Tax system overhaul is needed

Once again, the Greek state is attempting to deal with a grave situation – acknowledged widespread tax evasion – by forming a commission (this one under the Ministry of Finance). Several ways have been suggested in the past to fight tax evasion, from organizing campaigns urging citizens to change their attitude toward the state and become more civic-minded (such as the exemplary Scandinavians) to performing more intensive inspections, to the supply-siders’ favorite cure of cutting taxes as an incentive to citizens to declare their incomes. We argue that, first, only a radical change in the taxation system, combined with the political will to impose fines, will produce results; and, second, that increasing or decreasing tax rates does not matter as much as fair taxation. Before talking about the solutions, we must get an idea of the extent of tax evasion. Gray economy’s size It is very difficult to measure the size of the gray economy in a country. But, first of all, we must divide it into legal and illegal. By illegal, we mean a type of economic activity that, if discovered, would cease to exist because it cannot be legally allowed. A «legal» activity within the gray economy is one that, if discovered by the state, would increase its tax revenues. Even the latter is not easy to detect, either because the tax authorities’ approach is lacking or because there is no political will to discover it. Several researchers have tried to estimate the size of the «legal» gray economy over the past 25 years. A look at the data shows that its size may have declined slightly since 1990; we can approximately estimate its current size at about 28 percent of the official gross domestic product (GDP). It is worth trying to imagine what we would gain should the gray economy cease to exit. We have limited our investigation to the period 2004-2007. In this simulation, we have, for lack of a better alternative, to keep spending constant, even though we know that with so much extra revenues available, this would not be the actual outcome. GDP would then grow by 28 percent. But how about revenues? An acceptable hypothesis would be that the «discovered» income would mostly be added to individual and corporate incomes and thus would be taxed, on average, at a higher rate than the already declared incomes. For technical reasons, which would be too long to analytically present here, we have arrived at the conclusion that this additional 28 percent of GDP would generate 20 percent in additional revenues. Given that value-added tax (VAT) in the period we have chosen to investigate was either 18 or 19 percent, the top income tax rate was between 39 and 40 percent and that corporate tax varied between 27.5 and 35 percent, the 20 percent as added revenue appears reasonable and, probably, on the low side. The simulation results show that the general government budget, whose deficit ranged between 4.3 percent and 7.6 percent of GDP would, instead, show a surplus ranging from between 3.85 to 6.25 percent, if tax evasion had been detected. Public debt would easily be below 100 percent of GDP. Therefore, instead of being the black sheep of the eurozone, under constant surveillance by the European Commission and Ecofin, the council of EU finance ministers, we would be held up as a positive example. More importantly, we would have additional funds to tackle what is shaping up to be Greece’s most critical, and intractable, economic issue: the viability of its social security system. It is not enough to inflate the size of GDP as a response to the estimation of the gray economy’s size. We must find ways to get revenues out of this activity. Some expenses, such as medical, insurance and house rental ones, have been considered as tax-deductible. Taxpayers have also been asked to justify their income sources regarding the acquisition of property or luxury items, such as yachts. These measures are in the right direction and must be extended. (On the other hand, stopping consumers in the street and asking them if they carry a receipt for the goods they just purchased is ridiculous and must stop). They are, by themselves, not enough. A more radical approach is needed that would make more effective use of the sources of income declaration. (1) N.G. Pirounakis is a professor of economics at the American College of Greece.