreaseintheleveloftaxrelief.Theshapeofthecostcurveisdeterminedbythefollowingtwofactors:thevalueofthetaxbenefit(as%ofthecardtransactionvalue)andtheoverallvalueofcardpayments.Therefore,anincreaseinthelevelofcash-backawardedtoconsumercardpayments elevates the costs incurred by the government, because thisencouragesanincreaseinthevalueofcardtransactionsand

eachunitofcardpaymentisnowrewardedwithahigherprize.Whentherearenomoreconsumercashtransactionstobecrowdedout by card payments, the cost curve becomes linear.

Wethereforeseekoptimumlevelsofthetaxincentiveforconsumersthatmaximisethedifferencebetweenthebenefitsandcostsoftheregulation.Theresults,presentedinChart3.19andChart3.20,showthatthisregulationseemstohaveasignificantpotential to reduce the shadow economy and increase government revenues in all the analysed countries, with a particularly high net impactonthegovernmentbalance(ofatleast0.6%ofGDP)intheCzech Republic, Bosnia and Herzegovina, Serbia, and Slovakia.

Chart 3.19. The optimum level of consumer tax relief and its impact on the passive shadow economy.

1.31.4

1.7 1.71.9

2.2

2.7

3.1

2.2

2.8

3.4

6.7

4.1

6.4

5.8 6.0

0

1.6

3.2

4.8

6.4

8

0

0.7

1.4

2.1

2.8

3.5

Slovenia Bulgaria Poland Bosnia andHerzegovina

Croatia Serbia Slovakia Czech Republic

Tax relief (% of card payment value, left axis) Reduction in the passive shadow economy (% of GDP, right axis)

Source: EY


Whiletheeffectsofthisregulationseemtobeparticularlypromisingforallthecountries,themajorconcern,fromtheperspectiveofpublicfinance,mightbethatitentailscertain and quitesignificantcosts,whilethebenefits–althoughestimatedtobemuchhigher–taketheformofpotential additional revenues. Therefore,furtherresearch,dedicatedtoandaccountingforthespecificsofagivencountry,includingthebehaviourofdomesticconsumersandtheirreactiontofinancialincentives,mightbe

desirable. Moreover, there may be interest in adopting a solution thatwouldallowthegovernmenttocontrolthecostoftheregulationmoreeffectively.Inthiscontext,anexampleworthconsideringisthatofSouthKorea,whereanincometaxdeductionechanism, including a deduction cap, was introduced. However, thisisjustoneofmanyvariantsofthisregulation,whichmaybemodifiedinvariousways.

Chart 3.20. The impact of the optimum cash-back (specific to each country) for card payments on government revenues.

0.24

0.430.36

0.54

0.93

0.740.83

0.88

0.13

0.170.27

0.40

0.41 0.610.55

0.65

0.10

0.270.24

0.32

0.62 0.61 0.600.63

0.00

0.32

0.64

0.96

1.28

1.60

0.00

0.32

0.64

0.96

1.28

1.60

Slovenia Bulgaria Poland Croatia Bosnia andHerzegovina

Serbia Slovakia Czech Republic

Increase in VAT revenues (% of GDP) Increase in CIT revenues (% of GDP) Change in the net government revenues (% of GDP)

Source: EY

Estimated timing of the impact of the regulationAsignificantpartoftheestimatedimpactthatisrelatedtothebehaviourofcurrentcardholdersshouldtakeplacealmostimmediatelyaftertheregulationhasbeenintroduced.Forthosewhodonotownapaymentcard,theeffectsmayemergemoregradually (and should materialise almost completely within 1–2years,accordingtoourexpertjudgement).Therefore,theanalysedcountrieswitharelativelyhighshareofcardholdersinthepopulation (Slovenia, Slovakia and Croatia) may expect a quicker materialisationoftheestimatedimpactthanothercountries.Itis also likely that a relatively high tax incentive would accelerate thisprocess(higherbenefitsshouldencouragepeopletoapplyforpayment cards more quickly).

