Thinktank estimates paid work not declared to taxman worth 10% of national income in 2012 - half the level of Spain and Italy
Britain's shadow economy is now worth £150bn a year – but it is smaller than in most other western nations and last year fell to its lowest level in almost a quarter of a century, according to a report released on Tuesday.
A study by a free-market thinktank, the Institute for Economic Affairs, estimated that paid work not declared to the taxman was worth 10% of national income in 2012, half the level in Italy, Greece and Spain.
The report, by economists Friedrich Schneider and Colin Williams, found that the UK's shadow economy was smaller than the 13.4% average for the 34 developed nations in the Organisation for Economic Cooperation and Development. The UK rate peaked at 13% in 1997-98.
The authors said the most important factor determining the size of the informal economy was the tax and benefits system, and much of the shadow employment in Britain could be blamed on the loss of benefits and tax credits for low-paid workers as they earned more.
"A reduction in the tax burden is therefore likely to lead to a reduction in the size of the shadow economy," the report said. "Indeed, a virtuous circle can be created of lower tax rates, less shadow work, higher tax morale, a higher tax take and the opportunity for lower rates. Of course, a vicious circle in the other direction can also be created.
"Given this relationship, the high level of non-wage costs (averaging 39% of total labour costs) and the penalty on individuals who move from earning one third to two thirds of the median wage (averaging 58% of the increase in earnings for a one-earner couple) in the European Union should be a matter of real concern.
"The latter figure is 79% in the UK and thus low-paid UK workers have a huge incentive to supplement their incomes in the shadow economy."
The report said there was little evidence that state crackdowns on the shadow economy had an impact, and suggested instead that governments should legalise certain informal activities, perhaps through the use of amnesties.
"Policies focused on deterrence are not likely to be especially successful when tackling the shadow economy. The shadow economy is pervasive and made up of a huge number of small and highly dispersed transactions. We should also be wary about trying to stamp out the shadow economy as we may stamp out the entrepreneurship that goes with it."
The study said modern econometric techniques were making it easier to gauge the size of the shadow economy, and the latest estimates showed about 30 million people in the EU performed work that was not declared for tax. "Around half of all construction workers in Germany undertake shadow work; and over 80% of all Danes find shadow work acceptable – at least in some circumstances."
Although the report found that rising unemployment was linked to the size of the shadow economy, it found no evidence that there had been a surge in cash-in-hand work in the UK during the past five years, a period that has seen the deepest recession and slowest recovery of the post-war era.
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