Cash Payment Restrictions? No Solution to Shadow Economy

Photo via Photoree || Creative Commons

Earlier this year a proposal to restrict cash payments as a solution to curbing the shadow economy returned to the Lithuanian legislative agenda. Last year this proposal was ruled down in the parliament, and rightly so. MPs who voted against it noted that such restrictions would not only fail to reduce undeclared payments but would trigger additional problems.

Cash payment restrictions would increase individual and corporate expenses and would cause payment inconveniences. How would one be expected to make larger payments at weekends when interbank transfers are not made? A forced „banking“ of cash reduces competition among payments methods. If people and companies are forced to use just one method of payments and banned from using others, they are left with fewer choices of payment.

In addition, it is highly doubtful that cash payment restrictions would reduce the shadow economy. After all, the prohibition will not affect those who sell smuggled goods or pay wages “under the table”. They will keep doing so since they have not complied with the law before anyway.

Surely, the issue of tackling the shadow economy remains. If one regulation designed for curbing the shadow economy is ruled down, there are three new ones in line. It is instructive to note that the shadow economy evolves precisely because of taxes (e.g. payroll taxes or excise duties), regulations (e.g. labor market restrictions) and prohibitions (e.g. restrictions on the hours of selling alcohol). Paradoxically, governments expect to fight the shadow economy by ushering in more bans and regulations.

Taxes – excise duties and VAT – account for half of fuel prices. Diesel prices comprise about 40 percent of taxes. Lithuania charges higher excise taxes on fuel than the EU prescribed minimum rate. If this proportions were reduced to the EU-set minimum, fuel prices could fall by about 10 cents. High fuel taxes are thus an obvious driver of the shadow economy.

Yet, decision makers want to address this problem not by reducing taxes but by imposing new restrictions. For example, a proposal was put forward that, if fuel is poured out of a vehicle which is being repaired and this fuel was bought in a non-EU country and no VAT was charged, this must be reported to the customs authority no later than during one working day. Another proposal was to levy no excise tax on fuel carried in a standard fuel tank, i.e. a tank from the vehicle producer, and a tank that is permanently fixed to boot.

Or yet another example: Under the current law, lubricant oil is not subject to excise duty except when it is used as fuel. In addition, no control or transportation requirements are applied. Given that there are people who abuse these provisions and illegally use lubricant oil as fuel, proposals have been made to impose stricter control on certain types of such oil, such as producing it only in the so-called ‘excise goods warehouses’.

What do all such policies have in common? Well, they all propose new restrictions and prohibitions. Even though it is clear that they will not solve the problems related to the shadow economy, it is quite difficult to oppose them one by one. Many of them are concocted by government agencies which know that there are people who abuse the law. Yet, do the goals of combatting the shadow economy justify the means? Can one justify that policies to curb those who evade taxes and regulations hurt those who play by the rules?

The world will not collapse if all such ill-defined proposals are adopted. Most likely they will not ruin those who operate legally and will have to comply with yet another restriction. This involves a more important concern though. Unfortunately, bans and restrictions are seen as the main strategy to combat the shadow economy. Governments seem to forget that the more prohibitions, regulations and taxes they enforce, the more difficult it becomes to function legally. And the more shadow economy we have in turn.

Why not have the following rule: with each new restriction, at least one measure is proposed to reduce the tax, regulatory and administrative burden that legally operating market participants carry? Only an approach like this could give results. For example, the undeclared labor market could shrink if payroll taxes were lowered and the tax-exempt minimum income were raised.

‘Ask the right questions if you intend to find the right answers’, the saying goes. In addressing the shadow economy, the right question is not “how to detect and punish better,“ but “how to make legal operations easier?“

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