Israel’s shadow economy equal to 18.9% of GDP

High tax levels and unevenly distributed tax burden drive Israelis to avoid reporting or under-report deals, study says.

June 25, 2013 22:13
2 minute read.
shekel and dollar exchange

shekel versus dollar 370. (photo credit: REUTERS)

Amounting to an estimated NIS 185 billion, Israel’s shadow economy will reach 18.9 percent of its GDP in 2013, a study by credit card company Visa revealed on Tuesday.

The study defined the shadow economy as unreported or under-reported transactions in the legal economy, excluding illicit activities such as drug-dealing.

The 18.9% figure puts Israel on par with the European Union as a whole, but somewhat ahead of the OECD average, which stood at just 15.3%.

While countries like Turkey and Bulgaria had higher rates (27 and 31, respectively), the shadow economies in North America were significantly lower, said Justin Krampe, a senior consultant at ATKearney, which carried out the study. In the United States, it was just 7% of GDP.

Unreported transactions mean lower tax revenues for the government, unfair competition in the market, and a lack of protection for involved workers, Krampe said. During times of economic distress, however, activity in the shadow economy could also act as an economic stimulus because it helps shield people from taxes. Plus, money spent in the dark eventually makes its way into the rest of the economy.

That said, bringing more of the shadow economy into the light could help the country with its deficit problem; just a 2 percentage point drop in the shadow economy’s size could mean about NIS 9 billion more for the government, Krampe said.

According to the report, the drivers of the shadow economy in Israel include relatively high tax levels, an unevenly distributed tax burden, high amounts of bureaucratic redtape and insufficient financial inclusion of minorities, such as Israeli Arabs and Orthodox Jews.

While some of Israel’s shadow economy included household transactions like undeclared payments to nannies, nurses, house-cleaners and tutors, most of it came from businesses.

Manufacturing (including the diamond business), construction, and car dealerships and garages were among the greatest sources of unreported transactions.

Visa’s solution to the shadow economy, of course, was to encourage more electronic transactions.

“Cash is the fuel of the shadow economy. It’s the only way to work off the books,” Krampe said. “When you use cash, it’s easier to hide income.”

Oded Salomy, Visa Europe Country Manager in Israel added, “In order to reduce the shadow economy in Israel and increase government tax revenue, we propose to take steps to increase the use of payment cards.”

Increasing electronic payments by 10% could help reduce the shadow economy 4-6%, the study estimated.

To help steer more economic transactions away from cash, Visa recommended several policy measures.

Among them: increasing the amount of terminals that could process electronic payments in places that don’t have them, such as small shops and taxi cabs; offering a VAT discount for electronic transactions, setting a requirement threshold for transactions, so that large transactions would by law have to be carried out electronically; and developing mobile and other wireless payment systems.

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