Israel’s Shadow Economy – better known as the Black Market – is growing as a result of economic contraction caused by the worldwide Covid-19 pandemic. This according to a new study just released by Israel’s independent, non-partisan socioeconomic research institute the Taub Center for Social Policy Studies.
The rise of a shadow economy anywhere is important because it gives governments an idea as to the extent of tax evasion. And since, as Jewish Business News recently reported, Israel’s annual budget deficit is expected to triple this year, Israel needs every Shekel in tax revenue that it can get.
Everyone remembers what it was like when Israel maintained tight currency controls for its citizens and set an official exchange rate for the Shekel against the Dollar. People walked the streets offering to buy dollars from tourists at a better rate than the banks. Everywhere businesses of all types preferred to take the Dollar off the books rather than the Shekel. The policy encouraged tax fraud.
The new study conducted by Dr. Labib Shami estimates the size of the non-observed economy in Israel and finds that its share of GDP had actually been declining in recent years. This economy includes the usual suspects: illegal businesses like gambling, prostitution, and drugs. Higher taxes and social benefits to people who do not work also encourage people to keep income a secret since they would lose government subsidies if they earn too much themselves.
But with the Coronavirus, countless Israelis were forced to go on temporary unpaid leave or lost their jobs outright. These people received about 70% of their salaries in unemployment benefits. So as not to lose any of this money they obviously have encouragement to find work off of the books.
According to the Taub Center model, as well as other studies in Israel, indirect taxes and transfer allowances to households – child allowances, unemployment benefits, and income assurance payments – contribute to the expansion of the non-observed economy. The reason for this is that income-based benefits encourage those seeking these benefits to evade reporting income in order to ensure their entitlement. In addition, indirect taxes, like VAT, may also contribute to a decline in non-cash transactions and a preference to pay with cash.
The OECD defines the non-observed economy as having four main components: clandestine production (the production is legal but hidden from the tax authorities); illegal production; production in the informal sector (of unregistered organizations that produce beyond their personal needs); and unreported economic activity that is not included in GDP calculations due to deficiencies in the government data collection system.
The new study cites international estimates which placed the size of the non-observed economy in Israel between 1995 and 2015 as 19% to 23% of GDP.
Dr. Shami used the ratio between cash withdrawals from the public’s personal checking accounts and total non-cash transactions. This approach allows measurement of the demand for anonymous payments against every shekel used to pay transactions that are traceable.
According to the research, in the past decade, the share of tax evasion in the economy has been trending downwards and, in 2018, stood at only 1% of GDP. This is the result of a downward trend in the number of cash withdrawals from personal checking accounts alongside a rise in the extent of non-cash business transactions since 2016.
Dr. Labib Shami of the Taub Center warns that “despite the positive effects of limiting the use of cash, implementing the policy improperly can hurt the weakest populations and deepen the gaps between the rich and the poor since not everyone has equal access to bank accounts.”
Dr. Shami continues: “As in the world-wide economic crisis of 2007-2008, the coronavirus crisis is likely to affect the non-observed economy in Israel. What is more, social distancing policies put in place in Israel have caused the immediate slowing of economic activity in both the non-observed and the formal economic sectors.”
So to sum up, higher taxes, and greater government payments to its citizens, as is the case now in Israel due to the Corona Virus, will always lead to greater black market activities.
The Taub Center for Social Policy Studies in Israel is an independent, non-partisan socioeconomic research institute. The Center provides decision-makers and the public with research and findings on some of the most critical issues facing Israel in the areas of education, health, welfare, labor markets, and economic policy in order to impact the decision-making process in Israel and to advance the well-being of all Israelis.