Tackling the Undeclared Economy in Bulgaria: A Baseline Report
GREY Working Paper No. 1
93 Pages Posted: 1 May 2014
Date Written: 2014
This report provides a systematic review of available evidence on the extent and nature of the undeclared economy in Bulgaria, as well as on the institutional actors involved in tackling the phenomenon and their policy approach and measures used.
Extent of the undeclared economy - Bulgaria is increasingly included in international and European studies of the size and nature of the undeclared economy, allowing cross-national comparisons. Schneider (2013) estimates the undeclared economy in Bulgaria to be 31% of GDP in 2013, which is the highest estimated value in the EU-28. According to the World Bank Enterprise Survey 2009, 54% of firms assert that they compete against firms operating in the undeclared economy and for 28% of firms the practices of undeclared sector competitors represent a major constraint. This is high compared with other EU-27 member states.
Recent surveys indicate that although the undeclared economy appears to be shrinking over time, there is an increasing involvement in some types of undeclared work due to the economic crisis. This means that although the overall trend is downwards, not all forms of undeclared work are shrinking.
Nature and types of undeclared work - Examining sectorial and business variations, there is greater involvement in the undeclared economy amongst small and medium-size enterprises, and those operating in construction, retail, tourism, hotels and restaurants, real estate, garments, food processing and the agricultural sectors as well as some services. Overall, labour-intensive, low technology sectors are more vulnerable to entering the undeclared realm. Producers and distributors of excise goods (alcohol, cigarettes and fuel) are considered at high risk when it comes to tax/excise evasion and under-reported turnover. Examining the nature of undeclared work, national representative surveys indicate that under-reporting remuneration is more widespread than the lack of formal contracts, and has in fact increased since the beginning of the economic crisis. While primary work without contract is occurring less and less frequently (between 4% and 10% of the employed according to surveys), non-declaration of additional employment is a more serious problem (between 28% and 32% of all dependent employees with a second job). The economic crisis has forced employers to resort to under-reporting wages and registering workers on part-time contracts instead. “Envelope wages” are affecting between 14% and 21% of the employed, especially those in the service and retail sectors.
Looking at the supply and demand side of undeclared employment, the Eurobarometer survey shows that in 2007 the majority of undeclared workers were involved in construction, industry and agriculture, while in 2013 the most often provided type of undeclared work was repairs and renovations, followed by “other goods and services”. Males aged 40-54 years, the unemployed/temporarily not working, as well as those from small/middle-sized towns and rural areas are more likely to engage in undeclared work. The most frequently purchased product of undeclared work is food. While in the EU27 on average undeclared work is provided to, and purchased from, the immediate social network (friends, family, neighbours, relatives), in Bulgaria the sources and clients of undeclared work are more “anonymous” (other private persons and households, as well as firms and businesses). Tax evasion and under-reported turnover by firms has not been reduced on a sustainable basis despite intensified repressive and control efforts on the part of the Bulgarian authorities. VAT and excise duties avoidance in the production and sales of fuel and cigarettes is a substantial problem, exceeding 30% of all sales, while both organised crime and legitimate economic actors are involved in these activities. Criminal networks use legitimate business covers and create numerous opportunities for undeclared work (e.g. shuttle traders and low-level street distributors of cigarettes). All this creates an environment prone to corruption and stimulates a culture of informality, undermining business competitiveness.
Barriers to formalization - When it comes to the barriers to formalising undeclared economic activity, the tax and social security burden is a less serious concern for firms than the overall complexity of tax and regulatory systems, corruption and nepotism, institutional inefficiency and policy instability. According to the World Bank Doing Business study, although some improvement in relation to starting a business, paying taxes and trading across borders has been achieved since 2005, no progress is evident in areas such as dealing with permits, getting electricity, resolving insolvency and enforcing contracts. Although the overall tax rate is low, the cost of compliance for companies remains high in terms of time and effort spent on paying taxes and observing regulations. The perceived fairness of the business environment is low and affected by the existence of oligarchic economic structures that enjoy political protection. Strengthening contract enforcement and guaranteeing property rights through an efficient system for law enforcement and administrative control appear to be more pressing issues for policy makers than the popular resolve to reduce taxes (or keep them constant).
