Analytics, Financial Services, Latvia, Legislation, Markets and Companies, Shadow economy, Wages

He said that shadow economy has grown since 2016, and it is not a good signal. "I you have not succeeded to reduce shadow economy during economic growth, it will be even more difficult to do it now, when the economy declines. I expect that the 2020-2022 indicators will be worse than last year's," said Sauka.

At the same time, shadow economy in Lithuania has dropped by 0.5 percentage points to 18.2%, and in Estonia it declined by 2.4 percentage points to 14.3%.

Unreported wages made up 22.3% of shadow economy in Latvia, unreported income accounted for 16.6%, while illegal employees accounted for 10.9%. Unreported wages in Lithuania and Estonia in 2019, compared to in 2018, decreased (by 5.2% in Estonia and by 1.4% in Lithuania), while in Latvia there was an increase (by 0.8%). 

“According to the results of the study, there is an increasing gap between the level of envelope wages in Latvia as compared to that in other Baltic countries. Taking into account the expectable economic downturn in the coming years, action is urgently needed to deal with this problem in Latvia,” Sauka said.

In Latvia, a positive trend has been observed in the field of under-reporting of income (profit). Namely, in Latvia, in 2019 the average share of income that entrepreneurs hid from the state decreased by 1.3%, reaching 16.6%. While in Estonia, in 2019 the amount of under-reporting of income reached 10.6%, up by 0.7%, and in Lithuania, 14.4%, growing by 0.6%. 

In 2019, the amount of non-reported employees (average percentage of employees who work without a contract from the total number of employees) increased in all three Baltic countries, reaching 10.9% in Latvia, rising 1%, 8.3% in Lithuania, rising 2.9%, and 5.7% in Estonia, rising 0.3%.

“This indicator is closely related to the shortage of labor in Latvia and illegal importation of labor from other countries. The issue of local labor shortages, especially the availability of so-called “blue-collar” laborers, will largely lose its relevance in the event of an economic downturn,” Sauka said.

The biggest share of shadow economy was reported in Riga (24.2%), while the lowest share was in Latgale (18.1%). In respect to sectors, the biggest shadow economy was recorded in construction (33.3%) and wholesale (26.1%).

According to the results of the study, in 2019 the general level of bribery in Latvia reached 8.1%, down 0.2% compared to 2018; in Lithuania - 8.5%, down 1.4%; and in Estonia - 3.9%, down 1.1%.

Involvement or non-involvement in the activities of the shadow economy is influenced by several factors, and from the factors considered in the study, it is mostly related to dissatisfaction with the quality of business legislation and the State Revenue Service, followed by satisfaction with tax policy and state support for entrepreneurs. 

“Regarding attitude, companies in the Baltic countries are still relatively satisfied with the operation of the State Revenue Service (SRS). In addition, in all three Baltic countries satisfaction with the SRS slightly increased in 2019: on a scale of 1-5, where 5 means very high satisfaction, in Latvia the satisfaction of entrepreneurs with the SRS was assessed at 3.5 (3.39 in 2018); in Lithuania, 3.7 (3.53 in 2018); and in Estonia, 3.8 (3.57 in 2018),” Sauka said.

Satisfaction with the state tax policy has also increased in all three Baltic countries, but especially in Lithuania and Estonia. While in 2018 in Estonia, Lithuania, and Latvia entrepreneurs assessed their satisfaction with tax policy at 2.36, 2.85 and 2.41, respectively, in 2019 the assessments were 3.1, 3.1 and 2.6 (on a scale 1 to 5, where 5 means very high satisfaction). Satisfaction with the quality of business legislation has also slightly increased in all three Baltic countries, ranging from 3.01 to 3.35 in 2019. In turn, satisfaction with the state’s support for entrepreneurs in the Baltic countries in 2019 was approximately at the same level as in 2018 - in the range of 2.42-2.85.

The results of the study show that entrepreneurs who consider tax evasion to be a permissible behavior are more involved in the shadow economy. The study also shows that the higher the perceived probability of getting caught and the higher the penalties for being caught, the lower the involvement in the shadow economy. “These results show possible policy initiatives for reducing the size of the shadow economy, namely by increasing the probability that those entrepreneurs who engage in the shadow economy will be caught and will be adequately punished,” explained Sauka.

Another important factor in the decision to engage in the shadow economy is the size of the company: smaller and younger companies are more involved in the shadow economy than larger companies. “The results of the study indicate the need to continue reforms and other policy initiatives to reduce the shadow economy, both in Latvia and in the other two Baltic countries. It is especially important to implement such reforms, including reviewing the approach to limiting the size of the shadow economy, taking into account the economic downturn that is expected in the coming years,” Sauka said.

Since 2009 when the Shadow Economy Index was started, the biggest size of shadow economy was recorded in 2010 38.1%, while the lowest one was in 2016 - 20.7%. In 2018, shadow economy index increased by 2.2 percentage points to 24.2% of GDP.