Size of shadow economy in Latvia slightly shrank in 2015

Compared with the previous year, the size of the shadow economy in Latvia slightly shrank in 2015, while Lithuania and Estonia experienced a small increase in the size of the shadow economy.

Compared with the previous year, the size of the shadow economy in Latvia slightly shrank in 2015, while Lithuania and Estonia experienced a small increase in the size of the shadow economy – that is a conclusion drawn by the authors of the annual study of the Stockholm School of Economics in Riga (SSE Riga) on the shadow economy in the Baltic countries.

Latvia in 2015 was 21.3%, in Lithuania – 15%, but in Estonia – 14.9%. In the course of the year the size of the shadow economy in Latvia has decreased by 2.2% of GDP; however, the shadow economy in Latvia is still considerably higher than in the two neighbouring Baltic countries.

“Although contraction of the shadow economy in Latvia is basically due to a decline in the proportion of unreported business income and “envelope” wages, these indicators are still to be considered as very high in Latvia,” admits the author of the study, Associate Professor at SSE Riga Dr. Arnis Sauka. The highest level of shadow economy is registered in Riga and its vicinity, followed by the region of Kurzeme.

The largest share of the shadow economy in Latvia is due to underreporting of business income or tax avoidance reaching almost 45% of the Latvian shadow economy. Underreporting of business income in Latvia is considerably higher than in the neighbouring countries (in Latvia – 19.9% compared to 10.5% in Lithuania and 7.5% in Estonia). Moreover, the study results indicate that unregistered enterprises account for approximately 5%-7% of all the enterprises in Latvia.

The second largest share of the shadow economy in Latvia is still made up by “envelope” wages. The proportion of “envelope” wages in 2015 is roughly on the same level, namely, within the range of 15.2% to 17.9%. It should be noted, though, that the proportion of “envelope” wages in the totality of all the wages in Latvia has been falling already since 2010 and this trend continued also in 2015. Unofficial “envelope” wages is the most substantial problem of shadow economy in Estonia, as it constitutes up to 60% of its total shadow economy.

Among the Baltic countries, the highest level of bribery is in Lithuania which in 2015 witnessed an increase in both general business bribery (from 10.2% to 12.7% of revenue), as well as government bribery (from 10.9% to 11.5% of a government contract value).

Analysed by sector, the highest proportion of shadow economy in Latvia is traditionally in the construction sector, where about 40% of the sector activity takes place in the “grey zone”. The share of shadow activity in the construction sector in Lithuania and Estonia is about half that of the Latvian construction sector.

According to the study results, small companies tend to operate in the grey zone more than large companies, however, the differences among the company size categories are not large, and also some large companies contribute considerably to the shadow economy. 

Similar to the previous years, also in 2015 the highest dissatisfaction with the government’s tax policy among the three Baltic countries was observed in Latvia, although companies are still relatively satisfied with the performance of the State Revenue Service. Naturally, companies that are not satisfied with the tax policy of the government tend to engage in the shadow economy more often than their satisfied counterparts.

The study results prove that smaller and younger firms engage in proportionally more shadow activity than larger, older firms – the authors of the study explain it with the fact that tax evasion is used by firms to gain certain competitive edge.

To reduce the size of the shadow economy the authors suggest making tax policy more stable, making taxes more “fair” from the perspective of businesses, and increasing the transparency with which taxes are spent. Increasing the probability of detection is also expected to reduce shadow activity. It is concluded in the study that the ethnic composition also has an impact on the level of shadow economy, most probably as a result of minorities feeling less engaged in society and country-level decision making. Thus, the authors suggest that addressing social cohesion and integration of minorities may also lead to a reduction in the shadow economy.

Ievas Tetere, CEO of SEB Latvia:
“Although the size of shadow economy has been shightly reduced, the situation is still unacceptable. In the Baltic context Latvia still has the largest share of shadow economy and the worst legal environment. Tax evasion, money laundering and abusive practice by insolvency administrators are still serious problems and a reason why Latvia is losing budget income and its competitiveness in attracting foreign investment. Currently we are in a cycle of slow growth and therefore the risks of shadow economy are rising. I will not be surprised in next year the result will show a negative trend."

The SSE Riga Shadow Economy Index for the Baltic countries is estimated annually based on surveys of entrepreneurs in the Baltic countries. Since 2009, when the first study was carried out, all three Baltic countries have experienced contraction in the relative size of their shadow economies, with the most dramatic decline being experienced by Latvia (from 36.6% of GDP in 2009). The authors of the study are Dr. Arnis Sauka, Director of the Centre for Sustainable Business at SSE Riga, and Dr. Tālis Putniņš, Professor at SSE Riga. The study is supported by SEB.

The full version of the latest Shadow Economy Index is available here.