Lithuanian Shadow Economy

Lithuanian Shadow Economy

Lithuanian Free Market Institute Lithuanian Shadow Economy Periodical First half-year report 2013 Nr. 2 ISSN 2345-0274 Lithuanian Shadow Econom...

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Lithuanian Free Market Institute

Lithuanian Shadow Economy

Periodical First half-year report 2013

Nr.

2

ISSN 2345-0274

Lithuanian Shadow Economy Compiled by Vytautas Žukauskas

Lithuanian Free Market Institute Vilnius 2013

2

C o n t e n t

Content Introduction3 1. Shadow economy in Europe and Lithuania4 1.1. Definition4 1.2. The size of shadow economy in Europe5 1.3. Shadow economy in Lithuania6

2. Shadow economy in the labour market8 2.1. What is the shadow economy in the labour market?8 2.2. Why does the shadow economy in the labour market emerge and what does the size depend on?9 2.2.1. Income size and labour force taxation 9 2.2.2. Economic situation of a country12 2.2.3. Regulation of labour relations13 2.2.4. State support (unemployment benefits, social benefits and etc.)16 2.2.5. Liabilities of people18 2.2.6. Minimal monthly wage19 2.2.7. Government prevention of shadow economy20

3. The size of the shadow in Lithuanian labour market23 3.1. What are the measures to evaluate the shadow in the labour market?23 3.2. The shadow in the labour market in European Union countries24 3.3. Surveys of businesses and people in Lithuania27 3.4. Data about uncovered violations31 3.5. Survey of STI experts34 3.6. Econometric model36

4. Shadow in the excise goods market41 4.1. The shadow market of distilled alcoholic beverages41 4.2. The shadow market of cigarettes43 4.3. The shadow market of fuels45

Introduction

Introduction This is a second Lithuanian Shadow Economy publication. We are proud of the success of the first publication, which received a lot of attention and support. An issue regarding the shadow economy is as important as ever, so the Lithuanian Free Market Institute (LFMI) continues research in the area. Shadow economy is an important indicator of the overall economy. Small shadow economy indicates that the overall judicial environment and its laws are appropriate, people see them as just and have the ability to abide by them. Whereas a large shadow economy is demonstrating the situation when there are too many constraints for economic activity, they do not go hand in hand with the expectations, economic and social situation of people and creates too much burden. The shadow economy is a reflection of taxation and regulation policy adequacy. When increasing taxes and creating more regulations, certain activities, which otherwise are not being associated with the black market (i.e. sale of every day goods, labour relations), move to the shadow. If a duty of an individual is to fallow the law, then the state has the duty to create such rules, which are adequate and just in people’s mind. Exactly that can be seen by research in the field of shadow economy. The first Lithuanian Shadow Economy publication was dedicated for researching the shadow market of excise goods in Lithuania. The theme of the second publications is the shadow economy in the labour market. This topic was chosen, because illegal work, illegally paid

wages are widely spread phenomenon that engulfs a large share of the labour market in Lithuania. It is important to note that up until this research there were no comprehensive analyses of the reasons of shadow formation in the labour market in Lithuania – what causes the shadow labour market, which factors have the biggest impact? The publication is divided into four parts. In the first part there is a short analysis and comparison is given about the size of the shadow economy in European countries and its dynamics in Lithuania. Second and third parts are for the shadow in the labour market. The second part analysis reasons for the labour shadow market to form and factors that determine its spread are given. The third part is for evaluating the size of Lithuanian shadow labour market. This part also overviews other authors and their research and the research specifically designed and conducted for this publication. In the last part we overview the shadow market in the category of excise goods. In all sincerity we are saying thank you to everybody who have contributed to this publication by providing information and insights: State Labour Inspectorate, State Tax Inspectorate, Financial Crime Investigation Service, Police Department, Statistics Lithuania, National Tobacco Manufacturers’ Association, Association of Enterprises Trading in Alcoholic Beverages and others. Vytautas Žukauskas Senior expert of Lithuanian Free Market Institute

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1 . S h a d o w e c o n o m y i n   E u r o p e   a n d L i t h u a n i a

1.

Shadow economy in Europe and Lithuania

Shadow economy is: • Economic activity (i.e. producing goods and services) • Carried out without complying with legal environment. • To avoid taxes and/or regulations.

1.1 Definition In this publication, shadow economy, or shadow is described as an economic activity (i.e. producing goods and services), which is carried out without complying with the legal environment and to avoid taxes and/or regulations.

Shadow economy is not attributed with illegal activities that reward a person financially, when transactions are not conducted on voluntary basis, rather it violates proprietary and integrity rights of others (i.e. VAT fraud, theft, abductions, murder and etc.)

1.

Shadow economy in Europe and Lithuania

1.2 The size of shadow economy in Europe Size of the shadow economy varies greatly among European countries. It is considered that the largest underground economies are in Central and Eastern European and South European countries. Western Europe and Scandinavian countries enjoy the smallest underground economies instead. According to the research results by Professor Friedrich SchneiShadow economy in European countries 2013 (% of GDP) 5–10 % 10–15 % 15–20 % 20–25 % 25–30 % 30–35 %

Source: Friedrich Schneider (2013)

der, the largest shadow economies in terms of GDP in 2013 were in Bulgaria, Romania, Croatia and Lithuania. The smallest were in Switzerland, Austria, The Netherlands and United Kingdom. The averages size of the shadow economy in terms of GDP is 18%. However, it has slightly decreased since 2009, when it was around 20%.

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1 . S h a d o w e c o n o m y i n   E u r o p e   a n d L i t h u a n i a

Size of shadow economy in GDP (%), 2013 Bulgaria

31

Croatia

28

Romania

28

Lithuania

28

Estonia

28

Turkey

27

Latvia

26

Cyprus

25

Malta

24

Poland

24

Greece

24

Slovenia

23

Hungary

22

Italy

21

Portugal

19

Spain

19

European average

19

Belgium

16

Czech Republik

16

Slovakia

15

Sweden

14

Norway

14

Germany

13

Finland

13

Denmark

13

Ireland

12

France

10

United Kingdom

10

e Netherlands

9

Luxembourg

8

Austria

8

Switzerland

7 -

5.00

10.00

15.00

20.00

25.00

30.00

35.00

Source: Friedrich Schneider (2013)

1.3 Shadow economy in Lithuania Various sources indicate that in Lithuania from one-fifth to one-third of the total value added is created in the shadow economy. It had increased tremendously in the period of 2008-2010, however in the recent years it had decreased slightly, yet it still stays at a relatively high level.

According to the Survey of the Lithuanian Economy, which is being conducted by LFMI, the shadow economy increased rapidly in the period of 2008-2010 and had reached 28% of GDP, while in 2011-2012 it decreased slightly to 27% of GDP. In 2013 the shadow constituted 26% of GDP.

1.

Shadow economy in Europe and Lithuania

Size of shadow economy (officially unaccounted) in GDP (%) 40 32 30

32

31

31

30

24

22

22

20

19

20

16

19

18

18

28

21

21

20

30

30

29

27

21

14

13

18

18

12

13

29

29

28

27

27

26

23

17

15

p 13 20

12 20

11 20

10 20

09 20

08 20

07 20

06 20

05 20

04 20

03 20

02 20

01 20

00 20

99 19

98 19

19

97

10

LFMI data: from a Survey of Lithuanian Economy Officially unaccounted economy: Statistics Lithuania Data Shadow economy: Friedrich Schneider research : Source: A survey of the Lithuanian Economy (LFMI), Statistic Lithuania, Friedrich Schneider

When calculating gross national product, Statistics Lithuania, includes officially unaccounted economy as well. The main difference between shadow economy and officially unaccounted economy is that, officially accounted economy includes unaccounted activities, which are not related to law circumvention. Since 2011, Statistics Lithuania has included drug trade, Tabaco and alcohol smuggling and prostitution to officially unaccounted for economy. According to data provided by Statistics Lithuania, the unaccounted economy in Lithuania was 7% of GDP in 2009.

Results from the research conducted by Prof. Friedrich Schneider indicated that Lithuanian shadow economy in the period of 2003-2013 had changed marginally. In period of 20032009 shadow economy decreased from 32% to 29% and during the years of 2009 and 2010 (when the economic crisis began) had increased to 30%. Since 2010 until 2013 the Lithuanian shadow economy in terms of GDP decreased only slightly to 28%.