Theeffectsthattheconsideredregulationwillhaveovertimemayalsoplayacriticalroleinthecost-benefitanalysis.Foronemightassumethat,aftermanyconsumershaveshiftedfromcashtocardpaymentsasaresultofthecash-backincentive,theirpaymenthabitsmayoftenchangepermanently.Therefore,ifthegovernmentreducesthelevelofthetaxincentive,orevencompletelywithdrawsfromtheregulation,asignificantproportionofconsumersmaynotbewillingtoshiftbacktocashpayments.Consequently,thecostsoftheregulationmaybereduced(oreliminated)overtimewithalimitedimpactontheachievedbenefits.Therefore,theneteffectsoftheregulationonthegovernmentbalancemayincreaseovertime.


3.2.7. Tax incentives for merchants

Tax incentives for merchants for accepting

electronic payments

Consumers are more likely to make card payments due to

the improved card acceptance network


cash payments by

electronic transactions

Costs incurred by the

government in the form of tax deduction

Decrease in the size of the passive

shadow economy


revenues

Change in the government

balance

Merchants are more likely to accept card payments in the existing

POS terminals

Reduced cost of card acceptance

for merchants

More merchants install POS

terminal

Chart 3.21. Mechanism of the regulation – Tax incentives for merchants.Source: EY

Tax incentives for merchants – examples

Merchant-targeted policies of South Korea include VAT deduction and income tax deduction schemes (the latter abolished in 2011), both providing merchants with tax benefits for accepting card payments. The VAT deduction ratio (accompanied by a deduction cap) has varied over time and across categories of goods and services.

Another example is Uruguay, where a 2 p.p. VAT deduction on electronic payments accepted by merchants has recently been introduced.

Inmanycountries,consumersarediscouragedfromusingcardsbecauseofthelimitednumberofplaceswherecardsareaccepted.TheslowdevelopmentofPOSterminalsnetworkscanbearesultofhighcostsofcardpaymentsinsomecountries.Ontheotherhand,largefeesimposedonmerchantsmaybeaneffectoftheinsufficientprevalenceofelectronicpaymentsintheeconomy;ifrelativelyfewpeoplemakecardpayments,themaintenancecostsincurredbymerchantsaredividedoverasmallnumberof

transactions,resultinginlargefeespertransactionformerchants.Insuchcases,taxincentivesdecreasingthecostofacceptingcardpaymentsbymerchantsmaystimulatethegrowthofelectronicpayments, thus leading to a reduction in cash payments. This, inturn,wouldtranslateintoacontractionofthepassiveshadoweconomy and a subsequent increase in government revenues (see Chart 3.21).


Impact of the regulation on the passive shadow economy

Chart 3.22. The impact of the tax relief (0.5% of card payments value) for merchants on the passive shadow economy (% of GDP).

-0.37 -0.38-0.40 -0.42 -0.42

-0.47

-0.75 -0.76-0.8

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0Bulgaria Slovenia Slovakia Czech Republic Poland Croatia Serbia


Source: EY

DuetotherelativelylowvalueofcardtransactionspercapitaatPOS,aswellasthesignificantsizeofthepassiveshadoweconomy,thestrongestimpactoftheregulationontheshadoweconomycontractionhasbeenestimatedforBosniaandHerzegovinaandforSerbia(atthelevelof0.76%and0.75%ofGDP,respectively).Inotheranalysedcountries,theeffectrangesfrom0.37%ofGDPinBulgariato0.47%ofGDPinCroatia(seeChart3.22).

Using a panel econometric model, we have estimated how merchantcostsaffectthevalueofcardtransactionsinapanelof19 countries55.Weapproximatethemerchantcostbycalculatingthesumoftheinterchangeandassessmentfeesineachyearandcountry,assumingthatothercomponentsofmerchantcostsremainedunchanged,orareinsignificantonaverageoverthesampleperiod.Forillustrativepurposes,wefirstconsiderataxincentivethatamountsto0.5%ofthecardtransactionvalue.Inthenext step we translate the increase in consumer card payments into a decrease in consumer cash payments and calculate the resulting change in the passive shadow economy. For more details on the applied approach and obtained results see Appendix 5.

