Ethics@Work: How black is the black market?

Estimates: The black or “informal” market in Israel is around a quarter of GDP.

The tax authorities occasionally “raid” retail establishments in order to catch tax evaders and deter future evasion. The forays of these “tax commandos” serve an additional function: they give some estimate of the size of the black market – that elusive, unreported part of national income.
According to newspaper reports, the conclusion was that approximately 25% of transactions in Israel go unreported.
How reliable is this figure? On the one had it could be an underestimate.
The tax authorities concentrate their efforts on businesses they suspect to have a high rate of tax evasion. Or it could be an overestimate. The entire investigation checked only legitimate businesses and doesn’t relate to businesses which are completely black.
But other studies have come up with very similar estimates: the black or “informal” market in Israel is around a quarter of GDP. (Compared to around 10% for the US and over 60% for our neighbor Egypt.) In a way that’s good news.
While official figures give Israel’s GDP per capita at around $27,000, perhaps it is closer to that of Spain at $32,000. (Pretty unlikely given that Spain is also thought to have a large black market.) But it is bad news for the tax system. The black market means that the tax burden is spread very inequitably between the legitimate businesses and workers that are paying very high taxes and the evading ones that are paying very little. It also means that the total take is lower and the deficit more threatening.
The latest investigation provides a good basis to discuss the complex relationship between enforcement and collections in national taxation.
The efficiency of tax collection can be gauged by the fraction of collection costs to total taxes collected. This fraction varies very widely by country.
The US traditionally has had the lowest rate; a recent paper by Pinar Yesin showed that the US spends only about 50 cents to collect a hundred dollars in revenue. In Israel it is still relatively low – a little over 1%. In Australia the number is around 3% and in Turkey 14%.
We would expect that the greater the resources spent on enforcement, the smaller the black market would be. Yet the results seem opposite.
According to Yesin’s paper, Turkey is estimated to have a much larger black market than Australia, and Australia’s is larger than that of the US. It would seem that cause and effect here are reversed: the size of the black market is caused mostly by cultural factors, not by actions of the tax authorities, and the more tax evasion there is, the more it costs to collect taxes. It is sometimes supposed that there is even a counterproductive aspect to collection actions: aggressive collection actions can lead to an adversarial mentality between citizen and government which can encourage tax evasion.
The Tax Authority in Israel has apparently been sensitive to this issue.
Alongside collections actions like the recent tax raid, they also undertook last year a public relations campaign to explain to the public the importance and legitimacy of paying taxes. Time will tell if this two-pronged effort to motivate compliance and punish evasion will lead to a reduction in the size of Israel’s black market and a more equitable division of the tax burden among Israeli citizens and businesses.