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2. Shadow economy in the labour market

2.

Shadow economy in the labour market

Shadow economy in the labour market – this is a part of shadow economy which is related to labour relations. In this publication, the shadow economy in the labour market is considered employed work, when: • Not legalized by a contract or other form, e.g. a business license (i.e. illegal work); • Full or a part of salary/wage is being paid illegally (i.e. in „envelope“).

2.1. What is the shadow economy

in the labour market? Shadow economy in the labour market – this is a part of shadow economy which is related to labour relations. In this publication, the shadow economy in the labour market is considered employed work, when: • Not legalized by a contract or other form, e.g. a business license (i.e. illegal work); • Full or a part of salary/wage is being paid illegally (i.e. in „envelope“). Ministry of Social Security and Labour ascribe to the labor force shadow commercial, economic, financial, professional activities, which are being conducted without establishing an entity as required by law or without purchasing a required license, when a part of pay is paid in “envelope”, when people are working within le-

gal enterprises, but there are no contracts with them, or working longer time periods than is noted in the official employment contract.1 When describing shadow economy in the labour market in broader sense, we can attribute additional Labour Code or other legislation violations, which are not related to illegal work or a part of salary/wage being paid illegally (e.g. working time accounting irregularities, work safety violations and etc.). Further on we will focus on illegal work and illegally paid wage/salary, yet while analyzing the causes of shadow economy in the labour market, different effects of the shadow in the labour market will be discussed as well. 1 http://www.socmin.lt/index.php?256143790

2. Shadow economy in the labour market

2.2. Why does the shadow economy in the

labour market emerge and what does the size depend on? The size of the shadow in the labour market can be caused by all kinds of factors, such as economic and social situation of the country, labour force taxation, labour market regulations, activities of government institutions fighting this phenomenon, social policy carried out by the state and etc. Sometimes the shad-

ow economy is understood too simply – as the side effect of the lack of strict government measures. This part of the publication will prove that it is not the case. Moving further, many factors will be analyzed, which have the greatest impact on the shadow economy in the labour market.

2.2.1. Income size and labour force taxation Depending on the level of economic development, productivity and average income, taxation rates of people’s income have a different impact on the economy. When choosing where to use their incomes, people at first use it on the most important and valuable things for them, such as food. The rest of the income

is left to satisfy less important needs. This means, that in countries where people get more income they have more money to spend on more relatively less important needs, compared to people who are living in low income countries. Therefore, the same tax rate for individuals in poor countries with small incomes

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2. Shadow economy in the labour market

and lower standard of living is more hurtful, because this means discarding important needs, compared to the same tax rate introduced in rich country.2 This explains why the

same tax rates have different outcomes on economies, depending on the standard of living in the country.

2 Real incomes are taken into account, i.e. considering price differences in different countries. Price level in more productive countries is usually greater, yet it is redeemed by greater incomes of the people.

Hourly labour cost in 2011* 35 30 25 20 15 10

Netherlands

Luxembourg

Ireland

Norway

EA17

Cyprus

Sweden

France

Belgium

Denmark

Austria

Germany

Finland

Italy

EU27

Spain

United Kingdom

Malta

Greece

Slovenia

Portugal

Poland

Czech Republic

Slovakia

Estonia

Hungary

Bulgaria

Lithuania

0

Latvia

5

Romania

10

Taxes, EUR Net income, EUR * *Price of labour and price level - 2011, taxation burden - 2010. Data is provided after taking into account the price differences, meaning that the price of labour was reduced if the price level was higher in that country than EU average and visa versa. Source: Calculations by authors based on Eurostat and EC data.

Taxation rate on labour force in Lithuania is 39% and it is slightly higher than EU average (EU average 36%). Yet, the productivity in Lithuania is relatively low, thus the hourly salary to the employee is around 5 euros (price adjusted) and that is 3 times less than the EU27 average. There are only two countries in which employees receive even less than Lithuanian employee, these are Bulgaria and Latvia. Relatively low hourly wage/salary is present in Estonia, Hungary, Slovakia and Poland.

Thus, the impact of taxation burden on the behavior of people is dependent on what the person receives after taxes as his or her wage/salary. Even if the tax rate is the same, it will create more burden when the salary/ wage after taxes is lower. This is closely related with shadow economy and shadow economy in the labour market. One of the most determining factors for a person to choose to receive a part of wage/ salary illegally is his level of income. When the

2. Shadow economy in the labour market

Labour tax burden, 2010 60% 50%

50% 46% 45% 44% 44% 43% 43%

40%

42% 41%

39% 39% 39% 39%

37% 36% 36% 36%

35% 34% 34% 34% 34% 33% 33% 30%

30%

28% 23% 18%

20%

12%

10%

Cyprus

Malta

Ireland

Luxembourg

United Kingdom

Poland

Portugal

Norway

Bulgaria

‰e Netherlands

Greece

Slovakia

EU27

Spain

Finland

Denmark

Estonia

Slovenia

Lithuania

Sweden

Czech Republic

Latvia

Austria

Romania

Hungary

Italy

Germany

France

Belgium

0%

*Tax wedges for a single example worker at two-thirds of average earnings in 2010, percent. Source: Taxation trends in the European Union, Eurostat

income level is low, people are more willing to increase their incomes by choosing illegal work or wage/salary. Precisely for this reason, taxation burden on labour in countries with low productivity and wages/salaries have a greater impact to the shadow in the labour market, than in countries where people have relatively higher incomes.

One of the most determining factors for a person to choose to receive a part of wage/salary illegally is his level of income. When the income level is low, people are more willing to increase their incomes by choosing illegal work or wage/salary. Precisely for this reason, taxation burden on labour in countries with low productivity and wages/salaries have a greater impact to the shadow in the labour market, than in countries where people have relatively higher incomes.

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2. Shadow economy in the labour market

2.2.2. Economic situation of a country The economic situation of a country, its trends, income level of the population have an impact on people as they decide whether or not to get involved in shadow economy in the labour market. In times of economic downturn, when the incomes of people are decreasing and unemployment running high, people look for a way to compensate decreasing income. One way is to work illegally or receive a part

of wage/salary illegally. In times of high unemployment it is more difficult to find a legal work. Furthermore, if paying a part of wage/ salary illegally, the employer can pay more to the person if compared when doing everything legally and paying all taxes (taxation burden in Lithuania on labour is from 37% to 42% depending from the size of wage/salary).

GDP growth and unemployment in Lithuania 20% 15% 10% 5% 0% -5%

2005

2006

2007

2008

2009

2010

2011

2012

-10% -15% -20% GDP growth, percent

Unemployment level, percent

Source: Statistics Lithuania

In the period of 2005-2007 Lithuania saw rapid economic growth. Unemployment was constantly decreasing and in 2007 was lower than 5%. In 2008 the GDP growth rates started to slow down and unemployment level started to rise. The economic downturn began in 2009, when GDP fell by 15%, unemployment began to increase rapidly and kept on increasing until 2010. Incomes of the population were decreasing as well through 2009 and 2010. The financial situation of enterprises just like the populations has a strong effect on deciding whether to participate in a shadow economy or not. In times of difficult economic conditions, when more and more companies are suffering

increasing losses and employers face a difficult financial situation, they might choose to hire people illegally or pay part of wage/salary illegally, thus trying to reduce losses. The number of companies which were recording losses began to rapidly increase in 2008-2009, and it reached 53%. The number of loss-making companies began to decrease only in 2010. The impact on shadow labour market is illustrated and determined by financial situation of companies and households, because in 2009 state institutions had recorded a strong increase in number of detected illegally working people. In 2008 there were 3874 detected cases of illegal work, whereas in 2009 there

2. Shadow economy in the labour market

Financial indicators of enterprises and households 100%

60.000.0

90% 50.000.0

80% 70%

40.000.0

60% 50%

30.000.0

40% 20.000.0

30% 20%

10.000.0

10% 0%

0.0 2005

2006

2007

2008

2009

2010

2011

2012

Loss making enterprises, % Profit making enterprisess, % Disposable income per household in one year, LTL Source: Statistics Lithuania

were 4628. The number of detected illegal workers began decreasing only in 2012. Hence, the economic situation has a significant impact on the shadow in the labour market. The reasons for companies and people to get involved in the shadow in the labour

market (e.g. difficult financial situation of companies, unlikeliness to find a legal job, low income of people) become stronger in times of economic downturn, which in Lithuania began in late 2008.

