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Mediterranean Quarterly 18.2 (2007) 67-84

Informal Economy, Tax Evasion, and Poverty in a Democratic Setting:
Constantine P. Danopoulos
Boris Znidaric

Generally speaking, informal economy refers to undeclared economic activity that is not recorded in the formal national economic ledgers. Also known as black, unofficial, hidden, unrecorded, shadow, gray, parallel, dual, moonlight, unobserved, or underground, it is as old as humanity itself. The most widely used definition of informal economy refers to that portion of economic activity that should be but is not registered in state or national ledgers.1 It is neither a new phenomenon nor limited to the changing societies of the developing world; instead, it affects authoritarian as well as economically developed and democratic societies. By its very nature, informal economic activity is hard to pinpoint and even harder to measure. In addition, economists and other social scientists disagree with respect to its impact. Some view underground economy in negative terms because it denies the state revenue and wreaks havoc on the reliability and accuracy of the economic data governments rely on to plan economic policy and determine fiscal and monetary policy. Others find informal economic activity as something tolerated, if not deliberately promoted, by governments. They see it as increasing disposable income and competition, reducing unemployment, and acting as a safety valve in times of slowdown and economic transition.2 [End Page 67]

Connected to underground economic activity is the avoidance of paying taxes: tax evasion. But the two are not necessarily identical. Tax evasion is equally pervasive and hard to define, and most analysts view it as an illegal and/or deliberate act on the part of an economically active citizen/actor to reduce or altogether avoid his or her tax-paying responsibilities.3 Tax evasion includes avoiding taxes on wages and interest and direct or indirect taxes that legally should have been collected and paid to the state.4 Informal economic activity deals with the production of goods and the creation of parallel income, but tax evasion is different. In fact it is possible to have one without the other. An economic activity may be above board but the proprietor can find ways not to pay taxes, either through loopholes or by not reporting sales. In Greece and other parts of the world, agricultural productivity is recorded, but the majority of farmers do not pay taxes or file tax returns. In other words, the economic product is not taxed, although there is no underground economy.5 But even though the two are not identical, there is a close connection between them. As N. Tatsos points out, one of the most important reasons people "engage in underground activity is to evade paying taxes." Thus, to a large degree "when you have one, you also have the other."6

There is another important dimension associated with unreported economic activity and tax evasion: poverty. As noted, economists and other social scientists are split regarding the effects of informal economy. A similar division exists with regard to tax evasion. Some argue that tax evasion improves living standards by leaving more income in peoples' hands. Others argue that tax evasion contributes to poverty, for it deprives governments of needed resources to invest in economic development that would help the weaker segments of the population. Using Greece as a case study, in this article we argue that there is a strong correlation between underground economic activity and tax evasion and relatively high levels of poverty, especially among the elderly, farmers, pensioners, unemployed, underemployed, and vulnerable segments of the Greek population. [End Page 68]

Modern Greece has the highest level of tax evasion among the fifteen nations that made up the European Union prior to the enlargement in 2004, which added ten new, mostly former Eastern bloc, members. The Bank of Greece estimates that tax evasion reaches an astronomical 63.3 percent of the country's total economic activity.7 One of two taxpayers "commits tax evasion."8 Moreover, the country's level of underground economic activity was...


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pp. 67-84
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