Shadow economy & tax revenue

 Food for thought:

‘Shadow economy’ drives record jump in Spain’s tax revenue

Pandemic pushes informal business on to the books in a country where underground activity is rife 

 Spain’s proportional tax gains in 2021 exceeded increases in France, Germany, Italy, Portugal and Greece even when accounting for inflation.

 Spain is enjoying a record surge in tax revenue that is unmatched by its European peers after the pandemic forced underground business activity out of the shadows. The country’s net tax revenues hit their highest level since records began from January to November last year, jumping 15.9 per cent from the same period in 2021 and delivering an extra €33bn to the public coffers. 

 The expanded tax haul is especially welcome for Spain given its massive public debt load, but whether it becomes permanent depends on the durability of changes in behaviour inspired by Covid-19. 

Tax revenues also climbed from 2020 to 2021, increasing by 14.9 per cent or €27bn over the same period, according to data from the country’s tax agency. 

 Putting the figures in perspective, Spain’s Socialist-led government is seeking to raise annual sums of just €3.5bn from windfall taxes on banks and energy companies, coming into force in 2023. 

 One reason for the rise in tax revenue is economic growth, with the government this week estimating that gross domestic product increased by more than 5 per cent in 2022. Another cause — accounting for half of the increase according to some calculations — is high inflation, a factor present everywhere. 

But Financial Times research shows that Spain’s proportional gains in 2021 exceeded increases in France, Germany, Italy, Portugal and Greece even when accounting for inflation. Economists and finance ministry officials attribute the difference in part to changes in the shadow or grey economy, a murky zone of unregistered activity that spans everything from informal farm workers to plumbers failing to declare cash income and restaurants that pay some wages off the books. 

 Its invisibility has long facilitated tax evasion, to the consternation of governments, but Covid and related economic support policies created new pressures and incentives that revealed underground activity to tax collectors and public statisticians. 

 “People realised during the pandemic that if they had legal contracts and were above the ground, so to speak, then if things got tough they could ask for help from the government,” said Ángel de la Fuente, executive director of Fedea, an economic think-tank. Formalising business and employment meant being able to gain access to Spain’s furlough programmes for workers who were sent home but still received some pay, known as ERTEs. 

It also opened the door to liquidity support for businesses provided by the government. In October 2022, Jesús Gascón, secretary of state for finance, said: “If you’re not on the radar, you’re not receiving the aid.” 

 Announcing its latest data in late December, the tax agency said higher tax revenue reflected increases in the collection of sales tax, personal income tax and corporate income tax — all of which would show the impact of once underground activity that had become official. It confirmed that the new figures marked a record in a data set that stretches back to 1995. 

 Ignacio de la Torre, chief economist at investment bank Arcano, highlighted a discrepancy in employment figures. According to labour ministry payroll figures that do not include the shadow economy, the number of workers in Spain grew by an annualised 2.6 per cent in the third quarter of 2022. 

But separate data from the national statistics institute, which is based on surveys and includes underground work, showed there was zero change in employment. “This might be showing that previous workers in the underground economy are now regularised,” he said. 

 Underground transactions — known as “paying in B” in Spain — also declined owing to fears of cash becoming a vector for Covid germs. The pandemic accelerated a trend of consumers using less cash. A European Central Bank study published in December showed that in 2021-22 the amount spent via in-person card transactions overtook purchases in notes and coins for the first time. The decline in cash use was sharpest in southern Europe, with the proportion in Spain down 18 percentage points from 2019. 

 According to a 2018 IMF study, Spain’s shadow economy was equivalent to 17.2 per cent of GDP, a smaller share than in Italy, Greece and most of eastern Europe, but larger than in Portugal and the rest of western Europe. Informal activity in Spain grew in the 1980s and early 1990s after a tightening of tax rules, as the government sought to bring the country into line with European norms following the end of dictatorship and a return to democracy. 

The largest underground economies are Andalucía and the Canary Islands, two regions where tourism supports many restaurants and bars and grey payments tend to be rife. Although all rises in tax revenue are helpful, the contraction in shadow commerce will not, on its own, cure Spain’s unhealthy fiscal position. Public debt is equal to 116 per cent of GDP, according to the Bank of Spain. 

Raymond Torres, director for macroeconomic analysis at Funcas, Spain’s savings bank foundation, forecasts that the country’s budget deficit will rise to 4.6 per cent of GDP in 2023 from 4 per cent last year, partly due to rising interest rates. 

 Torres said Spain could not keep deferring a serious attempt to bring down the deficit, but added that regional and national elections in 2023 meant the government of prime minister Pedro Sánchez was unlikely to confront the challenge. 

 Last week Sánchez unveiled a €10bn set of measures to ease the cost of living crisis. The third such support package of 2022, it included cuts in sales tax, an extension of subsidies for public transport, and a one-off payment of €200 for 4mn households. Torres does not expect an increase in tax revenue this year to match 2021 and 2022. 

“What we’ve been seeing is an increase in the size of the taxable income base, but not an increase in the rate of income growth.” There is also no guarantee that the advantages of formalised payrolls and digital transactions will endure for all. “There can be relapses in the underground economy. Some activities can go back to being undeclared,” he said.