2.2.3. Regulation of labour relations Strict regulation of labour relations reduces the ability for people to agree freely and increases the likelihood of them working outside the labour laws. The Lithuanian Labour Code lacks flexibility, thus increasing the cost of creating new jobs.

Strict regulation of labour relations reduces the ability for people to agree freely and increases the likelihood of them working outside the labour laws. The Lithuanian Labour Code lacks flexibility, thus increasing the cost of creating new jobs. Lithuanian Free Market institute in 2012 conducted a research about the flexibility of labour relations and Lithuania was ranked only 127th among 183 countries. The most restrictive parts of the Lithuanian Labour Code are ones that have to do with

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2. Shadow economy in the labour market

EU raiting based on the world standings of labour relations 0 Denmark Bulgaria United Kingdom Belgium Ireland Austria Cyprus e Netherlands Hungary Czech Republic Italy Poland Estonia Romania Latvia Sweden Finland Slovakia Slovenia France Lithuania Germany Spain Greece Luxembourg Portugal

20

40

60

80

100

120

140

160

180

200

2 11 12 18 19 27 48 58 63 74 79 84 86 93 94 96 100 111 112 116 127 142 143 160 163 177

Source: the 30th Survey of the Lithuanian Economy, LFMI

the period of notice for firing an employee, (LC Art. 130) the size of compensation (LC Art. 140), fixed-term employment contracts (LC Art. 109). These articles did not see any essential changes in the period being analyzed from 2005 to 2012. Labour Code requirements which oversee the necessary period of notice for firing an employee, size of compensation, which prohibit fixedterm contracts in permanent jobs – makes the firing of an employee more difficult and costly. Today, based on the requirements in the Lithuanian Labour Code, employer in order to fire an employee has to give 2 month notice; he also has to pay compensation the size of 1 to 6 months of the employee’s salary. For example, newly hired employee, who receives average wage/salary (2232 Lt) will cost to fire 8784 Lt (2 month period of notice and compensation for 1 month) (see the following table). The compensation is taxed just like the wage/salary, so the employee only receives a part of what the employer actually pays.

2. Shadow economy in the labour market

The price of firing an employee*

Salary before taxes

Years employee spent in the company less than a year

1-3 years

3-5 years

5-10 years

10-20 years

More than 20 years

1000 (Minimal monthly wage)

3.935 Lt

5.247 Lt

6.559 Lt

7.871 Lt

9.183 Lt

10.494 Lt

2000

7.871 Lt

10.494 Lt

13.118 Lt

15.742 Lt

18.365 Lt

20.989 Lt

2232 (Average monthly wage)

8.784 Lt

11.712 Lt

14.640 Lt

17.568 Lt

20.496 Lt

23.423 Lt

3000

11.806 Lt

15.742 Lt

19.677 Lt

23.612 Lt

27.548 Lt

31.483 Lt

5000

19.677 Lt

26.236 Lt

32.795 Lt

39.354 Lt

45.913 Lt

52.472 Lt

* Table provides wage/salary which is being paid during the 2 month period of notice and compensation with all taxes attributed to it.

Difficult firing process creates conditions for shadow economy in the labour market, because it foster companies not to sing work contracts with new employees, if companies are not sure about the future, possible contracts and workloads and the ability to keep new jobs. This is especially relevant in times of changing economic conditions, when legal employment with all the requirements by the Labour Code is switched to work without a work agreement. Illegal agreement between employer and employee can be further fostered by the strict working time regulation. Labour Code requires that an employee cannot work longer than 40 hours a week, and a working day cannot be longer than 8 hours (LC Art. 144). During a two day period an employee cannot work more than 4 hours of overtime and in a year no more than 120 hours (LC. Art. 152). If a situation occurs in a company (e.g. new order), which leads to a need of working overtime and employer and employee have to agree on different working hours, which is not allowed by the Labour Code. As a result, these agreements become a part of shadow in the labour market. Results of a representative population survey conducted in 2012 show that 48% of people sometimes leave their work earlier and

work longer the next day. This proves the fact those flexible working hours is in full action even if it is prohibited by the Labour Code. Hence, regulation of labour relations, by increasing the financial burden of workplace, by prohibiting certain agreements between employees and employers is one of the reasons of shadow economy in the labour market.

Hence, regulation of labour relations, by increasing the financial burden of workplace, by prohibiting certain agreements between employees and employers is one of the reasons of shadow economy in the labour market.

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2. Shadow economy in the labour market



2.2.4. State support (unemployment benefits, social benefits and etc.)

State provides support for those without a work and with low official incomes. Such government support not only has an impact in shaping people’s decisions to work or not, but sometimes it leads to increasing the shadow in the labour market. If government benefits are similar or even greater than wage/salary, which can be received by a person, the motivation to work diminishes, because by working legally a person loses government support. This promotes dual behavior, when a person is encouraged to work illegally and to keep both sources of income – government benefits and illegally received wage/salary. This section will cover the basic government benefits, their size and trends.

State provides support for those without a work and with low official incomes. Such government support not only has an impact in shaping people’s decisions to work or not, but sometimes it leads to increasing the shadow in the labour market. If government benefits are similar or even greater than wage/salary, which can be received by a person, the motivation to work diminishes, because by working legally a person loses government support. This promotes dual behavior, when a person is encouraged to work illegally and to keep both sources of income – government benefits and illegally received wage/salary.

Unemployment insurance benefit Unemployment insurance benefit, its size and the way to calculate it, payment period and other conditions are regulated by the Law on Unemployment Social Insurance. The unemployment insurance benefit depends on insured amount of income, minimal and maximal

2. Shadow economy in the labour market

insurance benefit size and three years of income by a person before the loss of work. The duration of the benefit is regulated by law and it depends from age of a person and unemployment insurance record, which was acquired until registration day at the Lithuanian Labour Exchange. A person, who lost a job, receives full unemployment insurance benefit only for the first 3 months and from the 4 month it is reduced in accordance with the law.

Since 2005 the minimal payment had increased from 135 Lt to 350 Lt in 2012, and the maximum had increased from 726 Lt up to 1041 in the second half of 2008, but then it was reduced to 650 Lt in 2010 and is the same today. The average factual benefit received in the period of 2005 to 2012 had increased from 312 up to 561 . Yet, in 2009 the average payment reached 700 Lt. In total unemployment insurance benefits in 2012 required 377 million Lt.

Unemployment insurance benefit size in Lithuania 2000 1800 1600 1400

Minimal monthly wage, Lt

1200 1000 800

Average net salary, Lt

600 400 200 2013M01

2012M07

2012M01

2011M07

2011M01

2010M07

2010M01

2009M07

2009M01

2008M07

2008M01

2007M07

2007M01

2006M07

2006M01

2005M07

2005M01

0

Average monthly unemployment benefit, Lt

Source: Ministry of Social Security and Labour

Social benefits Size of the social benefit is determined by the Law on Monetary Social Benefit for Deprived Residents. The size depends from government supported level of income at the particular moment. Social benefit is the difference between the level of government supported income and the level of income which the person is receiving (e.g. if government supported income level is 350 Lt, and a person has an income level of 200 Lt, the social benefit would be 150 Lt). In the period from 2005 to 2008 government supported level of income had increased from 135 Lt to 350 Lt. The factual average social benefit kept on increasing as well, and in 2010 was 235 Lt. In 2012 it decreased slightly to 225 Lt per month. The total payment level in 2012 was 599 million Lt.

Compensations (heating, drinking water and hot water expenses) The Law on Monetary Social Benefit for Deprived Residents indicates sizes of those compensations. If the people who are living together have a combined income, which does not exceed government supported level of income (2012 – 350 Lt), the compensation is equal to the factual expenses for heating, drinking water and hot water. If a person is eligible to receive a social benefit, but the combined income level of those people living together is higher than government supported level of income, only a share of expenses are compensated. The total amount for compensations is constantly growing and in 2012 was 169,5 million Lt, or on average 853 Lt per person receiving the compensation.

