Under-Declaring Work, Falsely Declaring Work: Under-Declared Employment in the European Union
59 Pages Posted: 16 Oct 2017
Date Written: September 14, 2017
Under-declared employment occurs when a formal employer pays a formal employee an official declared wage but also an additional undeclared (‘envelope’) wage in order to evade the full social insurance and tax liabilities owed. The aim of this study is to evaluate the prevalence, characteristics and distribution of this fraudulent wage practice in the EU28, to explain its existence, to provide an evidence-based evaluation of the effectiveness of different policy approaches for tackling it, and propose a set of policy recommendations. Prevalence, characteristics and distribution of under-declared employment:
To evaluate the prevalence, characteristics and distribution of under-declared employment in the EU28, and explain its existence, there are two main datasets. The first is the 2013 special Eurobarometer no. 402 survey of 11,025 employees in the EU28. The second is the employee and employer surveys conducted in late 2015 in Croatia, Bulgaria and FYR Macedonia, funded by the European Commission’s Framework 7 Industry-Academia Partnerships Programme (IAPP) [grant number 611259] entitled ‘Out of the shadows: developing capacities and capabilities for tackling undeclared work’ (GREY).
In the 2013 Eurobarometer survey, one in 33 formal employees in the EU28 received envelope wages in the 12 months prior to the survey. Extrapolating from this, some 6.36 million of the 212 million employees in the EU-28 receive under-reported salaries. All employee groups, types of business and member states are involved in under-declared employment. However, it is relatively more concentrated in some employee groups, business types and member states. Men, younger age groups, those with financial difficulties, skilled manual workers and those travelling for their job, are more likely to receive envelope wages, and under-declared employment is particularly prevalent in smaller firms, and the agricultural, construction, transport, hotel and restaurant, repair services, and retail sectors.
Systemic determinants of under-declared employment:
Conventionally, under-declared employment has been seen as an individual criminal act, which is solved by increasing the penalties and risks of detection in order to deter participation. This, however, only deals with the effects. It does not deal with the causes of under-declaring wages. Under-declared employment is a symptom of systemic problems. To identify these, an evaluation of the relationship between cross-national variations in the prevalence of envelope wages and various macro-level economic and social conditions is undertaken. This reveals that the likelihood of under-reporting wages is higher in economies with: lower GDP/capita; unmodernised state bureaucracies with greater public sector corruption; higher levels of severe material deprivation; higher income inequality; lower levels of expenditure on labour market interventions to protect vulnerable groups; and less effective policies of redistribution via social transfers to protect workers from poverty. It is important, therefore, to confront these systemic determinants in order to solve under-declared employment.
Strategies and capacities to tackle under-declared employment:
To tackle envelope wages, two contrasting policy approaches are available to governments and social partners. A ‘direct’ approach ensures that the costs outweigh the benefits, mostly by increasing the penalties and risks of detection, which dissuades employers and employees from under-declaring wages. An ‘indirect’ controls approach, meanwhile, asserts that under-declaring wages occurs when the norms, values and beliefs of employees and employers are not in symmetry with the codified laws and regulations. Here, therefore, policy measures seek to align the norms, values and beliefs of employees and employers with the laws and regulations.
Evaluating their effectiveness in reducing under-declared employment, the finding is that although the ‘direct’ approach of increasing the penalties and probability of detection does not influence employees’ tendency to accept envelope wages, increasing the risks of detection does reduce the likelihood of employers paying under-declared wages. The ‘indirect’ approach of improving voluntary compliance, however, reduces the likelihood of employees receiving envelope wages and employers’ under-declaring wages. The outcome is that an indirect approach is recommended as the primary tool for changing the behaviour of employees and employers, and improving the perceived and actual risks of detection is a secondary tool recommended for changing the behaviour of employers. Improving the rate of detection of salary under-reporting, however, is difficult due to the problems involved in identifying such a wage arrangement during workplace inspections. This is because these formal employees have a written contract or terms of employment and a declared salary, and only 33% of employees receiving envelope wages would prefer full declaration, meaning that there is likely to be limited whistle-blowing from employees. Moreover, even those employees unhappy who might wish to whistle blow will be reticent about doing so for fear of losing their job. For this reason, a shift away from workplace inspections and towards data mining and matching, using dynamic benchmarking to identify anomalies/outliers, is required to detect under-declared employment. Databases are required that can analyse average earnings in firms, and cross tabulate this with average salaries in their region and/or sector, or by occupation, in order to identify outlier businesses paying below the average wage for their region and/or sector, or for particular occupations. However, this identification of potential outlier/anomalous organisations paying envelope wages, in order to enable more targeted inspections, does not help when it comes to proving salary under-reporting. It is unlikely employers and employees will admit to such a practice.
In consequence, there is a need for awareness raising campaigns and education about the benefits of fully declared work targeted at both employers and employees. For employers, such an awareness raising campaign should target small businesses in those regions and/or sectors where salary under-reporting is more prevalent, namely the agricultural, construction, hotel and restaurant, transport, repair services and retail sectors. For employees, meanwhile, such a campaign could be targeted particularly at the employee groups identified above, especially in small firms and the sectors where envelope wages are prevalent. This could focus upon the benefits of fully declared employment and the costs of receiving envelope wages in terms of the future benefits foregone. More widely, initiatives are also required to educate citizens about the benefits of taxation in terms of the public goods and services that they receive in return for the taxes they pay. Such policy initiatives might range from introducing into the civics curriculum in schools the issue of taxation and adhering to labour legislation, through letters to employees and employers as taxpayers about how their taxes are being spent, to signs stating ‘your taxes paid for this’ on fire engines, roads and ambulances, and in hospitals, doctors’ surgeries and schools.
Awareness raising and educational initiatives, however, will not alter the attitudes of employers and employees, and reduce under-declared employment, unless there is reform of the formal institutions, especially in countries where formal institutional deficiencies mean there is a lack of trust in government. On the one hand, this requires alterations in the macro-level structural conditions cited above that lead to lower voluntary compliance. On the other hand, the quality of governance needs improving. This is because voluntary compliance improves when employees and employers: believe they are treated in an impartial, respectful and responsible manner by state authorities; believe they pay their fair share compared with others, and believe they receive for the taxes they pay the public goods and services they deserve.
Keywords: informal economy, shadow economy, tax evasion, labor economics, informal sector
JEL Classification: H26, J46, J48, K34, K42, O17, P37
Suggested Citation: Suggested Citation