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How the level of Ukraine's shadow economy has changed over the past year

Author : Bohdan Danylyshyn

Ukraine’s Ministry of Economic Development and Trade has carried out new calculations of the level of the shadow economy of our state
14:45, 31 August 2018

112 Agency

Ukraine’s Ministry of Economic Development and Trade has carried out new calculations of the level of the shadow economy of our state. Of course, shadow economic activity negatively affects the sectoral structure of the country's economy and economic growth.

In addition, it has a negative impact on Ukraine’s monetary and credit system. Cash flows reamin unaccounted for the state statistics, so the state is unable to control them, and shadow turnover of debt capital create additional difficulties. The deformation of the monetary system distorts the structure of the payment turnover, contributes to increasing investment risks, stimulates inflation, deforms monetary relations, and may negatively affect the exchange rate of the national currency. Because of this, the rights of creditors are violated in case of abuse of borrowed capital, artificial bankruptcies of enterprises and banks are declared.

Related: Shadow economy: Disaster or source of survival for population?

Shadow economic activity causes serious damage to the ecology of our country. Shadow production is not officially taken into account, the negative consequences created by the shadow business are not taken into account, and this affects the environment. Measures to protect the environment from pollution by shadow enterprises are ignored.

According to the Ministry of Economic Development and Trade, in the 1st quarter of 2018, the level of the shadow economy was 4% less than in the same period of 2017. In the first three months of 2018, the level of the shadow economy was 33% of the official GDP, whereas in early 2017 this figure was 37%, gradually declining during the year. The ministry points out that the decrease in the level of the shadow economy became possible due to the presence of the main signs of macroeconomic stability. The report notes that for the period from February to March 2018 there was a moderate slowdown in consumer inflation and strengthening of the hryvnia rate after the January’s devaluation.

Efforts of the power structures for the bringing economy out of the shadow and its deregulation bring results. This process should be facilitated by Verkhovna Rada’s law “On Currency and Foreign Exchange Operations” and the future adoption of the law “On the Tax on Induced Capital,” which was also introduced by the President of Ukraine.

Related: Simplified taxation – is it beneficial or detrimental to Ukraine's economy?

Strengthening of the investment component has also contributed to bringing the economy out of grey. Nevertheless, the further removal of the economy from the shadow is hampered by the existence of significant challenges to the stability of the financial system (in particular, a significant public debt), as well as the military conflict in the east of the country.

The integrated indicator of the size of the shadow economy, according to the Ministry of Economic Development and Trade, has been gradually decreasing in recent years (for example, by the end of 2014 it was 41% of GDP, in 2015 - 43.5%, in 2016 - 38%), but it still continues to be high.

At the same time, the shadow economy is a global problem. In 1980 the share of the shadow economy was 5.6% of the world GDP, in 2017 it has reached 33%. At the same time, the absolute figure is impressive - the volume of the global shadow economy is about 39 trillion dollars!

Related: Level of shadow economy in Ukraine decreased to 40% of GDP

There is an opinion that the shadow economy has positive sides during the economic crises: it participates in the creation of value added, it produces goods and services, creating the demand for the legal part of the economy. Also, the shadow economy creates working conditions for a certain number of people. But it distorts the picture of the socio-economic situation in the country, makes it difficult to assess the structural changes in the economy. It is difficult to plan something if you do not understand the real state of the country. Consequently, it is difficult to carry out management functions.

To bring the economy out of the shadow, it is necessary to determine the reasons for this phenomenon:

  • Relatively high tax burden, especially from labor taxes (including social contributions) and excessive complexity of tax administration;
  • "Overregulation" of economic activity, a large number of administrative barriers for opening and doing business;
  • Weak protection of property rights, the inefficiency of the work of the judiciary;
  • Poor quality of public services and absence of a link visible for the taxpayer between the level of public services received by him and the number of his tax obligations.

I will make an important explanation: the last paragraph speaks of a high nominal tax burden. The corporate tax rates themselves are lower than in Europe, but the level of efficiency of using collected funds in the form of taxes is much lower.

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Why is it important? A considerable part of those entrepreneurs working in the shadow (reasonably) thinks something like this: "Why should I pay taxes if the majority of the money is still inefficiently used by the state." In our society, not quite legitimate forms of doing business are approved by a considerable number of businessmen and ordinary citizens.

Here is one more interesting nuance. Sometimes it is believed that the bulk of the shadow economy - small businesses and private entrepreneurs, working on a simplified scheme (they simply do not report the actual amount of their turnover and do not pay extra money to the state budget). Is this opinion based on the facts? Not fully. So, according to the data of the international research organization Global Financial Integrity, in some years offshore withdrawals were made in Ukraine, which amounted to an average of 10% of GDP. One can doubt the accuracy of such calculations, but it is unlikely that the owners of car washes or hairdressing salons will take money offshore. To a large extent, shadow money is the money of Ukrainian big businessmen, among whom there is an unofficial attitude that work "in the shadows" is normal.

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Consider the problem of illegal employment, which is common in our country. The Organization for Economic Co-operation and Development (OECD) has published a rating of Taxing Wages 2018, which assesses the level of tax burden on labor. The net average salary tax rate for 35 OECD countries is 25.5% (including 15.7% - personal income tax, 9.8% - social insurance contributions). How does Ukraine look at this background with 41.5% of the actual tax on labor (18% - personal income tax, 1.5% - military duty, in addition - 22% of unified social taxes)? We are not competitive because of the excessive tax burden on the payroll. Obviously, it is more profitable for many employers to carry out activities unofficially, thus saving on taxes turns out to be significant.

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How to reduce the level of shadow economy? Without political will here is indispensable. It is necessary to gradually but steadily struggle with the ways by which Ukrainian businessmen avoid taxes on an "industrial scale". Together with the economy's exit from the shadow, it is necessary to reduce the tax burden, which will stimulate work legally. Professor F. Schneider wrote: "Countries with relatively low tax rates, fewer regulations, and the real rule of law tend to have smaller scales of the shadow economy." And this is how he ranked the importance of factors. In my opinion, the problem of the rule of law is in the first place in Ukraine.

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