55 These countries include Poland, Croatia, Serbia, Slovenia, Slovakia, the Czech Republic, Bosnia and Herzegovina, Hungary, Denmark, Norway, Sweden,theUnitedKingdom,Austria,Finland,Germany,Portugal,Spain,Italy and Bulgaria.



Chart 3.23. The impact of the tax relief (0.5% of card payments value) for merchants on government revenues.

0.04 0.040.06

0.06

0.06 0.06

0.100.09

0.020.03

0.020.04

0.04 0.05

0.050.07

23.7

318.6

33.9

72.1

163.1

46.020.8

52.4

0

100

200

300

400

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

0.18

Slovenia Poland Bulgaria Slovakia Czech Republic Croatia Bosnia andHerzegovina

Serbia

Increase in VAT revenues (% of GDP) Increase in CIT revenues (% of GDP) Total increase in government revenues (m EUR, right axis)

Source: EY

The reduction in the passive shadow economy is associated with agrowthingovernmentrevenues.Itisthereforenotsurprisingthatthe highest increase in government revenues has been estimated forSerbiaandBosniaandHerzegovina(0.16%and0.15%ofGDP,respectively).Inothercountries,theeffectdoesnotexceed

0.11%ofGDP(seeChart3.23).Inabsoluteterms,theincreasein government revenues is the highest in Poland and the Czech Republic (EUR 318.6m and EUR 163.1m, respectively) and the lowest in Bosnia and Herzegovina (EUR 20.8m).


However,similarlytothetaxincentiveforconsumers,theregulationconsideredherealsoprovidesnotonlybenefitsintheformofshadoweconomycontractionandtheresultingincreaseingovernmentrevenues,butalsocostsintheformofreduced government revenues per registered card transaction, duetodeductingafractionofthetaxburden.Theactuallevelofcostsandbenefits,andtheresultingneteffectforgovernmentrevenues,ishighlycountry-specific.Consequently,theoptimumlevelofconsumerincentivevarieswiththecountryanalysed.TherelationshipbetweenthetaxrelieflevelandtheassociatedcostsandbenefitsisillustratedinChart3.24.Thereasonsfortheconstantslopeofthebenefitscurveandtheincreasingslopeofthe costs curve are the same as described in Chapter 3.2.5 on tax incentivesforconsumers.

Chart 3.24. The impact of the tax relief (as % of card payments value) for merchants on the government balance – an illustrative example.

Scale of the intervention (tax relief as % of card payment value)

Additional VAT and CIT revenuesCosts for the government

The break-even scale of invervention

The optimum scale of interventionEU

R

Source: EY

Wethereforeseekoptimumlevelsofthetaxreliefformerchantsthatmaximisethedifferencebetweenthebenefitsandcostsoftheregulation. The results, presented in Chart 3.25 and Chart 3.26, showthatthisregulationgeneratessmallereffectsintermsofreducing the shadow economy and increasing government revenues thanthepreviouslydiscussedtaxincentivesforconsumers(seeChapter 3.2.6). Nevertheless, the net impact on government

revenuesisstillsignificantforSerbia(0.25%ofGDP),followedbyBosniaandHerzegovina(0.19%ofGDP)andtheCzechRepublic(0.14%ofGDP).Incontrast,thiseffectforPolandandCroatiaismarginal(0.02%and0.03%ofGDP,respectively),whileforSloveniathecostsalwaysoutweighbenefits,andthustherecommendedsolution is not to implement this regulation.

Chart 3.25. The optimum level of the merchant tax relief and its impact on the passive shadow economy.

0.0

0.80.9

1.21.5

1.92.0

2.2

0.0

0.7 0.80.9

2.3

1.5

2.9

1.8

0

0.8

1.6

2.4

3.2

4

0

0.5

1

1.5

2

2.5

Slovenia Croatia Poland Bulgaria Bosnia andHerzegovina

Slovakia Serbia Czech Republic

Tax relief (% of card payment value, left axis) Reduction in the passive shadow economy (% of GDP, right axis)

Source: EY


Chart 3.26. The impact of the optimum tax relief for merchants (specific to each country) on government revenues.

