SHADOW ECONOMIC ACTIVITIES IN TURKEY: A REVIEW OF THE LITERATURE V. Vlachos, A. Bitzenis, P. Kontakos University of Macedonia, Thessaloniki, Greece Friday, February 6, 03:00 PM - 04:45 PM, Hotel Titania, Athens Session F1, Room Platon International Conference on Business & Economics, Hellenic Open University, Athens, February 6-7, 2015

2 Note: The current paper is presented under the auspices of the THALES Research Programme. THALES Programme has been co- financed by the European Union (European Social Fund - ESF) and Greek national funds through the Operational Program “Education and Lifelong Learning” of the National Strategic Reference Framework (NSRF).

Foreword to our Project Our aim is to research and measure the various aspects of shadow economy in Greece, including corruption, tax avoidance, social contribution avoidance, undeclared or illegal work, shelf consumption, illegal acts (black or underground economy). It will cover all economic agents in Greece, such as citizens and corporations (e.g. public and private individuals, companies and all professional categories, etc.) The research is also performed at sector levels, e.g. to identify the extent of tax evasion and corruption in the trading of oil in Greece. 3

Foreword to our Project (cont.) It does not aim to the precise percentage regarding the measurement of Greek shadow economy but aims to the qualitative analysis of questionnaire results and the comprehension of the problem. The implementation of our interviews, scientific games and economic experiments (tax compliance games) will involve at least 2,000 individuals and business owners (in majority small businesses). The project aspires to achieve numerous objectives, among which the development of a relevant theoretical background, and perform cross-country comparisons at regional level (e.g. Bulgaria, Turkey), but also with country groups with advanced taxation systems (e.g. Austria, Germany, Switzerland, France), other Mediterranean countries (Italy, Spain), South Eastern (Bulgaria) and transition and developing economies (Turkey, Peru). 4

Agenda 1. Aim of the paper 2. Introduction 3. Stylized facts and scope of the study 4. Turkey 5. Conclusions 5

1. Aim of the paper To identify which factors have an impact on tax morale and tax compliance in the case of Turkey. Empirical evidence retrieved from other contemporary studies is utilized for this purpose, based on an extended literature review performed by the authors. The methodology used is that of descriptive analysis. A comparative profile for Turkey is developed, with reference to various aspects of shadow economy, including corruption, tax avoidance, social contribution avoidance, undeclared or illegal work, shelf consumption, illegal acts (black or underground economy). Our ultimate aim is to use Turkey, as well as other developed and developing countries, as benchmarks and input for future work in the case of Greece. 6

2. Introduction The report is structured as follows: The next section provides a synopsis of some stylized facts pertaining to the shadow economy, i.e. its synthesis and determinants, the methods to measure it, its impact on the official economy and its relation with corruption. The same section also provides information about the studies reviewed. Sections 4 refers to the country of interest, i.e. Turkey. Finally, section 5 summarizes the findings of the studies reviewed. 7

3. Stylized facts and scope of the study A wide range of methods has been developed to evaluate and understand the dimensions and causes of shadow economy and corruption in the past three decades. These can be generally grouped under two approaches: indirect (macroeconomic) and direct (microeconomic) methods of measurement. Indirect methods are mainly intended at measuring the size of shadow economy. The real meaning of these methods is that they construe observable phenomena as signs of the unseen part of the economy. The most famous are discrepancy methods based on data comparisons, e.g. between labour force surveys and business statistics, as well as monetary methods (see e.g. Schneider and Enste, 2000). 8

3. Stylized facts and scope of the study (cont.) Direct methods refer to survey-based methods. They can measure not only the size but also the structure & motivations of the participants involved e.g. in undeclared work. Such methods have been applied in a number of countries in recent years. The commonly found macro estimations of the shadow economy is based on cross-country panel estimates of the multiple indicators multiple causes (MIMIC) approach that succeeded the currency demand approach (see the work of Schneider). The commonly explored determinants of the MIMIC approach are the tax burden (+), the self-employment quota (+), the unemployment rate (+), regulations (+), the quality of formal institutions measured (-) and the level of tax morale (-). 9

3. Stylized facts and scope of the study (cont.) With regard to the countries of interest to our wider report, the average estimates for the period are: 27 percent of GDP for Italy; 22.5 percent of GDP for Spain; 16 percent of GDP for Germany; 15 percent of GDP for France; 9.8 percent of GDP for Austria; 8.5 percent of GDP for Switzerland and 31.3 percent of GDP for Turkey (Schneider et al., 2010). 10

3. Stylized facts and scope of the study (cont.) The terms included in this report are shadow /informal /underground economy, which have the same meaning. The total hidden or total unobserved economy includes criminal activities. The formal /official economy are terms with the same meaning. Informal employment /labour and undeclared work have the same meaning and constitute part of the shadow economy. The shadow economy is more than tax evasion as it is the sum of all forms of tax non-compliance which are irrelevant to tax evasion, such as tax avoidance and concerns other activities generating concealed income such as bribery. Another issue discussed is the relation/effect of the shadow economy on the formal economy. The shadow economy may be pro-cyclical (i.e. follow) or counter-cyclical to the business/economic cycle. Schneider (2005) finds a negative correlation for developing countries & a positive for developed & transition countries. 11

