Non-observed economy and corruption: links and consequences

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Publishing date: Thursday, 05 July 2018
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Non-observed economy and corruption are closely linked and fuel one another. The spread of corruption in public institutions allows economic operators to avoid paying their taxes and then escape punishment. At the same time, corruption is an additional barrier for small entrepreneurs from the non-observed economy to enter the legal one. Such ‘vicious’ relations between corruption and non-observed economy have increased in recent years in the Republic of Moldova and are a major challenge for the country's sustainable development.

The share of non-observed economic activities in the Moldovan economy is significant. According to official data, in the last few years, the share of the non-observed economy has oscillated between 22% and 24% of the country’s GDP, except for illegal production. The most worrying thing is that the share of underground production, in other words – of tax evasion, has doubled in the last decade. The share of this non-observed economy component increased from 4% of GDP in 2007 to 8% in 2016. In addition, the share of the people employed in this sector has increased significantly in past years – from 30% of the total employed population in 2012 to 35% in 2017. These worrying trends speak of the failure of structural reforms and of the business environment in recent years, but also of the authorities’ failure to fight corruption in the country.  

In fact, corruption is one of the important factors that influence the evolution of the non-observed economy and needs to be taken into account when developing policies in this area. Because of corruption, state control institutions are neither able to detect and punish illegal activities and tax evasion, nor to facilitate the informal entrepreneurs’ transition into the formal sector. At the same time, the expanding non-observed economy also fuels the corruption phenomenon, as it serves as a source of ‘dirty money’ used for bribing civil servants. 

Corruption and non-observed economy are interdependent phenomena that fuel one another. The problem of corruption and tax evasion has become more acute in the Republic of Moldova in recent years. In the period between 2000 and 2016, the correlation between the non-observed economy and the level of corruption in the Republic of Moldova, as worldwide, was positive, but not very strong (only 0.3). At the same time, if we do not consider the whole non-observed economy, which depends on several factors and has several components, but focuses only on the tax evasion component (underground production) then the correlation will increase to 0.4.  

The expansion of corruption and of the non-observed economy leads to a greater tax gap – the difference between tax revenues collected and potential ones. In recent years, the total tax gap is estimated at around 7% of GDP, which is the equivalent to about MDL 9.5 billion in 2016. Thus, we can say that the indirect cost of corruption generated by the non-observed economy is the increase in the foregone revenues to the public budget.

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