کتاب Determining indicators of the underground economy in Iran

Introduction 4
Underground economy 6
The underground sector growth incentives 11
Consequences of the underground economy 12
Factors affecting the underground economy 13
Methods used to estimate the underground economy 18
Experimental studies 22
References 34

Table of Table and Figures

Table 1 Classification of economic activities 10

The underground economy is a phenomenon that all countries in the world are struggling with. Estimates in most countries suggest a considerable size of production activities in the subset of the underground economy. Many social and economic anomalies are rooted in underground economic activity. As a result, estimating this part of the economy is of a high importance regarding identifying the tax gap, the effectiveness of monetary and fiscal policies, economic growth and income distribution. Underground activities are usually carried out using cash in order to stay hidden from the government and to getting recorded for tax evasion. This study was conducted aimed at estimating the size of Iran’s underground economy and investigating the factors affecting it using the cash flow measurement method.
Today, access to accurate and comprehensive information on key areas of community activity is essential for sound political and economic planning. Among the concerns of most countries, dealing with underground activities can be noted that are not reported in national income accounts due to their nature. Understanding the underground economy and measuring its size is important and of interest to economists and policymakers because it is responsible for many economic anomalies and reveals the communication channels for criminal operations against the law. Estimating this part of the economy is of a high importance regarding identifying the tax gap, the effectiveness of monetary and fiscal policies, economic growth and income distribution. This is because underground activities evade taxation, which reduces government revenues, creates inefficiencies in fiscal policies, and widens the tax gap. An increase in these activities results in increased liquidity in circulation and inefficiency of monetary policies. They are not reported in the calculation of national production due to cash transactions and not being recorded.
In the literature on the underground economy, several contributing factors have been identified, among which tax burden, inflation, and income inequality can be mentioned. Evidence indicate the widespread presence of these activities in Iran and this is considered as a warning for policy makers. Si measuring this part of the Iranian economy and its determinants is very important.