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2. Shadow economy in the labour market

Government costs of social support 1400 1200

1.119

1.099

2010

2011

1.146

899

1000 800 600 400

332

354

2005

2006

405

431

2007

2008

200 0 2009

2012

Unemployment insurance benefits, mln. Lt Compensation (heating, drinking water and hot water expenses), mln. Lt Social benefits, mln. Lt Total, mln. Lt Source: Statistics Lithuania, Sodra

When combining all three forms of government support, it is evident that the total amount in the period from 2005 to 2008 which was around 400 million Lt, began to rapidly increase. 2010 to 2012 on a yearly basis when combining all three forms more than a billion Lt is spent for social and unemployment benefits and compensations. Consequently, the government support for unemployed and people who are receiving low incomes may increase shadow in the labour market. The greater support by the government, the greater the incentives for people to look for illegal employment opportunities in order not to lose benefits. This factor is espe-

Consequently, the government support for unemployed and people who are receiving low incomes may increase shadow in the labour market. The greater support by the government, the greater the incentives for people to look for illegal employment opportunities in order not to lose benefits. This factor is especially important, when the difference between the potential legal income and government support is not significant. cially important, when the difference between the potential legal income and government support is not significant.

2.2.5 Liabilities of people One of the reasons that forces people to choose unofficial employment or illegal pay is that they have all kinds of financial liabilities, which need to be paid when receiving income officially. A person can try to avoid complying with financial obligations for a number of reasons: seeks to maintain the level of income or does not see the point in complying, because these are too large and the remaining income is too small for a person to live. The most commonly avoided liabilities are alimony payments, fines and other various liabilities.

Results of a representative population survey conducted by LFMI request in 2013 show that 27% of Lithuanian population claim that one of the main reasons why people choose to work illegally or receive a part of payment illegally is to avoid paying liabilities. This was most common among people with lowest education and living in rural areas. In January 2013 an internet site “ManoCreditInfo.lt” provided data, that 12 500 Lithuanian citizens could have used a person bankruptcy law, because their debt was over 21 250 Lt.

2. Shadow economy in the labour market

2.2.6 Minimal monthly wage Minimal monthly wage (MMW) is a minimal pay regulated by government for a person, who is brought into the labour market, yet at the same moment it is a line which defines the amount of value added a person has to create in order to work legally. High and constantly increasing MMW is often a barrier for entry into the labour market for inexperienced and less skillful people, because for employers to hire such people becomes not beneficial due to their relatively low productivity, thus MMW is related with increasing unemployment level. But MMW has an impact on the shadow economy in the labour market as well. Businesses that lack financial resources to increase salaries because of increased MMW, in a way can solve this problem either by employing people illegally, thus avoiding taxation burden for labour force, or they can reduce the official working hours and paying a part of salary unofficially. Thus, high or increasing MMW creates incentive to get active in the shadow in the labour market. In order to evaluate the effect of MMW to the shadow in the labour market it is appropriate to compare it with the average monthly salary. This ratio best represents the MMW as a barrier to enter labour market. The minimum

MMW has an impact on the shadow economy in the labour market as well. Businesses that lack financial resources to increase salaries because of increased MMW, in a way can solve this problem either by employing people illegally, thus avoiding taxation burden for labour force, or they can reduce the official working hours and paying a part of salary unofficially. Thus, high or increasing MMW creates incentive to get active in the shadow in the labour market.

wage is paid to people with low skills or for new labour market participants without experience. Average wage rate serves as a reflection of the average labour market situation, which is dependent on changes of supply and demand in the labour market. Inadequate raise of

MMW dynamics in Lithuania 1200

45%

1000

43% 41%

800

39%

600

37%

400

35%

200

2005K1 2005K2 2005K3 2005K4 2006K1 2006K2 2006K3 2006K4 2007K1 2007K2 2007K3 2007K4 2008K1 2008K2 2008K3 2008K4 2009K1 2009K2 2009K3 2009K4 2010K1 2010K2 2010K3 2010K4 2011K1 2011K2 2011K3 2011K4 2012K1 2012K2 2012K3 2012K4 2013K1

0

33%

MMW and anverage salary ratio (right, proc.) Source: Statistics Lithuania

MMW size (Lt, left)

31%

19

20

2. Shadow economy in the labour market

MMW increases the cost of employing people with low skills, thus potentially increasing the amount of unofficial agreements in the labour market. In such case, inexperienced people or with low skills get less employment opportunities or they become employed unofficially. In the table above it is clear that MMW ratio to average salary began to rapidly grow since 2008, even though the MMW was not raised, but the average salary was decreasing, thus MMW ratio to the average salary began to increase. The ratio began to decrease

form 2010, when the average salary began to grow slightly. However, the situation had changed in 2012 and especially in the beginning of 2013, when the MMW was increased to 850 Lt and later to 1000 Lt from January 1st, 2013. After this, the ratio of MMW and average salary moved to 45%– the highest level in the period which is being analyzed. A severe increase in MMW will have a negative impact to the unemployment level and formation of shadow in the labour market in 2013.

2.2.7. Government prevention of shadow economy

Fines and the chance to be caught for illegal work and illegal salaries can be attributed to costs of working in the shadow in the labour market. The greater chance of being fined and the greater the fines (other negative consequences related to being caught, e.g. loss of reputation and etc.) the less likely market participants will get involved into the shadow in the labour market, while other conditions remain the same.

In Lithuania there are several institutions which directly deal with shadow in the labour market, such as State Labour Inspectorate, State Tax Inspectorate, Financial Crime Investigation Service and Police. In years 2003-2005 there were more than 4000 yearly illegal work inspections in Lithuania. From 2006 to 2010 this number decreased by half, but in 2011 and 2012 grew once again. In 2012 there were 3700 inspec-

2. Shadow economy in the labour market

Fines and the chance to be caught for illegal work and illegal salaries can be attributed to costs of working in the shadow in the labour market. The greater chance of being fined and the greater the fines (other negative consequences related to being caught, e.g. loss of reputation and etc.) the less likely market participants will get involved into the shadow in the labour market, while other conditions remain the same.

Number of inspections and court cases 6000

653

630

700 600

5000

500

4000 374

361

374

400

363

334

3000

284

292

295

300

2000

200

1000

100 0

0 2003

2004

2005

2006

2007

Cases that reached a court (units, left)

2008

2009

2010

2011

2012

Conducted illegal work inspections (units, right)

Source: State Labour Inspectorate

tions in order to find out cases of illegal work in Lithuania. In 2011 and 2012 the number of cases of illegal work going to courts doubled. Misdemeanor, which is done by a businessman, when seeking to hide a part of salary, is named as “violation of salary calculation and methods of payment”. An administrative punishment can be given in accordance with Lithuanian Republic Code of Administrative Offences (CAO) Article 41-4 and sometimes a punishment can be given based on the Criminal Code of the Republic of Lithuania (CC) Article 222. In case it is an administrative offence,

the fine is from 10 000 to 20 000 Lt for every person who received unaccounted salary. In a repeat misdemeanor the fine is from 20 000 to 50 000 Lt. In addition to paying the fine the employer has to pay all taxes that were not collected due to such actions. In case of applying a Criminal Code a sentence of 4 years of imprisonment is possible. Punishment for illegal work is indicated in (CAO) Article 41-3. When the employer is being punished for the first time for every illegal worker a fine from 3000 to 10 000 Lt can be given, yet often the court takes into consid-

21

22

2. Shadow economy in the labour market

Average fines for illegal work in Lithuania 4500 4000 Avarage size of fine

3500 3000

Average size fine,

2500

when given accoring to law

2000 1500

Average size fine,

1000

to law

which is less than according

500 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: State Labour Inspectorate

eration mitigating circumstances and reduces the fine. In repeat offence a fine from 10 000 to 20 000 Lt is given. Average factual fine for illegal work in 2012 in Lithuania was 2162 Lt. The average size of the fine for the illegal work was increasing until 2008 and then it began to decrease. The decrease was partly due to changes in court case law. It became more common to apply mitigating circumstances and to apply less severe sanctions than ones in the article. Averages for fines were decreasing as well (cases when there are no mitigating circumstances). Therefore, the actions of government institutions against shadow in the labour market and

the risk that the participants of the shadow will be caught and punished are factors, which determine the size of the shadow in the labour market. Strengthening the government institutions and their activities which are fighting the shadow in the labour market is not the only way of trying to reduce the shadow, but instead it should be used in tandem with other, especially incentives reducing measures to participate in the shadow. Especially strict measures may even make the economic and social situation worse, when actually the shadow in the labour market is a reflection of poor economic situation, not flexible labour relations, unfounded regulations or taxation burden.

