In 2015, the Serbian government adopted the National Program for Suppression of the Shadow Economy, which may be one of the largest in Europe.
The goal of the National Program is to downgrade the shadow economy to the average of the countries of Central and Southeast Europe (CSE) until 2020. A recent NALED study, using comparable company surveys between 2012 and 2017, estimated that in this five-year period the shadow economy in Serbia has been reduced by more than one quarter (i.e. by 27 per cent), which would mean that the goal of the Program is fulfilled before time and the level of the shadow economy in Serbia has been lower than the average CSE level already in 2017.
However, it is known that the subjective perceptions of citizens and businessmen do not necessarily reflect economic trends in a realistic way. There are many examples of contradictions and illogicality in international business conditions rankings in different countries based on surveys of subjective perceptions. Most analysis based on macro-fiscal data indicates that in the period 2012-2017 a more sensitive reduction of the shadow economy did not occur in Serbia. The movement of tax aggregates suggests a rise of the shadow economy during 2013-2014. In 2015, start of a fiscal consolidation brought reduction in the shadow economy. Although it’s down in the period 2016-2017, in some segments (such as VAT collection) estimates show that this reduction was only able to neutralize the increase in 2013 and 2014. Thus, the size of the shadow economy is approximately at the same level as in 2012, whereby it stagnated in the domain of goods and services (taxable VAT) and in the field of earnings and employment. In the petroleum transport shadow economy has been reduced, and in the tobacco market products has increased.
Is the shadow economy growing?
In 2012. according to the various economic research results, the shadow economy in Serbia was estimated to 30.1 per cent of GDP, which is about one-sixth above of the CSE countries’ average. Based on the comparison of the real changes in tax revenues, relevant tax bases and tax rates, in the period from 2012-2017, the level of the shadow economy in Serbia remained approximately unchanged. The share of tax revenues in GDP from 2012 to 2017 increased by 2.4 per cent, whereby in this period the rates of a large number of taxation forms were significantly increased, including VAT, excise and profit tax. Growth in tax revenues was achieved on the basis of revenue growth from excise, income tax, and somewhat less VAT and other contributions. In the period 2012-2017, tax revenues increased by 14.3 per cent, whereby in the period 2012-2015 its growth was very slow and amounted to only 1.6 per cent, and in 2016-2017 realistic growth was cumulatively 12.5 per cent. Among other things, the standard VAT rate was increased from 18 to 20 per cent in 2012; the lowered VAT rate was increased from 8 to 10% in 2014. The profit tax rate was raised 10 to 15 per cent in 2013. In 2015, excise for electricity was introduced with 7,5 per cent rate, and also progressive increase has been introduced for cigarettes.
At the same time, it is noticeable that in 2013, 2014 and 2015, tax revenue growth was significantly lower than the cumulative growth rate of GDP and average tax rates, which means that in that period there was a noticeable expansion of the shadow economy, in comparison to 2012. In 2016 and 2017, tax revenue growth was faster than the aggregate growth of GDP and tax rates, which may indicate that during that period there was a suppression of the shadow economy.
Significant growth of the shadow economy, which came about since 2012, is the result of a number of factors. First, the degree of tolerance on non-payment of taxes has increased within the new government, which was reflected in the tolerance of the failure in solving the tax debts, as well as unclaimed illegal turnover of excise goods to Kosovo. In addition, the political changes slow downed the transition of institutions, such as the Tax Administration, where long delay in setting up regional offices took place. Subsequently, the strategy of collecting taxes was primarily based on encouraging voluntary tax payments, rather than increasing the likelihood of discovery and punishment of non-compliance with tax regulations. From the middle of 2012 to mid2014 tax administrations received messages from the government about disadvantages in the application of existing repressive legal measures at that time in the suppression of the shadow economy. Possibility of political influence in the application of tax regulations is one of the numerous manifestations of institutions weaknesses in Serbia.
The sharp decline in tax discipline and the expansion of the shadow economy contributed to the acceleration of the growth of the fiscal deficit, which in 2013 reached 6.6 per cent of GDP. That is why in 2014, the government began implementing the measures to suppress the shadow economy. Some activities were not primarily motivated by the fiscal motives, but out of the need to improve the conditions of business. It is estimated that the reduction of the shadow economy is also the consequence of a larger number of institutional reforms. Among these is the reform of the penalties system for non-compliance with taxation. It increased the sentences, and the system penalties were made more transparent and consistent by adopting the Law on Inspection. The coordination of inspection services has improved. Labor legislation reform was carried out in 2014 as the liberalization of the labor market, which decreased the costs of legal recruitment and dismissal of workers decreased; it has created affordable conditions for reducing illegal labor. A certain shift was made in the efficiency of tax collection. After moving to electronic submission of tax returns, some workers of the Tax Administration were transferred to the control of fiscal accounts, which increased the perception of detection probability. In addition, a change in the political attitude of the government to the shadow economy came after parliamentary elections held in mid-2014. Instead of the previous high tolerance towards the shadow economy, series of actions started to suppress the shadow economy, accompanied by strong media support.
Further reforms are needed
Although there has been a shift in control over the past three years over the shadow economy, it is estimated it is still approximately at the 2012 level. This indicates that there is a considerable space for further activities to limit the shadow economy, which presumes implementing a number of institutional reforms. First, a more sensible shift requires a fundamental reform of Tax administrations, which would increase the number of employees and budgets; reform of the employment system, promotion and rewarding of employees, strengthening systemic risk assessment. Also, it is necessary to strengthen the independence of the Tax Administration, in order to protect it from political impact. Strengthening the independence of the Tax Administration is a condition for protection from various types of informal interventions, which affect the selective application of tax regulations. Parallel with the strengthening of the Tax Administration’s autonomy, it is necessary to develop mechanisms to control the legality of its work, in order to combat corruption. In this regard, it is necessary to reform of the Administrative Courts, with the aim of more efficient action in tax cases.
Also, to reduce the shadow economy improvement of tax morality is needed, i.e. taxpayers willingness to pay tax, which is crucial for improving the quality of goods and services that are financed from taxes, and systematically informing citizens about the significance and value of it.
Vedran Obućina is an analyst and a journalist specializing in the Croatian and Middle East domestic and foreign affairs. He is the Secretary of the Society for Mediterranean Studies at the University of Rijeka and a Foreign Affairs Analyst at The Atlantic Post.