Increase in VAT revenues (% of GDP) Increase in CIT revenues (% of GDP) Change in the net government revenues (% of GDP)

0.13

0.000.08

0.06

0.030.09

0.07

0.02

0.05

0.07

0.22

0.15

0.11

0.31

0.14

0.190.27

0.20

0.14

0.34

0.28

0.25

0.00

0.16

0.32

0.48

0.64

0.80

0.00

0.16

0.32

0.48

0.64

0.80

Slovenia Poland Croatia Bulgaria Slovakia Bosnia and Herzegovina

Czech Republic Serbia

Source: EY

Whilewehaverepeatedlyemphasisedtheconservativeapproachthatweoptforinanysituationsubjecttouncertainty,wehavetoadmitthatforthisparticularregulationthepresentedimpactongovernment revenues may have been overestimated. The reason is thattheestimatedoptimumlevelsofthetaxreliefseemtobetoolowtoincentivisethosemerchantsthatbenefitmuchmorefromnot reporting some cash transactions to start registering these transactionsbyacceptingcardpayments.Therefore,itislikelythatitwouldbemostlythosemerchantsthathavesofarregisteredcashtransactions that may have the strongest motivation to replace cash transactions with card payments. In the latter case, however, theshifttoelectronicpaymentswouldnotreducethepassiveshadow economy, since crowded out cash payments were already reported and included in the registered tax base. Taking that into account,andthefactthatinourapproachweassumethatagivenpercentageofcrowdedoutconsumercashpaymentsleadstoa proportional decline in the passive shadow economy, the obtained resultsfortheimpactoftheregulationonthecontractionoftheshadow economy and increase in government revenues may be overestimated.

On the other hand, it could be claimed that this regulation should contributetothedevelopmentofcardpaymentinfrastructureandstimulateelectronictransactions.Whenthecardnetworksufficientlydevelops,thecostsofitsmaintenance(intermsoffeespertransaction)shouldbereducedandtaxincentivesformerchants may no longer be necessary. The government may thereforewithdrawfromtheregulationandnolongerincurthecostoftaxrelief.Inthiscontext,theregulationmaybeconsideredasaninvestment, not least in countries with an underdeveloped payment infrastructure.

Aswiththeregulationontaxincentivesforconsumercardpayments,thetaxreliefformerchantsentailscertain, and quite significantcosts,whilethebenefits–althoughusuallyestimatedtobehigher–taketheformofpotential additional revenues. Therefore,furtherresearchdedicatedtoandaccountingforthespecificsofagivencountry,includingthebehaviourofdomesticmerchantsandtheirreactiontofinancialincentives,mightbedesirable.

Estimated timing of the impact of the regulationAsignificantpartoftheestimatedimpactrelatedtothebehaviourofmerchantswhoalreadyoperatePOSterminalsshouldtakeplacealmostimmediatelyaftertheregulationhasbeenintroduced.ForthosemerchantswhodonothavePOSterminals,theeffectwillmaterialisemoregradually.Therefore,theanalysedcountrieswitharelativelyhighnumberofterminalsper1000persons(Croatia,Slovenia)mayexpectaquickermaterialisationoftheestimatedimpact than other countries. It is also likely that a relatively high tax incentive would accelerate this process. However, it might takesometimeforconsumerstogetusedtotheimprovedcardacceptancenetworkandtousecardsmorefrequently.

Effectsthattheconsideredregulationwillhaveovertimemayalsoplayacriticalroleinthecost-benefitanalysis.Foronemightassumethat,afterthecardacceptancenetworkhasbeenimprovedasaresultofthetaxincentiveformerchants,thisprocesswouldnotbereversedevenifthegovernmentreducedthelevelofthetaxincentiveorevencompletelywithdrewfromtheregulation.Consequently,thecostsoftheregulationmaybereduced(oreliminated) over time with a limited impact on the achieved benefits.Therefore,neteffectsoftheregulationonthegovernmentbalance may increase over time.