3. The size of the shadow in Lithuanian labour market

3.

The size of the shadow in Lithuanian labour market

3.1. What are the measures to evaluate the

shadow in the labour market? It is difficult to evaluate the size of the shadow economy in the labour market, just like any other shadow economy activities, because those who are involved have an incentive to hide such activities. In order to evaluate the size and dynamics of the shadow in the labour market, various measures can be used to give at least approximate quantitative evaluation. The main methods to evaluate the shadow economy in the labour market can be divided into three categories. A survey (questioning labour market participants, experts) allows a direct evaluation of the

size of shadow economy in the labour market, the causes of the shadow and etc. The main benefit of this method is that the information is received directly from participants of the shadow economy or from experts of the field. The main drawback is that the results are dependent on the sincerity of the respondents when answering the questions. Statistical data analysis seeks to uncover the size of the shadow in the labour market by analyzing various statistical data which are related with the shadow economy in the labour market. First of all, in order to uncover what causes

23

3. The size of the shadow in Lithuanian labour market

The strength of these models is that they provide results expressed in numbers, which can be compared in a time frame with other countries. The weakness of such models lies in the assumptions used when creating the model. In this publication of the shadow economy the shadow economy in the labour market is being analyzed by using all three methods. Further on, the results of the surveys will be analyzed, which show the size of the shadow economy in EU and Lithuania. Statistical data analysis has been used to explain the reasons of the shadow economy in the labour market formation and this method will be used to analyze data provided by government institutions. At the end of this section an econometric model is chosen to evaluate the dynamics of the shadow economy in the labour market in Lithuania.

the shadow, statistical data is being analyzed (e.g. taxation burden on labour, economic situation of the country and etc.). Second, statistical data is being analyzed which shows the consequences of the shadow in the labour market (e.g. tax collection, registered violations and etc.). The main benefit of this method is the relative ease of accessing data, yet this method does not provide accurate measure of the size of the shadow economy. Econometric models are quantitative (statistical and mathematical) methods used to evaluate shadow economy in the labour market. Models use available data from different surveys, statistical databases which uncover the reasons for shadow to emerge or its consequences. Models are used to quantitatively calculate the size of the shadow and its dynamics.

3.2. The shadow in the labour market in European

Union countries

In order to evaluate the size of shadow in the labour market in Lithuania it is important to analyze the context of the European Union member states. A lot of information about the shadow in the labour market is provided by

the European Commission research of 2007.1 It is based on the survey of 26 800 EU citizens conducted in June 2007. 1 Undeclared Work in the European Union

Have you been working illegally in the past 12 months and have received a pay for it? (Yes) 20%

18%

18% 16%

15% 13%

14%

11% 10%

12% 10%

7% 7% 7% 7%

8%

6% 6% 6%

6%

5% 5% 5% 5% 5%

4% 4% 4% 4%

4%

3% 3% 3% 3%

2% 2%

2%

1%

Source: European Commission, Undeclaired Work in the European Union

Malta

Cyprus

Greece

United Kingdom

Italy

Portugal

Spain

Finland

Romania

Ireland

Greece

Slovenia

Poland

Luxembourg

EU27

Bulgaria

France

Slovakia

Belgium

Hungary

Lithuania

Austria

Czech Republic

Estonia

Sweden

Latvia

e Netherlands

0% Denmark

24

3. The size of the shadow in Lithuanian labour market

In 2007 about 7% of Lithuanians have acknowledged that they had been working illegally in the past 12 months (no work contract).

The results of this survey had uncovered the fact that in 2007 about 7% of Lithuanians have acknowledged that they had been working illegally in the past 12 months (no work contract). The European Union average was 5%. The highest number of people who said that they have received an illegal pay was in Denmark – 18%. In Latvia and Estonia this was around 15% and 11%. This is a sensitive topic for people, so it is very likely that not all of the people said truth, thus these results should be considered as a floor, when talking about the percentage of people who are involved in the shadow in the labour market. According to people the most important reason to work illegally in EU is that both parties receive benefit for such an agreement (47% chose this answer). The frequency of this answer shows that people perceive illegal work as an economic phenomenon, which is useful

The most important reason to work illegally in EU is that both parties receive benefit for such an agreement (47% chose this answer).

for both parties of the transaction. Mutual benefit is one of the exclusive traits of the shadow economy. The second most common reason for illegal work is the perception of it just as the seasonal work, so there is no need to declare (23%). Third and fourth reasons according to EU citizens are that the illegal work is widely spread in their region or sector and that it is difficult to find a legal work.

25

3. The size of the shadow in Lithuanian labour market

What the main reason of illegal employment?

Mutual benefit for both parties

47%

Œis is a seasonal work, so no need to declare it

23%

Working illegally is wildly spread in this region or …

16%

Difficult to find a permanent job

16%

Taxes and social security contributions are to large

13%

A person who had aquired it, asked not to delcare

12%

Bureaucracy hinders economic activity

8%

Government does not provide anything to you, so …

5%

You could ask for a larger pay for your work

5%

Other

8%

N/A

7% 0%

5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

Source: European Commission, Undeclaired Work in the European Union

Other question which was related with the shadow in the labour market was regarding the illegal pay. EU citizens were asked whe-

ther their employer had paid them at least a part of salary/wage in the past 12 months illegally.

Has your employer been paying you full salary illegally or a part of it in the past 12 month? 25% 23% 20%

17% 14%

15%

11%11%

10%

8% 8%

7% 7%

6%

5%

5% 5% 5%

4% 4% 4%

3% 3% 3% 3%

2% 2% 2%

1% 1% 1% 1% 1%

Source: European Commission, Undeclaired Work in the European Union

France

Germany

Malta

Luxembourh

United Kingdom

‰e Netherlands

Ireland

Denmark

Sweden

Greece

Finland

Portugal

Czech Republic

Cyprus

Austria

Spain

Slovenia

EU27

Belgium

Italy

Slovakia

Estonia

Hungary

Lithuania

Poland

Bulgaria

Latvia

0% Romania

26

3. The size of the shadow in Lithuanian labour market

About 11% of respondents in Lithuania claimed to have received a full or a part of salary/ wage illegally in the past 12 months. In Latvia there were 17% of people who agree with a statement, while in Estonia only 8%. On average 5% of people across EU admitted receiving a pay illegally. One of the interesting questions was regarding as how do people evaluate the risk of being caught by government institutions for participating in the shadow in the labour market. Lithuania stands out because a lot of pe-

ople (49%) think this risk is high. Only in Portugal there were more people (50%) who think that this risk is high. The EU average is 33%. Thus, even though survey results show that people in Lithuania view a risk of being caught very high, yet there are more people who are participating in the shadow in the labour market than in other EU countries. These results reveal that there are other factors for getting involved in shadow economy (economic and/ or social), not only government institutions’ control effectiveness.

3.3. Surveys of businesses and people

in Lithuania

At least 14% of Lithuanians in 2012 had been working illegally without a work agreement. Additional 17% while being employed had received a part of salary illegally. These results are from a representative population survey conducted on the request of LFMI, in which people were asked about themselves or their family members. It is very likely that the real share of people who were working without an employment agreement or had received a share of salary/wage illegally in Lithuania is higher than the results of this survey, because not all of the people gave an honest answer or did not wanted to admit it.

At least 14% of Lithuanians in 2012 had been working illegally without a work agreement. Additional 17% while being employed had received a part of salary illegally.

27

28

3. The size of the shadow in Lithuanian labour market

In the year 2012, have you or your family members: 17% 14%

Been employed illegally

Received part of a wage "in an envelope"

Source: Population Attitude Survey towards Smuggling and Consumption of Illegal Goods 2013 (LFMI)

When answering to the questions regarding working unofficially or receiving a salary illegally, people could choose one or both answers. Results show that 22% of survey participants had chosen at least one form of receiving a salary illegally. Out of this number 5% gave an answer that they had been em-

ployed unofficially, 8% had received at least a share of salary illegally and 9% chose both statements. Thus, the result of this survey is that at least one out of five Lithuanians of working age had been involved in the shadow in the labour market in 2012.

