Gorana Krstić

Main Findings and Recommendations

This chapter summarises the main findings of the study and recommendations for formalising the shadow economy. First the chapter outlines the key causes of the shadow economy in Serbia and it then provides an estimate of the shadow economy in relation to GDP, estimates of various forms of the shadow economy in the sectors of businesses and entrepreneurs, and the businesses’ and entrepreneurs’ characteristics. This leads to an examination of the effects that formalising the shadow economy can have on the government budget and economic growth. The chapter then reviews the findings on the administrative and institutional capacities of the government institutions tasked with overseeing the operation of business entities.

What Is the Extent of the Shadow Economy in Serbia

There is an extensive literature on the shadow economy and the methods used to estimate it, but a limited amount that applies to Serbia. This chapter presents recent estimates of the shadow economy in Serbia using three methods. The first is the MIMIC method, a modelling-based approach covering Serbia and ten other Central and Eastern European countries between 2001 and 2010. The second is the Household Tax Compliance (HTC) approach based on macroeconomic data for Serbia for 2010. The third method is based on the data obtained from the representative survey of registered businesses and entrepreneurs in Serbia. This survey was the basis for estimating the extent of the shadow economy in the sector of businesses and entrepreneurs for the two main types of informal activity, illicit trade in goods and undeclared work. The methods used differ in their coverage of the shadow economy in terms of institutional sector, form of shadow economy, and methodology. The MIMIC method has the broadest coverage since it covers all institutional sectors and all forms of the shadow economy. The HTC method estimates only those forms of the shadow economy that can be identified on the basis of household income and consumption data, while estimates based on the survey focus on the most important forms of the shadow economy among business entities. In addition to the shadow economy, this chapter also estimates the tax evasion gap for the most important types of tax in Serbia: value added tax (VAT), social security contributions, and personal income tax.

Effects of Formalisation of the Shadow Economy

Based on the estimate of the tax evasion gap, this chapter looks at the benefits of a reduction in the shadow economy—or, rather, the reintegration of a portion of it into the formal economy—to the Serbian budget. We show separate estimates of possible fiscal effects for the three key types of public revenue for which we have estimated the tax gap: value added tax, personal income tax, and social security contributions. The chapter also considers how formalising the shadow economy affects economic growth. Although there is a large body of empirical research on the impact of the shadow economy on economic growth, there are still no unequivocal empirical and theoretical findings. The basic question is this: Is the shadow economy a positive phenomenon? In other words, does it make a positive contribution to economic growth? The answer to these questions result in two possible avenues of approach for government policy on the shadow economy: tolerance or active suppression.

Shadow Economy in the Business and Entrepreneurial Sectors

Research to date on the shadow economy in South Eastern Europe and beyond has mainly focused on macro assessments of this phenomenon or on the socio-economic characteristics of individuals involved in these activities. There have been far fewer studies analysing the characteristics of businesses engaged in the shadow economy and the factors that drive them to operating informally. This chapter provides an analysis of the shadow economy in the business and entrepreneurial sectors using data from the Survey on Conditions for Doing Business in Serbia. This analysis is based on three indicators: (1) the share of business entities engaged in the shadow economy in the total number of business entities; (2) the share of informal workers in the total number of workers, both overall and by type; and (3) the share of cash payments in the total volume of payments. In addition to descriptive statistics that show how the shadow economy varies by key factors, the chapter provides econometric analysis identifying specific factors that are statistically significant in a company’s decision to take part in the shadow economy.

The Concept of the Survey of Businesses and Entrepreneurs Operating Informally

Incentives to formalise the shadow economy should be based on knowledge of the causes and structure of informal activity. A specific problem in designing these incentives is the fact that information on the shadow economy is inherently unreliable and incomplete. A survey of the informal activities, the Survey on Conditions for Doing Business in Serbia, was therefore carried out for the purpose of this study on a representative sample of 1,251 businesses and entrepreneurs. This survey allows us to explore the shadow economy in Serbia from the business perspective for the first time, to assess the various forms that the shadow economy takes, and to analyse them according to the relevant characteristics of business entities, as all previous research has been based on household surveys. The survey also allows us to analyse the causes of and motives for informal activity, which is of particular importance in drafting recommendations for formalising the shadow economy.