3.2.8. Receipt lotteries

Theideaofreceiptlotteriesistoreducethepassiveshadoweconomy by limiting unreported transactions through the increased issuanceofreceiptsinbusiness-to-consumertransactions.Specifically,consumersareprovidedwithanincentivetoaskforareceipt,asitmayalsoserveasafreeofchargeticketinVATlotteries,thereforegivingitsholderachancetowinattractiveprizes. In the longer perspective, this measure aims to get consumersusedtoaskingforfiscalreceipts.Itisoftenassumedthat,afteracertainperiodoftime,peoplewilldevelopsuchahabit(e.g.bymakingaskingforreceiptssociallyacceptableanddesirable,orbyraisingawarenessofthebenefitsofcombattingtheshadoweconomy)andthuswillcontinuetodemandfiscalreceiptseven without such an additional monetary incentive.

Receipt lotteries – examples

National receipt lotteries have been introduced in several countries (starting from Taiwan in the early 1950s) in order to increase the issuance of receipts in consumer transactions. In Slovakia, Malta and Portugal, the lottery is considered as a continuous solution, whereas in some other countries, it is designed to run only for a specific period of time.

For instance, in Poland the programme is explicitly introduced for 12 months. In South Korea, a cash receipt lottery was organised for several years but was discontinued in 2010 after user involvement reached a desirable level. Another example is Bulgaria and Croatia, where several rounds of VAT lotteries have been organised, though not on a regular basis and on a relatively small scale (usually as part of the national educational campaigns to raise awareness of the existence of the shadow economy).

Consumers are more likely to use cards due to the improved card acceptance network

Crowding out of consumer cash

payments by electronic transactions

Merchants are more likely to accept card payments using the existing POS terminals

and to install new POS terminals

Consumers ask for receipts

more often to take part in the

lottery

Merchants more often register their (cash) transactions and issue receipts

Decrease in the size of the passive shadow economy


revenues

Introduction of receipt lottery

Chart 3.27 Mechanism of the regulation – Receipt lotteries.

Source: EY


Impact of the regulation on the passive shadow economy and government revenuesItmustbeemphasisedthattheimpactofthisregulationontheshadowmarketmaybetwofold.Firstly,itislikelytohaveanimpactoncustomers’“demandforreceipts”andhencedirectlyreducethenumberofunreportedtransactions.Secondly,itcanincrease(atleasttosomeextent)thepropensityofmerchantstoacceptelectronic payments. In these new circumstances, in which more transactionshavetoberegisteredafterall,cardpaymentsarenotasunattractiveformerchantswhencomparedtoregisteredcashpayments as they would be when compared to unregistered cash transactions (Chart 3.27).

Tothebestofourknowledge,theefficiencyofreceiptlotteriesincombattingthepassive-shadoweconomyhasnotyetbeenthoroughlyinvestigatedintheliterature.Duetothelackofdatarequiredtoestimatethedirectimpactofreceiptlotteriesonthepassiveshadoweconomy,wefocusontheirindirectimpact,relatedtothechangeinpopularityofconsumercardpayments.Forthatpurpose we use an econometric model similar to that already discussed in Chapter 3.2.3.

Atfirstglance,theeconometricanalysisseemstoconfirmthepositiveimpactoftheintroductionofaVATlotteryonthevalueofcardpayments.Thisregulation,however,isrelativelyscarceandrecent,andusuallyfollowstheintroductionofthemandatorypossessionofcashregisters(seeChapter3.2.3).Afteraccountingforthelatterinthemodel,theimpactofreceiptlotteriesonthevalueofcardpaymentsbecomesstatisticallyinsignificant.Itmeansthat, while receipt lotteries seem to have some positive impact

oncardpayments(andthroughthatchannel,alsoonthepassive-shadoweconomy),noquantitativeconclusionsonthestrengthofthis impact can be drawn. More details on the applied approach and obtainedresultsmaybefoundinAppendix5.

