Czech Shadow Economy: A Complex Picture of Decline and Persistent Challenges
Prague – Recent statements by Czech Finance Minister Alena Schillerová regarding substantial annual revenue losses due to the shadow economy have sparked debate, but available data suggests the issue is far more complex than attributing it solely to the actions of individual ministers. Estimating the size of the shadow economy itself presents a significant challenge, with varying methodologies yielding drastically different results.
While some analyses estimate the shadow economy at around 6% of the Czech Republic’s GDP, others place it at over 15%. This discrepancy stems from the inherent difficulty in directly measuring illicit economic activity, differences in input data used by analysts, and varying definitions of what constitutes the “shadow economy.”
Why Calculating the Shadow Economy is Problematic
The very nature of the shadow economy – its deliberate concealment – makes accurate calculation elusive. Economists employ various methods to estimate its size, both for calculating overall GDP and as an indicator of tax evasion. However, each analysis inevitably produces a different outcome. Defining the scope of the shadow economy also contributes to the divergence. Questions arise regarding whether to include informal services like household chores or imputed rent for homeowners, while illegal activities are traditionally excluded from these estimations.
Commonly used methods include surveys of businesses and households, audits of representative tax samples, and analyzing discrepancies in national accounts.
Two analyses provide a useful framework for understanding the situation. A study by the European Parliament’s Directorate-General for Internal Policies (DG IPOL) utilizes the MIMIC (Multiple Indicators, Multiple Causes) model. According to Hana Zídková, an economist at the University of Economics in Prague, “In this model, the shadow economy is estimated using measurable variables divided into causes – what drives the shadow economy, such as high taxes and regulations – and indicators, the consequences of the shadow economy, like high demand for cash and high unemployment.”
A separate study by the consultancy firm Ernst & Young (EY) estimates the shadow economy based on cash flow. Zídková notes that EY’s methodology is generally considered more precise than that of DG IPOL. The analysis prioritizes data from EY.
Current data from EY dates to 2023, while the DG IPOL study, offering year-on-year comparisons, covers 2022. Both estimates differ significantly, but they agree on one key point: the share of the shadow economy in GDP has been consistently declining, regardless of which political party holds the Ministry of Finance.
The only years to see a slight increase in the shadow economy’s share were 2008 and 2020, coinciding with the onset of the global financial crisis and the COVID-19 pandemic, respectively. It’s important to note that the 2022 data may not fully capture the economic impact of Russia’s invasion of Ukraine and subsequent complications, potentially underestimating the shadow economy’s size that year.
Czech Republic Performs Relatively Well Compared to Other Countries
In international comparisons, the Czech Republic consistently performs relatively well in combating the shadow economy. According to EY data, only five EU countries – including Denmark and Luxembourg – have a smaller share of the shadow economy as a percentage of GDP.
Even when comparing the Czech Republic to Ireland, often considered a leader the potential increase in the shadow economy would only be around 1.5 percentage points, equating to approximately 115 billion Czech crowns, and a theoretical tax revenue increase in the low tens of billions.
There is broad consensus that the Czech Republic ranks among the top performers in combating the shadow economy within the former Eastern Bloc, often alongside Slovakia.
“In international comparison, our shadow economy isn’t such a big problem,” summarizes Petr Vilím of PAQ Research.
Experts agree that completely eliminating the shadow economy is unrealistic, and undesirable. Michal Šoltés, an economist from the IDEA think tank and the Faculty of Law at Charles University, states, “The goal isn’t a zero share of the shadow economy, but to implement measures that reduce the shadow economy by more than the cost of implementing and enforcing those measures.”
The Ministry of Finance, under Minister Schillerová, has yet to present a comprehensive list of steps to combat the shadow economy, but the potential return of electronic evidence of sales (EET) is frequently discussed.
While the share of the shadow economy continued to decline after the EET was abolished in 2022, experts point to its positive influence. “Electronic evidence of sales discourages businesses and entrepreneurs from concealing income. Evaluations by the Ministry of Finance, the methodology of which is not public, estimate a positive effect on collected VAT of more than 7 billion crowns annually,” comments Vilím, who specializes in tax reform. The Confederation of Industry and Transport also supports the return of EET.
Economists recommend systemic changes and a conceptual approach to combatting the shadow economy and increasing tax revenue. The Confederation of Industry and Transport emphasizes the need for a transparent and predictable environment, low administrative and control burdens for taxpayers, and the avoidance of restrictions on business capacity and long-term development.
“When trying to suppress the shadow economy, it’s important to understand who the people in the shadow economy are. Are they low-income employees paying a disproportionately high share of contributions from employment, or are they in the shadow economy to avoid obligations arising from foreclosures or other reasons? There will be a better tool to get each group out of the shadow economy,” notes Šoltés.
PAQ Research researchers point out that addressing related economic problems is crucial for effective tax evasion control within the shadow economy. These include the prevalence of “sham employment” (švarcsystém), where an estimated 100,000+ people are employed, and the misuse of short-term employment contracts. Data from the Czech Social Security Administration shows that 180,000 people have a short-term contract with the same employer as their main job, often to optimize taxes by avoiding contributions on income up to 12,000 crowns.
“It seems strange that the government declares a fight against evasion and the shadow economy, but leaves these loopholes in income and social security contributions, worth tens of billions, unaddressed,” says Vilím.
While Minister Schillerová suggests that suppressing the shadow economy could yield significant additional revenue, publicly available data offers a more cautious outlook, indicating that relying on such income is unrealistic, especially considering the influence of external economic factors.