Shadow economy in the labour market in Lithuania Have

Have been working

Have received

been working

illegally and have

a part of

illegally

received a part of

salary

salary illegally

illegally

9%

8%

5%

22 % Source: Population Attitude Survey towards Smuggling and Consumption of Illegal Goods 2013 (LFMI)

3. The size of the shadow in Lithuanian labour market

In addition, people were asked to give their opinion on what the reasons why do people choose to work or receive salary illegally are. The most common reason was related with financial benefits of illegal employment and illegal salaries – when receiving a salary illegally a person is getting more than working in a legal work. This answer was chosen by 62%. Inability to find a legal employment where the full salary was legally paid was the second most common reason mentioned by the people – 52%. This reason is related with requirements of minimal monthly wage (MMW), because not everybody who is looking for employment is as

productive or as skillful to get paid the MMW. The third most commonly mentioned reason for the spread of illegal employment and salaries is the fact that people do not want to lose their social benefits, which they would have to reject when receiving a legal salary. Not seeing a point in paying taxes and avoidance of liabilities that need to be paid if receiving a legal salary were mentioned as the most important reasons by 35% and 27% of people respectively. Hence, people think that the most important motives to get into the shadow in the labour market is excessive taxation burden on labour and lack of legal employment opportunities.

In your opinion, why people are working illegally or are receiving a part of salary illegally?

Receive a larger salary while working illegally, than working legally

62%

52%

Difficult to find a job where full salary is being paid legally Does not want to lose social benefits, which would ortherwise be rejected if receiving a legal salary

43%

35%

Does not see a point in paying taxes To avoid financial liabilities, that would otherwise be paid if receiving a legal salary Other

N/A

27%

1%

3%

Source: Population Attitude Survey towards Smuggling and Consumption of Illegal Goods 2013 (LFMI)

The spread of the shadow in the labour market is based on the information and data from the LFMI Survey of the Lithuanian Economy, which is received by questioning market participants. Market participants were asked to evaluate, what could be the share of Lithuanian businesses in 2013, which have illegal employees or what share of tho-

se employees are receiving and illegal salary. Results show that illegal salaries are widely spread among Lithuanian businesses – market participants estimate that about one third (31%) of Lithuanian enterprises employ people who get paid illegally. One tenth (11%) of businesses have illegal employees.

29

30

3. The size of the shadow in Lithuanian labour market

What share of Lithuanian business enterprises in 2013: 31%

11%

Have illegally working people

Have workers who get paid

(no employment agreement)

a share of their pay illegally

Source: 31st LFMI Survey of the Lithuanian Economy

Also the survey revealed what were the main reasons for a legally working company to choose to pay a part of salaries illegally. The main reason for illegal pay according to the market participants (the same as general population) is excessive taxation on labour, meaning that companies would not sustain their activities if they had to pay salaries legally (35%). The next reason for illegal pay is that employees and employers do not see the point in paying taxes (32%). This might be because people

which are being questioned are unhappy and not satisfied with government provided services for their taxes and think that they can use the money which is for taxes better. Third reason mentioned by the experts is the fact of large unaccounted incomes, which in turn promotes paying salaries illegally (27%). As the least important measure for illegal pay, market participants mention employees asking them to pay illegally (5%).

What is the reason for a company to pay their wages illegally?

Could not survive if they had to pay the wage legally

35%

Does not see a point in paying taxes

32%

Has a lot of unaccounted income

Employees ask to pay illegally

27%

5%

Source: 31st LFMI Survey of the Lithuanian Economy

VMI nustatyti darbo užmokesčio mokėjimo „vokeliuose“ atvejai

3. The size of the shadow in Lithuanian labour market

3.4. Data about uncovered violations Data about uncovered illegal work and illegal pay violations from government institutions provide valuable information regarding the spread of the shadow in the labour market. Of course, when analyzing such data, one needs to keep in mind, that dynamics of uncovered cases of shadow economy and spread in different sectors may depend not only on fluctuation of scope of shadow economy , but from activities and priorities of government institutions as well.

In 2012 there were 66 detected cases of illegal salaries which in total was 2 million Lt of unaccounted pay.

Confirmed cases of illegal employess 10000

8776

9000 8000

7341

6964

6678

7000 6000

State Tax Inspectorate

5077

5000

4262

4000

7148 6988

4628 3874

3000

Financial Crime Investigation Service State Labour Inspectorate

2000 Police Department

1000 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: State Labour Inspectorate

31

32

3. The size of the shadow in Lithuanian labour market

Confirmed cases of illegally working people based on economic activity in 2012

1% 2% 2% 3%

Construction

9%

Other services Wholesale and retail trade

3%

36%

Farming Hotels and retaurants

4%

Forestry 4%

Garages Wood and wood procuts

6%

Food and beverages Sewing Transport, logistics, communication

8% 11%

12%

Furniture manufacturing Other sectors

Source: State Labour Inspectorate

Based on the available data it is evident that the largest share of illegally working people was in 2004 and it was almost two times smaller when economy was growing rapidly up till 2008. The situation began to change in 2009 when the number of cases for detecting illegal working people began to skyrocket; in 2011 it was more than 7000 cases. In 2012 this number slightly decreased but remained relatively high if compared to 2008. The greatest number of cases for illegal work in 2012 was in the construction sector. Since 2003 the construction sector is recording the largest share of illegally working people, which on average is 36% of all cases. 2012 saw rising numbers of people who were working illegally in services sector. If compared with 2011 this share increased from 6% to 12%. All other sectors remain in the same level and hold similar proportions among all those working illegally. 11% of illegal work cases were in wholesale and retail trade. 2010 and 2011 saw and increase not only on cases of illegal employment but as well in ca-

ses of illegal salaries. According to State Tax Inspectorate the share of cases of illegal pay was decreasing in the period of 2008 - 2010 and at the same time there were fewer cases of unaccounted salaries. However, in 2011 and 2012 the numbers of illegal salaries had dramatically increased. In 2012 there were 66 detected cases of illegal salaries which in total was 2 million Lt of unaccounted pay. According to State Tax Inspectorate (STI), the most common sectors of economy where officially unaccounted payment cases are found: catering, construction, trade of motor (used) vehicles and repair, production, taxi services, trade sectors in which settlements are cash only when selling goods and services to people. In order to hide payments of illegal salaries, the salaries are being accounted as other payments/transactions, e.g. issuing an advance (e.g. for household expenses), payments for rent of automobiles, transactions from personal accounts of company directors, payments for supposedly done work/services, long-term interest free loans, money for

3. The size of the shadow in Lithuanian labour market

STI detected cases of illegall salaries 80 70

4000 70

66

66 59

60 50

3500 3000 2500

46

40

2000

30

1500 22

17

20

1000

10

500

0

0 2006

2007

2008

2009

2010

2011

2012

Cases of illegal salaries (units, left) Unaccounted salary size (thousand Lt, right) Source: State Tax Inspectorate

business trips, hiding of labour relations by creating contracts with supposedly a business license holding employees. One out of all possible forms of illegal work is based on a situation when a person is being employed to work not full day thus paying him or her only a share of the minimum monthly salary.

Based on the data from STI call center about the possible payments of illegal salary, almost in half of the cases the unofficial salary is in the range from 600 to 1000 Lt.

