Booming Shadow Economy Could Pay for Some 'Social Justice'

The social protests, which are demanding a change in the country's socioeconomic priorities, have barely touched the issue of Israel's black economy.

Israel has one of the largest shadow economies relative to its GDP in the developed world, according to the Taub Center for Social Policy Research in Israel, based on a report by the World Bank. A black economy, or shadow economy, is economic activity carried out beyond the reach of the regulator and without paying taxes.

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The social protests, which are demanding a change in the country's socioeconomic priorities, have barely touched this matter - even though a massive amount of money is changing hands under the table. If this activity were taxed, it could well provide financing for some of the social plans the middle class is demanding.

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Shadow economies are more common in less developed countries. Off-the-books activity is most common in industries that necessitate a significant amount of labor but little skills, such as renovations, private lessons, cleaning and babysitting. It's also common in lines of work that wouldn't be legal in any case, such as the sex industry, illegal labor migrants, gray-market loans, gambling, smuggling and sales in stolen goods. It is generally carried out by individuals or small groups, not large businesses.

Dan Ben-David, head of the Taub Center, found that the country's shadow economy has expanded over the past few years due to tax increases on consumption and tax breaks on income.

How much is the shadow economy costing us?

The problem is that while everyone pays taxes on consumption, only legal income is taxed - not under the table income.

Just how large is Israel's black economy? A 2010 report by Schneider, Buehn and Montenegro, published by the World Bank, found that it was equal to 23% of the GDP in 2007. This is much higher than in Germany (16.7%), Britain (13.2%), Japan (12.1%) and the United States (9%), among others.

In total, Israel came in 38th on the researchers' list of 151 countries, ranked starting with those with the smallest shadow economies between the years 1999 and 2007, placing it right after Belgium and Kuwait and right before India and Spain.

Even if we assume that it did not grow between 2007 and 2010, this is still a huge amount of economic activity taking place beyond the formal economy.

The size of the black economy was estimated at NIS 190 billion in 2010.

Shadow economies are particularly large in former Soviet countries, where they can equal nearly half of the "official" GDP. They tend to be largest in sub-Saharan Africa, where they can be worth more than half of GDP, putting them at a scale where they function like parallel economies.

One way of estimating the size of the shadow economy is by comparing gross national product to gross expenditure.

Black economies distort the tax burden - people who obey the law carry more of the burden than those who work off-the-books. People working under-the-table further distort the burden because, officially, they are considered much poorer than they really are, and thus receive government assistance and subsidies.

Israel's problem is not only the size of the black economy, but also the fact that it is growing much quicker than in most OECD countries. The 2010 report found on average, black economies grew another 6% relative to GDP in the 25 countries that made up the OECD over the past decade.

Meteoric growth

Over that period, Israel's black economy grew by another 8.5% of GDP, a faster rate than in all 25 countries except for Japan and South Korea.

Furthermore, the rate of non-employment - people outside the labor force altogether - is high, at 18.9%, versus the 11.9% OECD average. This indicates not only problematic work habits among a large portion of the population but also large-scale tax evasion.

The economic troubles that came to light in some European countries during the 2008 financial crisis should serve as a warning for Israel, too. Even if Israel got through the crisis better than most other countries, these problems could affect us too, and over the long term things look much more worrisome.

Greece and Italy, for instance, have sizable black economies, which limits their governments' abilities to raise the resources necessary to address their financial problems. In addition, knowing that much of Greek and Italian economic activity is occurring off-the-books does not encourage the German taxpayer to want to give these Mediterranean countries assistance from their hard-earned tax euros.

While the shadow economies are larger in Greece and Italy than in Israel, Israel still has a significant amount of economic activity going on beyond the tax authorities' auspices - too much activity to ignore. And since Israel also receives a significant amount of foreign aid, it needs to pay close attention to any decisions involving these two factors.

Israel's black economy receives too little attention, and it is responsible for increasing the burden on the middle class, says Ben-David. "This could be an excellent source of not only income, but also social justice," he suggests.

"People are demanding more services, and social justice costs money. Just like the existing pie needs to be divided in a more equal way, money needs to be raised from taxes in a more equal way," he says.