Last year the Institute of Economic Affairs (IEA) published a report entitled The Shadow Economy. They estimated that the shadow economy amounted to over £150bn in 2012 – and has no doubt increased since that time.
In producing the report the authors admit that:
“Measurement of the shadow economy is notoriously difficult as it requires estimation of economic activity that is deliberately hidden from official transactions. Surveys typically understate the size of the shadow economy but econometric techniques can now be used to obtain a much better understanding of its size.”
£150bn represented about 10% of GDP in 2012. This compares to 14% in Nordic countries and as high as 30% in many southern European countries.
It’s difficult to see how a virtuous circle of improving tax take can be established based on the present trends towards higher taxation. The position of lower paid workers, who are trying to extract themselves from the “benefits trap”, should also be addressed. The loss of benefits and tax deducted from earnings can create significant marginal rates. As the IEA report confirms:
“…low-paid UK workers have a huge incentive to supplement their incomes in the shadow economy.”
It is difficult to see how HMRC can make inroads to reduce the size of the shadow economy. Although legislation now empowers HMRC to reduce tax avoidance at the same time government is reducing HMRC’s head-count as part of its drive to cut public expenditure. Surely, there must be a limit to the automation of assessment and collection processes?
Perhaps a few more hands at the HMRC wheel and investment by government in reducing tax rates will help to convince the shadow economy to step into the light?