Underground economy
Nowadays, much of the economy of the country is made up of underground activities and many economic studies have examined this undeniable fact. Such activities have a wide scope and many vocabulary terms are considered to be equivalent to them. Therefore, many definitions can be provided for them. Underground activities are responsible for many economic anomalies and reveal the communication channels for criminal operations against the law. So they are of great importance to economists and policymakers. It is necessary to provide a precise and accurate definition of underground economic activities and determine their nature to identify them. In this chapter, the underground economy is first explained and the factors affecting it are identified in the literature. Then, economic studies in the field of underground economy are presented.
By studying the literature on the phenomenon of the underground economy and its related issues, it is found that many terms are applied to it.
The use of various terms in examining this phenomenon has led to different measurement methods depending on the operational definitions applied. So it makes difficult to compare the results of using different methods in one country or across countries.
These terms are underground, hidden, shadow, illegal, unobservable, unreported, unrecorded, informal, secondary, parallel, black, irregular, etc., which are used in the field of economic performance of countries with prefixes such as economy, sector, economic activity, or the like to introduce completely identical or less or more overlapping phenomena.
Most people who are trying to measure the underground economy faced with the problem of how to define it. There are many definitions for the underground economy. A commonly used practical definition is as follows: All currently unrecorded economic activities that contribute to observed GDP (Fige, 1989). In general, providing a precise definition of the underground economy seems to be difficult, though not impossible.
According to Fieg (1990), the underground economy falls into four categories: illegal, unreported, unrecorded and informal.
1. Illegal economy: It includes revenues generated by economic activities that are targeted in violation of the legal conditions determining the scope of the correct business form. These include the production and distribution of banned substances, trafficking of drugs and the black millet market.
2. Unreported economy: It involves those economic activities that bypass formally established financial laws. The measurement of unreported economy, in fact, contains some of the income that was supposed to be reported to the tax authorities but failed, such as a tax evasion where the income is underreported for not paying taxes. The size and growth of the unreported economy and tax evasion affect the size of the budget deficit, government debt and tax enforcement policies. Another problem is the receipt of income for monetary policy.
3. Unrecorded economy: It involves those economic activities that bypass the institutional rules established by the report of government statistical agents. This means it includes revenues that were supposed to be recorded in the national accounts system but were not. Unregistered revenues designed by statistical accounts to measure economic activities create a discrepancy between total and actual amount of production or income, such as voluntary activities and those activities within the household excluded from national accounts due to the difficulty of measuring.
4. Informal economy: It involves those economic activities that evade the costs deceitfully and are excluded from rules of firms, administrative laws covering financial communications, business licenses, business contracts, financial credits. And the social security system.
Schneider (1994) defined the underground economy as follows: All economic activities normally involved in the calculation of GDP but not currently recorded.
Smith (1994) defined it as a market based on the production of goods and services, both legal and illegal, which evade the formal GDP estimate.
Thomas divided the underground economic activities into four groups:
1. Household sector: This sector produces goods and services that are consumed in the same sector. In this sector, products are less marketed and the lack of prices for manufactured goods makes it difficult to evaluate the value of goods, thus being ignored in national accounts.
2. Informal sector: In many developing countries, in addition to domestic production, this sector is of interest to economists alongside traditional products (mainly in the agricultural and modern industrial sectors). Although the activities of Itinerant merchants are among the most prominent of these types of activities, without workers, often located in homes (cottage industries) are more important in number.
3. Irregular sector: All activities classified in this sector are more or less illegal in nature, such as tax evasion, evasion of regulations (such as workplace regulations and observing safety measures in the workplace), social insurance fraud and the like. In this sector, there is a violation of the way in which the goods or services are produced or distributed, despite the legality and permissibility of the principle.
4. Illegal (criminal) sector: As stated earlier, the products of the irregular sector are legal and permitted, but the products of the illegal sector include the activities and production of goods and services contrary to the law, such as theft, production and sale of drugs, etc.
Schneider and Enste (2000) stated that the shadow economy includes unreported income from the production of legal goods and services, whether monetary transactions or barter economy. So all economic activities reported to tax authorities are generally taxable. As a result, the shadow economy encompasses all current economic activities that participate in formalizing GDP.
The second category includes informal economic activities that, like the unrecorded economy, do not violate certain laws and regulations. The difference, however, is that the informal economy is done in the marketplace and may even be recorded in turnover status statement offices personally just for personal use. The most notable example of the informal economy is the activities of small merchants who not required no law to record and report their activities.
The third category comprises the extralegal economy that derives from private monopolies in foreign trade licensed by the state. Monopolies in domestic distribution, credit market networks outside the government system, and rental transactions that benefit from special information and privileges are also in this category.
The fourth category is the unreported economy. These activities are not prohibited by law. For example, a firm produces a product the production of which is not banned. If the firm does not record the production process, does not report its production and thereby does not pay taxes, it has committed a criminal act. Also, if the firm underreport its products, it has violated the law. In the above cases, unreported activities are included in unreported economy.
The fifth category includes activities that are clearly banned by law and regulations. In the Islamic Republic of Iran, the production of wine and drugs as well as the smuggling of goods and currency are considered as a subset of the prohibited economy.
According to the definitions given in the System of National Accounts (SNA), 1993, Arab Mazar Yazdi defined the black economy as a combination of illegal production and hidden production as follows:
Illegal production: There are two types of illegal production.
(A) The production of goods and services the sell, distribution or possession of which are prohibited by law.
(B) Production activities that are often legal but become illegal when performed by unauthorized manufacturers (such as medical practitioners without the necessary certification).
Hidden production: It involves certain activities that may be both economically productive and completely legal (if they meet certain criteria and regulations) but are often kept secret from public authorities for the following reasons:
A) Avoid the payment of income tax, value-added tax (VAT) or other taxes
B) Avoiding the payment of social security costs
C) Avoid the compliance with specific legal criteria such as minimum wage, maximum working hours, safety or health criteria, etc.
D) Avoiding the compliance with certain administrative procedures, such as completing statistical questionnaires or other administrative forms.
It should be noted that the deliberate concealment of production with the above four motives varies widely depending on the conditions of the countries regarding the extent of the state supervision over the enforcement of existing laws, regulations and custom. According to our definition, in the context of Iran conditions, activities such as drug and alcohol trafficking are obvious examples of illegal production and tax evasion or customs fees and duties are examples of hidden production.
Since broad and various definitions have been provided for the underground economy, the following table can be useful in reaching a rational agreement on the definition of this phenomenon.