That means that formalizing every economy should be viewed as a global public good. The G-20 and other international entities should take the lead in ensuring the coordination and cooperation needed to provide it.
The biggest losers of the informal economy are ordinary citizens, because informality inhibits long-term economic growth and productivity gains; creates unfair competition; hinders the growth of small and medium-size enterprises (the main sources of employment); and leaves millions of workers without basic rights, such as health insurance and pensions. It also leads to significant tax-revenue losses, reducing both the quality and quantity of public services. Income inequality and social injustice invariably increase as well.
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Reducing the scope of the formal economy may seem to be a national task; and governments should indeed act. They should reduce the tax burden, simplify tax systems, and reduce regulatory compliance costs, while strengthening enforcement. Likewise, they should eliminate barriers to competition, simplify business registration processes, increase the transparency of public procurement, and improve access to credit.
But combating the informal economy requires international cooperation as well. According to the European Commission, “non-cooperative” and “non-transparent” jurisdictions – also known as tax havens – cost the European Union’s member states more than $1 trillion in revenue every year. Controlling and decreasing the risks that these jurisdictions pose can happen only at the global level.
Here the OECD and G-20 can play an important role. The OECD already provides vital support in promoting international cooperation on taxation. Article 26 of the OECD Model Tax Convention on Income and on Capital regulates the content and practice of bilateral exchanges of tax information, which are crucial to fighting tax avoidance and evasion and combating harmful tax competition.
Similarly, the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes is leading an extensive peer-review process of legal frameworks and implementation of standards. The OECD recently issued an Action Plan on Base Erosion and Profit Shifting (BEPS) that identifies specific measures to combat double non-taxation and to establish comprehensive and transparent standards of fair taxation.
The focus of G-20 summits on global tax evasion in recent years is also encouraging. When the G-20 leaders convened in Los Cabos, Mexico, in June 2012, they reiterated their commitment to strengthen transparency and comprehensive exchange of tax information. They also reiterated the need to prevent BEPS.
Moreover, the G-20 has launched efforts to encourage all jurisdictions to sign the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, developed jointly by the Council of Europe and the OECD.
But more must be done to combat the informal economy. I can easily imagine bilateral agreements – and then a multilateral arrangement – that establishes a unique global tax ID for all taxpayers.
In Turkey, a comprehensive plan to reduce the scope of the informal economy involves 14 major public institutions, including the Ministry of Finance. Proactive tax-collection mechanisms to improve voluntary tax compliance have been put in place. For example, a system developed for landlords has helped to double the number of taxpayers reporting rental income. Turkey has also improved regulatory enforcement, created a more effective Tax Audit Board, and invested in human capital and technology.
Macroeconomic reforms have also helped to curtail Turkey’s shadow economy. In 2006, the corporate-tax rate was lowered from 33% to 20%, and rates for personal-income tax were also reduced, with the highest rate falling from 49.5% to 35%, and the lowest rate to 15%, from 22%. Moreover, in 2008, the income-tax burden on minimum-wage earners was set at a low of 0%, depending on marital status and number of children. Further, the rate for value-added tax on health, education, clothing, and tourism was cut from 18% to 8%, while the VAT on major food items is now 1%.
Last but not least, Turkey’s authorities have implemented major reforms aimed at improving the business environment. These include a new commercial code and debt legislation. A new income-tax law is currently under parliamentary consideration, and a law on tax procedures will be submitted soon.
Turkish policymakers have also focused on international cooperation and coordination in creating a level playing field globally. Turkey now has double-taxation agreements with 82 countries and information-exchange agreements with five countries.
As a result of these efforts, informal employment in Turkey has declined by 14.5 percentage points since 2002, to 37.6% in April 2013. Likewise, the informal economy as a share of GDP declined by six percentage points during this period, to 26.5% in 2013.
But these ratios remain too high. The authorities’ medium-term objective is to reduce the informal economy’s GDP share by five more percentage points and to reduce informal employment in non-agricultural sectors by five percentage points as well.
Determined efforts such as these are indispensable to dispelling the shadows in which informal economic activity exists. But national policymakers cannot hold the light alone.