Control Freaks' Solution to Shadow Economy: Nag People and Abolish Cash

They'll try anything but lowering taxes and reducing regulations



The shadow economy—off-the-books business and labor that would be perfectly legal if people felt like subjecting themselves to taxes and regulations—ebbs and flows with the years. Right now, it's down a bit in many countries from the days of the recession, but shadow economic activity is still huge. Across the European Union, it's estimated to amount to 18.4 percent of GDP. Why people work off the books is no secret—high taxes and burdensome regulations are constantly cited by economists as primary drivers for people to hide what they're doing. So, current policies are like kryptonite to people who want to keep the fruits of their labor. Got it. The obvious solution then is to…harangue and coerce people back into the official economy?

Yeah, those are really serious recent proposals.

First, let's be clear that we are talking about a lot of productive activity in the shadow economy. "[I]n both OECD nations and developing countries, two-thirds of all businesses start-up unregistered in the informal economy," notes Prof. Colin C. Williams of the University of Sheffield at the London School of Economics' European Politics and Policy blog. That's a large majority of businesses starting off the books.

For his figures on the size of the shadow economy, Williams cites Friedrich Schneider, one of the world's foremost experts on the field. In a 2010 paper for the World Bank, Schneider and his co-authors argued that "the overall tax and social security contribution burdens are among the main causes for the existence of the shadow economy." They also noted that "[i]ncreased intensity of regulations is another important factor that reduces the freedom of choice for individuals engaged in the official economy," and they cite research by others concluding that "every available measure of regulation is significantly correlated with the share of the unofficial economy."

So burdensome taxes and regulations created a situation in which a majority of businesses start up illegally. What to do? Maybe cut taxes and regulations so that people find the legal economy a tad more attractive?

Oh no. "[D]e-regulating the declared economy is also a non-starter," insists Williams, "because it results in a levelling down of working conditions." We can't have less onerous regulations because they'd be less onerous and regulatory. Much better to have people ignoring them entirely.

Well, that's not exactly what he wants. He concedes that the "stick"approach—punishing the non-compliant—isn't working and that stepping it up would "squash precisely the active citizenship and entrepreneurship that with the other hand governments want to foster."

His solution is to…umm…talk people into paying more taxes and submitting to red tape. Or, as he puts it, "developing the social contract between the state and citizens to engender a voluntary commitment to compliant behaviour and thus greater self-regulation." Apparently, this involves "openly engaging citizens to consider their obligations and take responsibility for regulating themselves."

That and a euro will get you a cup of black market coffee. It's just not going to work. Sorry.

Then again, it's better than the proposal of Peter Bofinger of the German Council of Economic Experts. He wants to abolish the use of cash, which he calls an anachronism. He frets that old-fashioned notes enable undeclared work and black markets, and stand in the way of central bank monetary policy. So rather than adjust policy to be more palatable to the public, he'd rather leave no shadows in which the public can hide from his preferred policies. The idea is to make all economic activity visible so that people have to submit to control.

Denmark, which has the highest tax rates in Europe and a correspondingly booming shadow economy, is already moving in that direction. With almost half the workforce in construction and agriculture laboring, at least sometimes, off the books, the Danmarks Nationalbank will stop internal printing of banknotes and minting of coins in 2016.

After all, why adjust tax and regulatory policy to be acceptable to constitutents when you can nag them and try to reinvent the idea of money instead?

All very creative stuff as bureaucratic wishful-think goes, for sure. But this dance has continued for millennia, with government officials forever trying to force people to disclose their incomes and comply with impossible rules. After thousands of years of this, Williams and Bofinger think they've found the key to enforcing official will without having to make any adjustments for public preferences.

I'm willing to bet that the creativity of all of those millions of people working and starting businesses in the shadows will ultimately prevail. Again.