Milojko Arsić

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.

Causes of the Shadow Economy

A shadow economy does not happen by accident. It is a recognised consequence of imperfections in the economic system and inadequacies in economic policy. While the factors that generate and foster the growth of a shadow economy are many and complex, literature considers the following to be the most important: excessive tax burden, government over-regulation of business, and poor performance by government bodies (tax, judiciary, police, and other authorities). Identifying the fundamental causes of a shadow economy is a precondition for designing efficient instruments and policy measures to tackle it.

Fiscal Multipliers in Emerging European Economies

Filling the evidence gap on the size and variations of fiscal multipliers in developing countries, and contributing to the debate on the fiscal transmission mechanism, we found that the government spending multipliers in emerging Europe are (i) higher than in developing countries and at lower end of those in developed countries; (ii) the fiscal multiplier is large under fixed exchange rate and close to zero under floating and this is related to different monetary policy stance across regimes; (iii) the multiplier substantially increases in the Great Recession relative to pre-crisis expansion; (iv) upon government spending shock private consumption increases under both exchange rate regimes, in downturn and expansion, and hence in the over-all sample, thus mimicking the corresponding pattern of spending multipliers, and hence supporting predictions of traditional and new Keynesian models rather than those of neoclassical ones.

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.

Fiscal Pressure of Interest Payments in Serbia - A Time Series Exploration

We focus on the response of primary fiscal balance to interest payments and borrowing costs on Serbian public debt before and in the aftermath of the global financial crisis. Our analysis reveals: i) policy makers financed up to 50% of each percentage point increase in interest payments to GDP ratio with new public debt issuance; ii) the government has responded to rising interest payments and borrowing costs by reducing primary fiscal balance from the onset of the global financial crisis; iii) the response of primary fiscal balance to interest payments mimics the response of primary fiscal balance to the costs of borrowing; iv) fiscal austerity measures adopted after the breach of fiscal rule for public debt have been insufficient to stabilize fiscal policy stance in Serbia.