# **_Data Sources_**

Data on tax revenue to GDP and the composition of tax revenue (direct and indirect taxes) are from OECD Stat, EuroStat, The World Bank ECA FACE Database, and the World Development Indicators.. Data on PPP adjusted GDP per capita, share of industry in GDP, share of services in GDP, share of trade in GDP, , and age dependency are from the _World Development Indicators_ (WDI). Data for the shadow economy is from Schneider et al (2010). Data for the policy variable measuring tax burdens (VAT and corporate tax) are from the _World Development Indicators_ (WDI: 2010). Data on governance indicators are from _World Bank Governance Indicators_ .

# **_6. Tax burdens and the shadow economy_**

The shadow economy includes all market-based legal production of goods and services that are concealed from the government primarily to avoid payment of income, value added or other taxes; to avoid payment of social security contributions; and to avoid having to meet certain legal labor market standards, such as minimum wages, maximum working hours and safety standards (Schneider 2010).

|65<br>58 58<br>50 46 45 43<br>39 37 34 31 31 30 27 27 25 22 19 19 16 16 12 11 9<br><br>10<br>20<br>30<br>40<br>50<br>60<br>70<br>**Shadow Economy as Percent of GDP**|
|---|
|0<br>Georgia<br>Peru<br>Azerbaijan<br>Thailand<br>Belarus<br>El Salvador<br>Russian Fed<br>Brazil<br>Colombia<br>Venezuela<br>Serbia<br>Malaysia<br>AVERAGE<br>South Africa<br>South Korea<br>Argentina<br>Spain<br>Indonesia<br>Sweden<br>Germany<br>Canada<br>UK<br>Japan<br>Switzerland|

Despite tax reform measures, the size of the shadow economy has stubbornly **Shadow Economy as Percent of GDP** remained at an average of about a third of 70 65 the GDP in ECA countries. According to 58 58 60 recent estimates by Schneider, Buehn and 50 50 46 45 43 Montenegro (2010), the three countries with the smallest shadow economies 40 among the 23 ECA countries analyzed in 30 this study were the Slovak Republic, the 20 Czech Republic and Hungary<sup>13</sup> with an average size of 18 percent over the period 10 1999-2007. During this same period, the 0 shadow economy in Russia and Moldova was around 44 percent and Georgia topped the list as the country with the highest “shadow” of a size close to two thirds of its GDP. In this sample, UK, Japan and Switzerland had the smallest percentage in the shadow at 12%, 11%, and 9% respectively.

The incentive to evade taxes due to the heavy burden imposed by the overall tax structure and social security contributions is one of the main causes for the existence of the shadow economy. It follows that the larger the shadow, the greater is the underreporting and the consequent loss in tax revenues.

The official GDP of a country tends to be underreported due to the existence of a shadow economy. Hence, the “official” or actual tax /GDP ratio figures may actually be much lower if we take into account the shadow economy which completely escapes taxation (by definition). However, it cannot be assumed that the official GDP of a country is fully increased by the size of the shadow as this would imply that that there is no overlapping between the estimates of the shadow and the estimates of the GDP. In addition, a fair amount of the shadow activity in every country occurs in activities that are below taxable thresholds. To account for the fact there is the issue of double counting and that all shadow activities are not taxable, in this paper we have assumed that just 1/3 of the shadow escapes taxation **.** The methodology to compute the tax gap and tax space with and without the shadow is in Annex B.

> 13 These three countries have since graduated from the ECA region, but where in it for the period involved in our analysis.

12