Withnoclearimpactonthevalueofcardpayments,itisalsoimpossibletoestimatethefiscaleffectofreceiptlotteriesthroughthepromotionofelectronicpayments.However,itisverylikelythatsuchlotteriesareanefficientinstrumentincombattingthepassiveshadoweconomyinadirectway,i.e.byreducingthenumberofunreported cash transactions, since merchants should be more oftenaskedtoissuereceipts.However,thescarcityofhistoricalexperience,andthusinsufficientdata,donotallowustoprovidequantitativeevidenceofsucharelationship.Thechallengeofdataavailabilityisadditionallyreinforcedbythewiderangeofpossibleimplementationsofreceiptlotteries(differing,forexample,intermsofeaseofparticipation,numberandvalueofexpectedrewards,etc.).

Potential costs of the regulation The main costs are linked to prizes and the expenditures related to organising the lottery, such as setting up a website, etc. The overall valueofprizesofferedinthelotteryshouldbelowinrelationtotheexpectedgainsintermsofadditionaltaxinflowsfromthenewlyregistered transactions. Such costs can easily be controlled by the regulator.

Estimated timing of the impact of the regulationThedirecteffectsoflotteriesshouldbevisiblealmostimmediatelyafterintroducingtheregulation.However,theassessmentofhowmany receipts have been recorded only due to the lottery remains hard to estimate.


ConclusionsAhighleveloftheshadoweconomyhassignificanteconomicandsocial implications. Its adverse consequences comprise, among otherthings,areducedtaxbase,alowerquantity/qualityofpublicgoods, more distortions in market competition, the degradation ofeconomicandsocialinstitutions,and–throughtheabove-mentionedchannels–lowereconomicgrowth.Therefore,itisimportanttoseektoolsandsolutionsthatmighteffectivelyreducethe shadow economy.

This report contributes to the literature with respect to the impact ofcashvs.electronicpaymentsonthenon-observedeconomy.Wehaveintroducedadivisionoftheshadoweconomyinto: (1)thepassive(wherecashpaymentisthecauseofunreportedtransactions) and (2) the committed component (where cash paymentistheconsequence).Wehavealsoproposedarefinementoftheexistingeconometricmethodsofestimationoftheshadoweconomy in order to better understand its determinants, especially ofthepassivecomponent.Inparticular,wehavediscussedtherelationbetweenthevalueofcardpaymentsandthesizeofunregistered activities. In addition, we have addressed some methodologicalissuesthat–inouropinion–wouldotherwiseleadtoanoverestimationoftheshadoweconomy,asactuallyoccurredin some other studies.

WehaveusedourmethodologytoconsistentlyanalysetheshadoweconomyinthegroupofeightCentralandSouthernEuropeancountries: Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Poland, Serbia, Slovakia, and Slovenia. As shown in thisreport,thesecountriesdiffernotonlyintermsoftheirsizeandlevelofeconomicdevelopment,butalsointermsofothercharacteristicsrelevantforthepassiveshadoweconomy,notleastthedevelopmentleveloftheirelectronicpaymentsinfrastructure.

Ourresultsshowthatthepassivecomponentaccountsforthevastmajorityoftheshadoweconomyineachoftheanalysedcountries,rangingfrom60.8%(Bulgaria)to90.6%(CzechRepublic).Thesectorialbreakdownoftheseunregisteredactivitiesconstitutesanothercontributionofthisreporttotheliterature.Itshowsthatthebiggerthesectorandthehighertheshareofcashtransactionsin this sector, the greater its contribution to the passive shadow economy.Therefore,itshouldcomeasnosurprisethatthefood,beveragesandtobaccosector,whichisbyfarthelargestinalloftheanalysedcountries,accountsforthelargestshareofunreportedconsumer cash transactions.

