High Taxes Drive Shadow Economy in Nordic Welfare States

Not hard to figure out

About half of Danes said they'd paid for undocumented labor in the previous year in a confidential survey, and a full 80% said they would be comfortable doing so. Around 50% of German construction workers have done shadow work. In 2007–the last year for which data for all of the following countries is available–the undocumented trade accounted for 18% of GDP in Norway, 17.9% in Sweden, 17.0% in Finland, and 15.3% of GDP in Germany. By contrast, the shadow economy accounted for 12.2% and 8.4% of UK and US GDP that year, respectively.

So why all this off-the-books activity in northern Europe, where workers enjoy low overall unemployment rates and a bunch of social benefits? It's especially surprising when you consider that those benefits are so good that everyone wants a job, so there's virtually no incentive for an individual to work entirely off the books. In Nordic countries, "although the unemployed constitute 4 per cent of the surveyed population, they conduct just 3 per cent of all undeclared work and receive just 2 per cent of all undeclared income," the study's authors, Friedrich Schneider and Colin C. Williams, write.

However, those benefits come with a price tag. Once you have health and social security from the state, working more won't get you more health and social security. But it will mean you pay a higher rate of tax as your income rises. So you have an incentive not to declare all your income.