STI reliance phone line information regarding the size of the illegal salary (2006-2012)

7%

5%

7% 13%

8%

up to 300 Lt 301–600 Lt 601–1000 Lt 1001–1500 Lt 1501–2000Lt

12%

2001 Lt and more Full salary paid illegally

Source: State Tax Inspectorate

48%

33

34

3. The size of the shadow in Lithuanian labour market

3.5. Survey of STI experts Shadow in the labour market was examined by J. Krumplyte and J. Samulevicius. Authors have decided to

conduct a direct survey in order to examine the shadow in the labour market. State Tax Inspectorate (STI) auditors were chosen as the respondents. In total 703 experts were questioned. Experts had to evaluate the size of the shadow in the labour market in two periods: 2006 to 2008 and 2009 to 2011. Experts have estimated that in period of 2006-2008, 15% of small companies (less than 9 employees) had employees without a work agreement, whereas in companies with 250 employees and more this was only 9%. According to experts in the period of 20092011 the number of small companies who had employed people illegally should be about 18% and among the larger companies this number should be around 12% (research conducted in 2009%). The same tendencies were

observed when asking about illegal pay. In the period of 2006 to 2008 19% of small companies were paying salaries to their employees illegally, whereas in big companies with more than 500 employees this number was about 10%. The forecasts in this field had shown a growth, up to 24% and 13% respectively. The research had an additional objective apart from measuring the spread of the shadow, which is related to specific violations, but to measure the size as well. Experts estimate that in the period of 2006-2008 illegal salaries constituted 16% of the total salary budget in large companies (more than 500 employees) which were paying illegal salaries and almost 28% in companies with less than 9 employees. Prognosis of this phenomenon was pessimistic, because according to experts, small

3. The size of the shadow in Lithuanian labour market

Share of companies, in which employees were working witout an agreement or received a part of salary illegally (%) 30% 24%

25% 19%

20% 15% 10%

18%

15% 10%

9%

13%

12%

5% 0% Worked with no agreement

Received an "envelope"

Worked with no agreement

2006-2008

Received an "envelope"

2009-2011 Large company

Small company

Source: Jolita Krumplyte ir Jurgis Samulevicius „Complex Research on Undeclared Work: eoretical Aspects and Empirical Application in Lithuania“, 2010

companies in the period of 2009-2011 had to devote 31% of their salary budgets for illegal salaries and large companies – 20%. Interestingly, even though more people have been receiving the illegal salary the size of the illegal salary had to decrease – this is related to oversupply of labour force and decreasing official salary. In 2006-2008 in larger companies the illegal salary was 987 Lt and it was forecasted to reduce to 897 Lt, whereas in small companies during the economic boom this number was 1150 Lt, yet a decrease to 1018 Lt was foreseen.

Experts have estimated that in period of 2006-2008, 15% of small companies (less than 9 employees) had employees without a work agreement, whereas in companies with 250 employees and more this was only 9%.

35

36

3. The size of the shadow in Lithuanian labour market

3.6. Econometric model

It is difficult to directly evaluate the phenomenon of shadow economy. However, it is often a case when one comes into receiving data which shows different factors which have an impact on emergence of shadow (e.g. taxation rate, justification of shadow economy by the people and other) or which indirectly show the existence of the shadow economy (e.g. decreasing budget revenues, number of detected violations and other). These econometric models allow quantitatively assessing the dynamics of shadow economy by using the data about the reasons of shadow formation and consequence showing indicators. In this segment in order to estimate the dynamics of the shadow economy in Lithuania we will be using one of the most commonly used model - MIMIC (Multiple Indicators Multiple Causes). This model can estimate the shadow

in the labour market from two types of variables. The first type is causal variables, which show what creates or has an impact to the shadow in the labour market. The second type is consequential (indicator) variables, which show what consequences arise due to shadow in the labour market. In short, this model will calculate shadow economy in the labour market dynamics based on the causes and consequences of the shadow labour market 1. There is a simple model chart provided below. 1 In this research we use a structural econometric model MIMIC (Multiple Indicators Multiple Causes). The main idea of such equations of this model is to examine the relationship between immeasurable and observable variables based on their covariance expressions. Based on the maximum likelihood method unknown parameters are assessed. Before conducting a simulation all data was handled meaning removing seasonal impacts, because of the existence of a unit root the percentage changes were made in order to make them stationary. For this reason we avoid false regression, supposedly significant variables with a large determining R2 coefficient. This variable transformation resulted that MIMIC model evaluates the dynamics of the shadow economy.

3. The size of the shadow in Lithuanian labour market

Causal variables

Indicator variables

X1

X2

Y1

Y2

The shadow in the labour market



… X10

Y6

Causal variables – X1, X2, … , X10 Indicator variables – Y1, Y2, ... , Y6

Causal variables

Reliability of the MIMIC model depends on the selected variables. One has to choose such variables which best represent the causes and consequences of the shadow in the labour

market. A table provides an overview of variables chosen for this model and reasons for using them in this model based on their impact on the shadow in the labour market.

Variable name

Variable relation with the shadow in the labour market

„+” if included

Disposable income, Lt

Low and decreasing disposable income forces people to look for additional, sometimes illegal sources of income.

Total state support, Lt

Generous social support promotes looking for unofficial income in order to keep social benefits.

+

GDP growth, %

Quick economic growth decreases unemployment and increases income of people, and that reduces incentive to participate in the shadow economy.

+

Loss making companies, %

In difficult financial times, illegal employment and salaries might be a way for companies not to go bankrupt and reduce losses.

+

Unemployment level, %

Larger unemployment makes difficult to find a job and encourages looking for alternative sources of income in the shadow in the labour market.

+

37

3. The size of the shadow in Lithuanian labour market

Indicator variables

38

Taxation burden on labour, %

High labour force taxation increase the disparity between work place costs and after tax salary, this creates initiatives for illegal work and “envelope” payments.

Unemployment insurance benefit and MMW ratio

Increasing unemployment insurance benefits incentivize people to look for illegal job and to have several sources of income (illegal salary and unemployment benefit).

MMW and average salary ratio

Businesses that lack financial resources to pay increased MMW may choose to employ a person illegally and in that way to avoid labour taxation or to decrease official working time and pay a part of salary illegally.

Government institutions combat against the shadow in the labour market

The variable is expressed as an index, which shows an active role of government institutions in fighting illegal work and salaries. Active government institutions which seek to reduce the number of illegal employees is increasing the risk of illegal activity.

Indicator of economic expectations

Good expectations about the future encourage companies to abandon risky actions which are related with shadow activities.

+

A class budget revenues from personal income tax (PIX)

Decreasing revenues from personal income tax are sending signal about a larger shadow labour market.

+

Long-term unemployment level, %

A part of long-term unemployed are involved in unofficial employment relations, therefore increasing level of long-term unemployment may be a sign of growing of the shadow in the labour market.

+

The use of cash, %

An increase in the demand of cash can be a sign of increasing shadow economy, because cash is the dominant form of payments in the shadow economy.

Labour force activity, %

Low labour force activity may result from people’s involvement in unofficial labour relations.

Cases of illegal salaries detected by STI, units

A large amount of detected cases of illegal salaries indicate a growing shadow economy in the labour market.

Confirmed cases of illegal employees, units

A large amount of confirmed cases of illegal employees indicate a growing shadow economy in the labour market.

+

+

3. The size of the shadow in Lithuanian labour market

After conducting the modeling process, final results were received and were connected2 with population survey data in sections 3.2 and 3.3 – and that is the dynamics of the Lithuanian shadow economy in the labour market from 2005 to 2012.

Only those causal and indicator variables were included in the final model, which were statistically significant, meaning that the dynamics of the shadow in the labour market were best represented by them. These variables were market as “+” in the table. Analysis was conducted by using quarterly data from 2005 to 2012.

2 MIMIC provides not the size of the shadow in the labour market but its change and dynamics. In order to evaluate the shadow in the labour market and its changes, the model results have to be connected with other available data (i.e. survey results).

Dynamics of the shadow economy in the labour market in Lithuania 50% 45% 40% 35%

2

30%

22%

25% 4

20% 15% 10%

5

3

11% 1

5%

2012K4

2012K3

2012K2

2012K1

2011K4

2011K3

2011K2

2011K1

2010K4

2010K3

2010K2

2010K1

2009K4

2009K3

2009K2

2009K1

2008K4

2008K3

2008K2

2008K1

2007K4

2007K3

2007K2

2007K1

2006K4

2006K3

2006K2

2006K1

2005K4

2005K3

2005K2

2005K1

0%

Graph provides the share of people who have been working illegally or have received a share of salary illegally. *e number directs to a particular survey provided lower in the table.

According to results of the research, the size of the shadow in the labour market in Lithuania has been decreasing from 2005 to 2007 and was around 12%. As seen in the graph, when the economic downturn began in 2008, there was a rapid increase in the numbers of people who are involved in the shadow in the labour market. 40% of people in 2009 have been working illegally or have been receiving a part of salary illegally. These numbers started to decline in 2010 and 2011. Even though the share of people who were participating in the shadow in 2012 was stable, it was larger than in 2007.