Acriticalelementofourresearchisthebudgetarycostrelatedtotheexistenceofthepassiveshadoweconomy.Ourcalculationsshowthatlostgovernment(CITandVAT)revenuesrangefrom1.6%ofGDP(forSlovenia)to4.2%ofGDP(forBosniaandHerzegovina).Importantly, one should remember that this revenue shortage does notaccountforthewholetaxgapthatindividualgovernmentssufferfrom.Onereasonisthatthecommittedcomponentofthe shadow economy also includes unreported transactions that


otherwise should be taxed. Another reason is that government revenuesarealsoreducedbecauseoftaxfraud/evasionmechanismsthatoftentakeplacewithinregisteredtransactions(oneexamplebeingmissingtraderfraud),manyofwhichareevenpaidelectronically.Still,theestimatedbudgetaryeffectsofthepassive shadow economy are high enough to show that the game is worththecandle,andthatpotentialbenefitsfromaddressingthisissuecanbesignificant.

Inouranalysiswehaveidentifiedthefactorsthatimpactthelevelofthepassiveshadoweconomy.Themostimportantare:thepopularityofcardpayments,theratiooftaxestoGDP,andinstitutionalandtaxmoraleinagivencountry.Itisimportanttonotethatthosefactorsdiffersignificantlyintermsofthepolicymakers’abilitytoinfluencethem.Forexample,animprovement in the institutional and tax morale may require agovernmenttointroducemany,oftendifficult,reforms,whichmayadditionallytakealongtime.Itisalsonoteasytosignificantlyreducetheburdenoftaxandsocialsecuritycontributions.Ontheother hand, public policies leading to an increase in the popularity ofnon-cashpaymentsseemrelativelyeasiertoimplement.

Consequently,inthisstudyweanalyseasetofvariedregulationsthat–byreplacingcashwithelectronicpaymentsorbyincreasingtheshareofregisteredconsumercashtransactions–mayleadtothereductionoftheshadoweconomyintheanalysedcountries.Manyoftheconsideredsolutionsarealreadypresentincountriesaroundtheworld.Someofthemarebasedonenforcementorobligationmechanisms,whereasothersfocusonprovidingincentives, either to consumers or merchants. The measures analysed in this Report include:

• Obligationtomakeanelectronicpaymentofwagesandsalaries

• Obligationtomakeanelectronicpaymentofsocialsecuritybenefits(includingpensionsandunemploymentbenefits)

• Introductionofthresholdsforthemaximumallowedconsumercash payments

• Obligation to possess and use cash registers

• ObligationtooperatePOSterminals(forselectedtypesofbusinesses)

• Providingconsumerswithtaxincentivesforcardpayments

• Providingmerchantswithtaxreliefforacceptingcardpayments

• Receipt lotteries

Theeffectsoftheconsideredregulationshavebeencalculatedwith using econometric modelling or a simulation approach. The obtainedresultsshowthatthereisindeedasignificantpotentialto reduce the passive shadow economy and increase government revenuesthroughthepromotionofelectronicpayments.


Chart C1. Summary of the impact of the analysed regulations on the passive shadow economy, compared to the passive shadow economy level (% of GDP).

2.94

6.74

1.14

0.74

5.21

0.59

0.013

0.28

9.22

0.71

2.21

0.26

0.52

2.28

0.16

0.002

0.02

0.0 2.0 4.0 6.0 8.0 10.0 20.0 22.0

Passive shadow economy level









21.04

Minimum impact

Maximum impact

Minimum Maximum

Source: EY

Chart C2. Summary of the impact of the analysed regulations on the government VAT and CIT revenues, compared to the overall lost VAT and CIT revenues due to the passive shadow economy (% of GDP).

0.0 0.4 0.8 1.2 1.6 2.0 4.0 4.2

Overall lost VAT and CIT revenues









Minimum impact

Maximum impact

4.191.56Minimum Maximum

0.25

0.27

0.13

1.04

0.12

0.003

0.051

0.02

0.10

0.01

0.12

0.39

0.03

0.0004

0.003

0.63

Source: EY

Conclusions


Theimpactoftheconsideredmeasures(excludinglimitsonmaximumconsumercashpayments)onthecontractionofthe shadow economy varies with the analysed instrument. Themostefficientregulationistheprovisionoffinancialincentives to consumers to use electronic payments, which maycontributetothereductionofthepassiveshadoweconomyby2.2%ofGDP(Slovenia)to6.7%ofGDP(BosniaandHerzegovina).Thisregulationisalsothemostbeneficialintermsofitsimpactongovernmentnetrevenues,whichrangesfrom0.1%ofGDP(Slovenia)to0.63%ofGDP(theCzechRepublic).