Labour market regulations create specific disincentives for low earners to “come into the light”, who bear the main burden of efforts to close social security and pension deficits. The frequent increases of the Minimum Social Insurance Thresholds lead to regressive taxation on workers whose actual pay is below the threshold or stimulate undeclared work instead of reducing it. At the same time, the legitimacy of the social security system is low, and the inadequate quality of public services puts off potential contributors. Institutional actors - There is no single body in Bulgaria responsible for tackling undeclared work. Although the policy response is focused on labour, in recent years the tax authorities have played an increasingly important role, as improved tax and revenue collection has become a top political priority. The Ministry of Labour and Social Policy (MLSP) has a key role in devising and implementing policies and measures to reduce undeclared work. Tax evasion and violations of the fiscal discipline by both individuals and firms falls within the realm of the Ministry of Finance. When it comes to enforcement and control, two government agencies have been traditionally at the forefront of efforts to reduce the undeclared economy: the MLSP’s General Labour Inspectorate (GLI), monitoring the observance of the labour legislation, and the National Revenue Agency (NRA) at the Ministry of Finance, responsible for state revenue collection (taxes and other receivables). They conduct regular inspections and audits, including joint campaigns for collection of taxes and social security contributions. Cooperation and joint actions have been strengthened in recent years through important legislative amendments and inter-institutional agreements, including with trade unions. Recently the two bodies have improved their ability to detect and penalise undeclared work through risk assessments and monitoring, as well as data sharing. Despite the increased use of e-services and development of consultation and education services by control authorities, a customer-oriented approach and increasing public trust in the state are areas that require further efforts. Although the membership base of trade unions is declining, they continue to play an important role in the formulation of national labour market reforms and social policy. Together with business organisations, they are actively involved in a wide range of initiatives aimed at raising public awareness in relation to the undeclared economy, and developing targeted measures to tackle it, together with the government, or on their own. Tripartite dialogue is well institutionalised through social pacts, national councils and formal roundtables. Associations of small and medium enterprises are not representative, and are excluded from formal tripartite dialogue.
Policy approach and measures - The policy response of the authorities to tackling the undeclared economy has been focused on tightened control for both firms and individual taxpayers, while some preventative and curative measures have also been introduced, with mixed results. Overall, the national policy approach towards the undeclared economy is characterised by the following deficiencies: 1) lack of systematic evaluations and cost-benefit analysis of measures; 2) insufficient tailoring of measures to the features of the national economy, as well as fitting those into the existing policy infrastructure; and 3) economic and administrative measures neutralise their respective effects.
Preventative measures targeted at businesses include the adoption in 2003 of an act aimed at clarifying and simplifying the rules of administrative regulation and reducing administrative control on the business. Despite its ambitious goals, its application has been limited at best. Administrative procedures continue to be non-transparent and vulnerable to authorities’ discretion. Ex-ante impact assessments, in theory mandatory for each new regulation, have not been systematically performed, if at all. Deterring entry into the undeclared realm has been pursued through measures targeted at both employees and firms, through mandatory registration of work contracts and the introduction of mandatory minimum incomes, on which social security is calculated. While the first measure resulted in a significant reduction in the incidence of work without contract, the second has proved more controversial. The main objective of the Minimum Social Insurance Thresholds was to ensure declaration of wages closer to the actual pay levels in different sectors and occupations, instead of the minimum wage. However, the subsequent increase of the thresholds has put upward pressure on lower wages, and created incentives for micro-businesses to employ wholly unregistered or part time workers. Repressive measures have been increasingly applied by Bulgarian governments in the light of shrinking budget revenues. Detection of tax evasion and underreported turnover was improved through introducing a mandatory real-time link between fiscal devices of economic entities and the servers of the revenue authorities. Additional monitoring has been imposed on the movement of excise goods through the installation of special control devices linked to the Customs Agency, which placed a large administrative burden on excisable traders and enforcement bodies alike. This required a subsequent modification of the measure due to its overall negative economic effect.
Undeclared employment has been targeted through extending the powers of control bodies, increasing penalties, improved risk assessment and data sharing. These measures have been followed by extensive inspection campaigns, conducted separately or jointly by control bodies, leading to temporary compliance at best, but also placing a substantial administrative burden on compliant firms. The sustainability of the effect of such efforts conducted in a “campaign-like” manner is questionable, considering that measures aimed at changing attitudes and fostering voluntary compliance remain limited in scope.
Curative measures aimed at supporting undeclared firms and workers to formalise include the introduction of the flat tax on personal incomes, which is now among the lowest in Europe, as well as a food voucher system for private sector employees. The latter is aimed at providing employees with additional non-taxable income, as well as substituting the payment of “envelope wages”. Food vouchers are positively evaluated, despite some implementation hurdles.
Several public campaigns aimed at raising awareness and fostering commitment have been conducted by social partners, and recently followed up by a four-year project with a wider scope, launched by trade unions and business associations. This project’s more holistic approach is promising in terms of ensuring greater sustainability of efforts to tackle the undeclared economy. It has resulted in establishing a national “Rules for Business” centre, which is expected to become the national focal point for coordination of policy actions, information gathering and consulting services.
Keywords: informal sector, informal economy, Bulgaria, tax morale, tax compliance, tax evasion, public policy
JEL Classification: H26
Suggested Citation: Suggested Citation