The dynamics received from the data extracted by the model are confirmed by population survey results in 2010, 2011 and 2012 (graph Nr. 2, 3 and 4). For example, large size of the shadow in the labour market in 2009 is confirmed by a representative survey results conducted in 2010, which showed that about 40% of people knew other who in 2009 received at least a part of salary illegally. Below you can find a table with different population surveys and their results directly linked to the graph.

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3. The size of the shadow in Lithuanian labour market

Nr. graph

1

2

3

4

5

Time of survey

The question

Results

Organization

2007

Has your employer been paying you full or a part of salary without declaring it to institutions responsible for taxes and social insurance in the past 12 months?

11%

European Commission, Eurobarometer

2010

Have there been any people close to you who have received at least a share of salary illegally without paying or hiding taxes in 2009?

38%

Spinter

2011

Have you (your family members) received at least a share of salary illegally, without paying or hiding a share of taxes in (no business license, no certificate for individual activity, by selling cigarettes, fuel or alcohol) 2010?

20%

Spinter

2012

Have there been any people who are close to you which have received a share of salary illegally or in any other way avoided payment of taxes in 2011?

24%

Spinter

2013

Have you or your family members been working illegally, without a working agreement or while being employed have received an illegal salary in 2012?

22%

Spinter

4. Shadow in the excise goods markete

4.

Shadow in the excise goods markete

This section provides an overview of the shadow economy in the market of excise goods (fuel, tobacco products and alcohol). The in depth analysis regarding the shadow market of excise goods was presented in the first publication of Lithuanian Shadow Economy, which can be found on the LFMI webpage.

Taxes consist about 60% of overall price of strong alcohol. It is calculated that because of the shadow market of strong alcohol, the budget lost more than 400 million Lt of excise and VAT taxes.

4.1. The shadow market of distilled alcoholic beverages The evaluation of the shadow market size of strong alcoholic beverages consists of three parts. Three surveys are being conducted: survey of Lithuanian elders (administrative title), survey of experts (producers of alcohol drinks, traders, control and health institutions, eco-

nomists and analysts) and population survey. In the first half of 2013 a survey was repeated by questioning experts and citizens the results showed a decrease of strong alcohol shadow market in Lithuania from 36% in the second half of 2012 to 33% in the first half of

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4. Shadow in the excise goods markete

Share of illegal market - fortified (strong) alcoholic beverages 40%

36% 33%

35% 30% 25% 20% 15% 10% 5% 0% 2012

2013

Methodology LFMI, based on: Survey of general population, (Rait , February 2013) Survey of alcoholic market specialists (Spinter research, February 2013) Survey of elderships of Lithuania, (EKT, June 2012)

2013. Experts who have participated in the survey said that the use of cosmetic products (mouthwash, cosmetic spirit) not for their intended purpose decreased from 7% to 5% of alcohol market. Illegal market share is only being calculated in the segment of distilled alcoholic beverages, because in this segment taxes constitute a

bigger part of the final price than in beer or wine segment. Taxes constitute more than 60% of the price in a category of average price strong alcoholic beverages, whereas in beer and wine it is only about a quarter. In the beginning of 2013 there were conducted two additional representative population surveys, where people where asked whether

Share of people who have aquired illegal alcohol 25%

21%

20%

16%

15% 10% 5% 0% YES - in the last year have you or your family members purchased or consumed illegal alcohol bevarages (home made vodka, smuggled beverages and etc.)?*

YES - have you or your family members purchased smuggled or unofficially made and sold alcohol bevarages in 2012?**

*Population Attitude Survey towards Smuggling and Consumption of Illegal Goods (Spinter research, January 2013) **Lituanian population opinion survey (Rait, February 2013)

4. Shadow in the excise goods markete

they or their family members have purchased illegal alcohol products. Results show that about one fifth of all respondents or their family members have participated in the shadow alcohol market by purchasing alcohol products illegally. Regarding the specifics of the

question, one needs to keep in mind the fact, that not all of the people where honest and have disclosed their actions, thus there is a likelihood that the share of people who have purchased illegal alcohol products is actually greater.

4.2. The shadow market of cigarettes

Non-domestic share of cigarette market 41.3%

45.0%

42.8%

40.0%

35.4%

34.5%

35.0%

30.8%

29.3%

30.0% 25.0%

21.2%

20.0% 15.0%

12.5%

10.0% 5.0% 0.0% 2009K2

2009K4

2010K2

2010K4

2011K2

2011K4

Non-domestic share of cigarette market Source: Empty pack survey, Nielsen

2012K2

2012K4

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4. Shadow in the excise goods markete

In the fourth quarter of 2012 a research of empty cigarette packages have provided data that 35.4% of cigarette packages were not Lithuanian, meaning that no excise or VAT taxes were collected in Lithuania. A research carried out on a regular basis by a research company “Nielsen”, when in a random order empty cigarette packages are examined in 20 largest Lithuanian cities, allows evaluating the spread of ille-

gal tobacco products in Lithuania regarding size and trends of this market. Even though market of cigarettes, that are being sold without paying taxes was decreasing from the fourth quarter in 2010, at the end of 2012 it had increased by 6% once again if comparing with the same year second quarter. The research had uncovered that most of non-Lithuanian origin cigarettes are coming from neighboring Belorussia.

Have you or your family members purchased smuggled or unofficially made and sold cigarettes in 2012?

Yes; 35%

No; 65%

Source: Population Attitude Survey towards Smuggling and Consumption of Illegal Goods (Spinter research, January 2013)

A representative population survey conducted in February 2013 uncovered that more than a third of respondents have confirmed that they or their family members have acquired smuggled or illegally produced and sold cigarettes in 2012. Men living in rural areas and receiving income up to 1500 Lt were the most common buyers. The main reason for smuggling is the price difference in EU member states when compared to Lithuanian neighbors Russia and Belorussia. In August 2012 the price of a pack of cigarettes in Belorussia was 1 Lt, in Russia 2 Lt and in Lithuania 7 Lt. The illegal market is affected by an increase in excise since March 2013 for cigarettes. In the final price of the cigarette, taxes (excise and VAT) make up 80%.

In Lithuania taxes consist about 80% of the final price of cigarette. It has been calculated that due to illegal cigarette market the budget in 2012 had lost 341 million Lt of excise and VAT taxes.

4. Shadow in the excise goods markete

4.3. The shadow market of fuels

A representative population survey conducted in February 2013 had shown that at least 29% of Lithuanians have acquired illegally sold fuel during 2012. Similar results are provided by “Autoplius.lt” survey1 done in January 2013, with 7 thousand participants. 37% of respondents in this survey claim to be using fuel bought not in Lithuanian fuel stations.

1 http://auto.plius.lt/tyrimai/pranesimai-spaudai/beveik-puse-dyzelino-lietuvoje-nuperkama-nelegaliai

In Lithuania taxes make up 50% of gasoline and 40% of diesel fuel price. By filling up 50 liters of illegal gasoline the budget would not receive revenue of 118 Lt in a form of excise and VAT taxes.

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4. Shadow in the excise goods markete

Have you or your family members purchased smuggled or unofficially made and sold fuels in 2012?

Yes; 29%

No; 71%

Source: Population Attitude Survey towards Smuggling and Consumption of Illegal Goods (Spinter research, January 2013)

In most cases the fuel comes from Belorussia, which is bought or transported by the respondents themselves – 16%. About 7% claim that they are using fuel bought from truck drivers. It should be noted that diesel car owners are more prone to choosing illegal fuel than gasoline car owners. 75% of gasoline car owners are buying the fuel at the fuel stations,

whereas only 62.6% of gasoline car owners are doing that. The main reason of illegal fuel trade is taxation. In gasoline final price excise and VAT make up 50%, in diesel fuel it is about 40%. It is claimed that the diesel fuel is cheaper in the range of 1-1,5 Lt than in the legal market.

Lithuanian Free Market Institute 3A Seimyniskiu Street, LT-09312 Vilnius, Lithuania Tel. +370 5 250 0280, fax +370 5 250 0288, email [email protected] www.freema.org

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