Consumer cash payment thresholds may be regarded as adifferentcategoryoftheanalysedmeasures,since,ifestablished at a very low level (controversial though it may be), they may almost completely eliminate the passive shadoweconomybycrowdingoutalargeshareoftheexisting consumer cash payments. In this context, it should be emphasised that the thresholds considered here are presented asnothingmorethanexamplesofdifferentlimitsonthemaximumvalueofconsumercashpayments.Whileweagreethat the presented thresholds, especially the lowest ones, may seemunacceptableandhardlyfeasibletoimplement,theywellillustratehowtheimpactofthisregulationvarieswithachangeintheirlevel.Moreover,asconfirmedbyouranalysis,establishinghighthresholdsforconsumercashpaymentswouldhavelittle,ifany,impactonthepassiveshadoweconomy.

Theobtainedresultsshowthattheeffectsoftheanalysedtoolsturnouttobehighlycountry-specificanddependonsuchfeaturesoftheanalysedmarketsastheshareofcashvs.card payments in the overall consumer transactions, the share ofcashlesspaymentsinGDP,thesizeofthepassiveshadoweconomyandtheeffectivetaxrates.Despitethesedifferences,foreachcountrywecanidentifyatleastoneregulationwithconsiderable potential to reduce the shadow economy.

Consequently, we have shown that an increase in the popularity ofelectronicpaymentsmaybeanimportantmeasureinaddressingtheproblemofunreportedactivities.Toillustratethisdifferently:anincreaseinthevalueofcardpaymentsby100% should lead to a reduction in the shadow economy in the analysedcountriesby0.6–3.7%ofGDP,andtoanincreaseingovernmentrevenuesby0.1–0.8%ofGDP.

Finally,wehavetoemphasisethateachofthepresentedmeasuresshouldberegardedasjustoneofmanypossiblevariantsofagivenregulation.Sincethesesolutionsmaybemodifiedintermsoftheirscope,timingandotherparameters,their actual impact would change accordingly and depend onthefinaldecisionoftheregulators.Consequently,themeasures analysed in this study should not be treated as recommendations, but rather as examples illustrating the effectsofpotentialregulationsthatmaybeconsideredbypolicymakersintheirattempttoaddresstheissueofthepassive shadow economy.


The authors EY Poland, Economic Analysis TeamPiotr DybkaMagdalenaKarskaMichałKowalczukBartoszOlesińskiPawełOpalaMarek RozkrutAndrzejTorój

EY Poland, Business Tax AdvisoryBarbara BonaMateusz PociaskAleksandra Skrzypek

Contact

Marek Rozkrut, Ph. D. Partner,ChiefEconomist Economic Analysis Team

Tel.: +48225576411 Fax: +48225577001 Email: [email protected]

EY | Assurance | Tax | Transactions | Advisory

About EY

EY is a global leader in assurance, tax, transaction and advisory services. Theinsightsandqualityserviceswedeliverhelpbuildtrustandconfidenceinthecapitalmarketsandineconomiestheworldover.Wedevelopoutstandingleaderswhoteamtodeliveronourpromisestoallofourstakeholders. In so doing, we play a critical role in building a better working worldforourpeople,forourclientsandforourcommunities.

EYreferstotheglobalorganizationand/oroneormoreofthememberfirmsofErnst&YoungGlobalLimited,eachofwhichisaseparatelegalentity.Ernst&YoungGlobalLimited,aUKcompanylimitedbyguarantee,doesnotprovide services to clients.

Formoreinformationaboutourorganization,pleasevisitey.com.

©2016EYGMLimited. All Rights Reserved. SCORE: 006.11.15

ey.com/pl

Designed by EY Creative Services

reducing the shadow economy through electronic …file/report_shadoweconomy_final.pdfcontents...

Documents