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Faltering economy boosts Spain's black market

Source: Reuters - Tue 1st Mar 2011

Tackling Spain's huge black economy would help plug the hole in public finances, but an unpopular government facing an election next year is unlikely to crack down while many families struggle to make ends meet. With unemployment at 20%, the highest level in the EU, working cash-in-hand or dodging taxes is a safety net for millions of Spaniards in hard times.

For plenty of other Spaniards in the small business sector, it is the only way they have ever operated.

"In this country people show off about dodging taxes. The consequences of that level of tolerance (of fraud) is devastating for the economy," said Javier Diaz-Gimenez, economist at IESE Business School in Barcelona.

For example, when a Spaniard takes out a mortgage the loan officer often asks for the price of the house for tax purposes and the real amount of cash that exchanged hands.

Such common practices mean the underground economy may be equivalent to up to one fifth of total gross domestic product, or around 200 billion euros, according to estimates by economists and a government minister.

That is more than double the hole in public accounts in 2010 and a potential goldmine for the depleted public purse as Spain works to prove financial stability and persuade investors it will not join Greece and Ireland in seeking a euro zone bailout.

But the widespread underground activity and a relatively generous benefits system have combined to help keep protests at government austerity measures to a minimum in Spain.

That contrasts with Greece, where public spending cuts continue to trigger violent demonstrations.

Moreover the government, trailing in opinion polls in a pre-election year, will not win any friends by tracking down those claiming benefits and working cash-in-hand.

"(The government) may well see the black economy as the lesser evil in the current circumstances," said Jose Maria Serrano, Professor of Applied Economics at Zaragoza University.


The government should use cross-checks and publicity campaigns to target tax-evading companies rather than workers who dodge taxes in economic bad times, experts say.

"Although there are many unemployed people on welfare and doing odd jobs on the side ... it's a very small amount, it wouldn't even be profitable to pursue it," said Angel Laborda, research director at savings bank foundation Funcas.

"Another thing entirely are those working businesses that don't declare income or VAT. The real tax fraud is where there is most activity," he said.

Income seized by inspectors from tax fraudsters in 2010 rose 24% year-on-year to about 10 billion euros.

Economists urge deeper reforms which would make the economy fairer and more flexible.

According to a 2010 survey by the official Sociological Research Centre, or CIS, over 80% of Spaniards believe there is a lot, or quite a lot of tax fraud. But more than half say the government is doing little to curb it.

Government officials have sent mixed messages. Treasury Secretary Carlos Ocana recently said it was "exaggerated" to estimate the black economy at one fifth of GDP, but Labour Minister Valeriano Gomez has given that exact figure.

Economists say Spain's black market is partly counter-cyclical, growing in size when the economy shrinks, and partly correlated to tax rates and labour market reforms that make it cheaper for companies to hire and fire.

"Liberalising the jobs market would have positive effects on the level of economic activity, by increasing it, and on the black economy, by shrinking it," Serrano said.

But the government's options are limited since tortuous negotiations with unions led to a labour market reform that many said did not go far enough.


"For someone my age, looking for a job is like a bad joke," says Juan, an unemployed man in his 50s who did not want to give his last name.

Juan's situation is common. He was laid off from a job in the tourism sector late in 2008 and claimed an unemployment benefit of 1,000 euros per month until a month ago, when the subsidy reached its 2-year maximum limit.

Since then he has been working off the books as a hairdresser one day a week, claiming a special over-50s benefit of 430 euros a month, and living on his savings.

This is an example of the failure of legislation to reflect the needs of the workforce, IESE's Diaz-Gimenez argues.

"It is a snapshot of reality; people need labour flexibility but the only way to get it is by flouting the law," he said.

Emiliano Carluccio, economist at Carlos III University in Madrid, nevertheless sees the submerged economy in Spain as less problematic than in Greece or Italy, where the informal sector accounts for up to a quarter or possibly more of the economy.

All of these countries have heavy bureaucracies.

The crisis is an opportunity to rationalise and simplify red tape for companies. As long as bureaucracy is complicated, the underground economy is a temptation," Carluccio said.

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