"The Economist" recently gave estimates for the shadow economy in 76 countries. These were based on a study conducted by Prof. Friedrich Schneider, of the Johannes Kepler University in Linz, Austria. His article in "The Economist" did not include estimates regarding Israel, and we therefore approached him directly in order to learn the extent of Israel's shadow economy.
A shadow economy consists of economic activity by individuals and companies that is not reported to the income tax and National Insurance authorities. The professional definition is: any unreported economic activity not contributing to official computations and estimates of the Gross National Product.
According to Prof. Schneider, the shadow economy operates on two principal levels: patently illegal activity, and lawful activity involving tax avoidance or even tax concealment.
Patently illegal activity includes trade in stolen property (automobiles, for example), the manufacture and sale of drugs, prostitution, games of chance, smuggling, theft, fraud and embezzlement for "public" and private use.
Lawful activities include unreported income from (additional) work of wage-earners and the self-employed, discounts, expenses and gifts to wage-earners and managers, and barter trade of goods and services.
Schneider's study purports to estimate the share of the shadow economy as a percentage of GNP. He divided the 76 countries into three groups: rich economies (OECD), former Soviet bloc countries, and developing states in Asia and Africa.
There is probably no one method for reaching reasonable estimates. Schneider accordingly based his research on several methods. In rich countries, he examined the (unexplained) increase in the demand for cash. Elsewhere, he examined the increase in electricity consumption relative to the increase in GNP. Discrepancy is supposed to indicate the level of shadow activity.
The conclusions are that the average (unweighted) size of the shadow economy (as a percentage of GNP), in the developing countries, is 39%, compared to 23% in former Soviet bloc countries and 14% in rich (OECD) countries. Israel, with 29%, is in the middle of the chart.
Other conclusions are that the higher that rate of taxation of National Insurance payments, the larger the share of the shadow economy; and also, that there exists a correlation between corrupt practice in the regime and the extent of the shadow economy.
The writer teaches at the Faculty of Industrial Engineering and Management at the Haifa Technion.
Published by Israel's Business Arena September 29, 1999