4. Turkey The common features of the estimations of the Turkish shadow economy from papers published in the 1990s to mid-2000s, is that they follow the currency demand approach: –For the period of , Kasnakoglu (1993) finds that the shadow economy ranges from 0 to 23 percent of GDP. –For the period of , Halicioglu (1999) finds that the shadow economy ranges from 0 to 10 percent of GNP. –For the period of , Ogunc and Yilmaz (2000) find that the shadow economy ranges from 11 to 22 percent of GNP. –For the period of , Cetintas and Vergil (2003) find that the shadow economy ranges from 17 to 31 percent of GNP. 12

4. Turkey (cont.) MIMIC estimates of the shadow economy range from 10 to 45 percent of GDP for the period of (Savasan, 2003) to 32 to 35 percent of GDP for the period of (Schneider and Savasan, 2007). In other approaches, Karanfil and Ozkaya (2007) explore environmental indicators and report that the shadow economy ranges from 12 to 30 percent of GDP for the period ; Davutyan (2008) adopts the Pissarides-Weber expenditure approach and finds that the shadow economy was 21 percent of GDP in Dell'Anno and Halicioglu (2010) emphasize on the criticisms about the reliability of currency demand estimations and adopt an autoregressive approach / co-integration analysis. They find that the shadow economy expanded from 10.7 percent of GDP in 1987 to 18.9 in

4. Turkey (cont.) Schneider and Savasan (2007) find that the shadow economy is positively linked primarily to the direct taxation and social security burden and to a lesser extend by indirect taxation. The authors also indicate a positive relationship of the shadow economy with unemployment and a negative with GDP per capita, which both signal for a counter-cyclical trend. Dereli (2011) emphasizes on the importance of the tax burden, the inefficiency of the auditing and inspection mechanisms, the political intervention that results in tax amnesties on a regular basis, income inequality (low wages force individuals to find a second job in the shadow economy in order to fulfill their needs) and the perceptions regarding the quality of public services. 14

4. Turkey (cont.) Turning to informal labour through irregular migration, an EU funded study (Icduygu, 2006) about the relationship between irregular migration flows and the Turkish shadow economy reveals two broad phenomena: – On the one hand, irregular immigrants benefit from the opportunity to get easily absorbed by the country’s vast shadow economy and end up doing less desirable jobs. –On the other hand, irregular immigrants may become victims to criminal trafficking networks or be subjected to forced labour. By addressing the main features of the Turkish informal labour market, Ozdemir et al. (2004) emphasize on the problem that rapid urbanisation is not accompanied by employment creation in technology or manufacturing sectors. As a result, the majority of families depend on non-industrial, unskilled work and have to face the continuous inflow of irregular immigrants. 15

4. Turkey (cont.) Turning to the issues of deterrence and tax compliance, McGee et al. (2011) explore the ethics of tax evasion by surveying 176 Turkish accounting practitioners. The authors find that opposition to tax evasion is weakest in cases where the government is perceived as corrupt or where the system is perceived as being unfair and in that sense, highlight the significance of tax morale. Moreover, the authors indicate the presence of a gender effect (male practitioners are significantly more opposed to tax evasion than females) and an age effect (younger practitioners are less opposed to tax evasion than the older). 16

4. Turkey (cont.) Last but not least, Turkey is affected by the phenomenon of corruption as several case studies reveal. However, according to the Corruption Perceptions Index results for 2013, Turkey is placed on the 53rd position which is far better than eurozone countries such as Italy and its neighbor, Greece. A study focusing exclusively on the determinants of corruption in Turkey has not been published to date. As a result, information on the subject concerning exclusively its Turkish dimension arise from case studies (such as Velioglu and Argan, 2005) and from the business literature (with respect to its ability to hinder business activity). 17

4. Turkey (cont.) Tatar et al. (2007) explore with a questionnaire the belief that a considerable amount of out-of-pocket payment in the health sector in Turkey is informal. Their study is based on a sample of 3,727 subjects (face to face interviews were carried out in a medium size city in 2002). The authors report that 25 percent of total out-of-pocket payments were informal and that each amount of both formal and informal payments was of equal size. The authors state that the majority of out-of-pocket informal payments in public sector health care providers was for drugs and was followed by respective payments for physicians’ surgical services. The authors argue that this finding implies the effect of underinsurance. Finally, the authors assert that the motive behind out-of-pocket informal payments was for getting more attention at the time of treatment or in the future. 18

7. Conclusions The paper reviews the size and determinants of the shadow economy in Turkey. The content of this manuscript is a byproduct from an ongoing EU funded project titled “The Shadow Economy (Informal Sector) in Greece: Size, Causes and Consequences”. Our wider project, named as THALES, aims to facilitate the understanding of the reasons of black/shadow economy in Greece, the typology of Greek taxpayers and of the factors that influence and shape his/her behavioural dynamics. 19

7. Conclusions (cont.) Our Project, as aforementioned, aims also to perform cross- country comparisons at regional level, but also with country groups by advanced taxation systems, other Mediterranean countries, South Eastern Europe and transition and developing economies. A mixture of suggestions and structural policies are expected to be provided to the Greek Government at the conclusion of the research, for the efficient conduct of black/shadow economy and tax evasion in Greece. 20