New research shows tax evasion costsGreece billions

Using bank data on household borrowing, a new academic study has estimated tax evaded income in Greece to be 28 billion euros for the self-employed alone. The estimation is based on the new insight that banks adapt to the environment in Greece (and many other places) in which establishments act in the formal economy but hide income from the tax authorities. Such an environment is “semiformal”. Banks must adapt to this environment of semiformality to remain competitive by lending off banks’ best guess as to households’ true income.

As evidence that such adaption is happening, the researchers, Adair Morse & Margarita Tsoutsoura of the University of Chicago Booth School of Business and Nikolaos Artavanis of the Pamplin College of Business at Virginia Tech, show that on average self-employed Greeks spend 82% of their reported income servicing debt (in some industries as Financial Services, Medicine and Law, this percentage climbs to over 100%). The possibility that for every euro of earned wages, 82 cents go to servicing debt is not feasible; a norm for lenders is to never extend loans such that monthly payments on debt exceed 30 percent of income.

“The goal of the paper is to use our rich bank data to provide a country-representative estimate of tax evasion in aggregate and by occupation, and to offer analysis relating to factors that allow the tax evasion to persist,” said Adair Morse, Associate Professor of Finance at Chicago Booth.
The researchers’ strategy is to infer what the true income for the self-employed across industries should be to support their level of credit.

The study found 28 billion euros in evaded taxable income for 2009 just for the self-employed. At a tax rate of 40%, the foregone tax revenues would account for 31% of the budget deficit shortfall in 2009 (or 48% for 2008). They claim that a conservative estimate of the true income of self-employed is 1.92 times their reported income.

In particular, the study finds that doctors, engineers, private tutors, financial services agents, accountants and lawyers have the highest reported-to-true income multipliers (see Table below). The results are consistent across different credit models.

The researchers then use the industry distribution of tax evasion to explore theories as to why tax evasion might be allowed to persist. They find strong evidence that industries with a high paper trail are less likely to tax evade, implying that enforcement involves information.

Finally, the results line up very well with the occupations targeted by a legislative bill in 2010 (refer to Table above). The legislation would have mandated audits for those reporting low income in exactly these professional service industries. The bill was never voted. Supporting this political economic story, the paper shows that occupations represented in Parliament are very much those which tax evade, even after excluding lawyers.

Together, the evidence suggests that (i) individuals in industries lacking a paper trail find it easier to tax evade more, and (ii) the Greek Parliament lacks the political willpower to enact tax reform.