Underground economy accounts for one fifth

By Kim Da-ye

Korea’s underground economy accounts for more than 19 percent of the gross domestic product (GDP), which could shrink further if more payments are made with credit cards, a Credit Finance Association report showed Sunday.

The size of the shadow economy drops 0.11 percent to 0.13 percent for each 1 percent that credit card usage increases, the researchers ― Bin Ki-bum and Woo Seok-jin, professors at Myongji University and Park Myung-ho of Korea Institute of Public Finance ― said in the joint report.

The shadow economy is either legal or illegal unregistered economic activities that are not counted in the official GDP estimates.

The underground economy is divided largely into three types: non-market economic activities such as self-supporting; illegal market activities including drug dealing and prostitution and legal activities that go unrecorded for various reasons including tax evasion. Much of Korea’s shadow economy comprises of transactions undisclosed for tax evasion.

The size of the underground economy had dropped from 26.7 percent of the GDP in 1993 to 17.7 percent in 2003. But it gradually began to rise from 17.8 percent in 2004 to 18.7 percent in 2007, 18.9 percent in 2008 and 19.2 percent in 2009.

The researchers say that the growth of the shadow economy was encouraged by the heavier taxation policy and public resistance against it.

The portion of taxes against income rose from 17.5 percent in 1990 to 19.7 percent in 2009. The ratio of taxes plus social security contribution against income soared from 18.4 percent to 25.6 percent during the same period.

The size of the underground economy, however, did not increase as much as the tax rate did partly because consumers increasingly use credit cards.

“Despite the steady growth of tax rates and social security contribution rates, the shadow economy shrunk. This indicates that the government’s policy to make taxation more transparent including promoting credit card usage worked.”

The 19.2 percent calculated by Bin, Woo and Park is much higher than those of the 21 OECD countries researched by Friedrich Schneider, the world-renowned expert in shadow economies.

In 2009, a handful of OECD countries exceeded Korea in terms of their shadow economy size ― Greece at 25 percent, Italy at 22 percent, Portugal at 19.5 percent and Spain at 19.5 percent. The average of the 21 OECD countries that do not include Korea was 13.8 percent. Schneider projects the average would increase to 14 percent in 2010.

The size of the U.S. shadow economy is expected to be only 7.6 percent of the GDP in 2010 ― the lowest figure among the 21 OECD countries ― followed by Switzerland at 8.3 percent, Austria at 8.5 percent and Japan at 9.5 percent.

A large shadow economy is a serious problem that should be tackled. Its growth triggers a vicious cycle that could eventually weaken the official economy.

More tax evasion due to unrecorded market activities results in lower tax revenues, causing the government to raise tax rates and try to collect more. That would encourage even more hush-hush transactions, putting the government in further budget constraints.

Schneider also pointed out in his paper for the International Monetary Fund, “A prospering shadow economy makes official statistics on unemployment, official labor force, income and consumption unreliable. Policies and programs that are framed on the basis of unreliable statistics may be inappropriate and self-defeating.”