THE UNDERGROUND ECONOMY AND AUSTRALIA'S GDP Tony Johnson ABS

Introduction  "Measuring the Non-Observed Economy: A handbook" (2002) OECD, IMF,ILO, CIS Key aim - to promote best practice to ensure estimates of GDP are as exhaustive as possible within the production boundary defined in SNA93  Some academic economists claim Australia's GDP understated by 15% because of missed underground production  ABS has recently reviewed its treatment of underground transactions in the national accounts

 Economic activity typically missing from data sources used to compile the national accounts. Includes transactions that are either:  Underground  Illegal  Informal  Household production for own use  Australian practice - Illegal activity is excluded from GDP. The remaining components are included, but are often based on scant and fragmented information. The third and fourth components are relatively small for Australia The "non-observed" economy

 Definition - "Those activities that are productive and legal but are deliberately concealed from the public authorities to avoid payment of taxes or complying with regulations" (Handbook 2002, p 13)  "Skimming" of cash receipts and overstating (or understating) of expenses by businesses  "Moonlighting" by householders Underground activity

Underground economy in Australia  Estimates are made using aggregate tax audit information available for a single period only  Percent adjustments by industry have been held constant over time  Supply and use balancing may add some further implicit adjustment

GROSS DOMESTIC PRODUCT ACCOUNT, INCOME ESTIMATES 2001 Explicit adjustment for underground activity $m Adjustment to initial income estimate % CoE00 GOS Non fin. corps. Private Public Total Financial corporations00 General government00 Dwellings00 TOTAL GOS GMI Total factor income Taxes less subsidies on production and imports -0 GDP

Upper limit to missing GDP  Review data sources and make judgements about potential for missed underground transactions  Assign hypothetical "upper limits" to missing transactions at most detailed level possible  Individual judgments subject to potentially large error, but in aggregate provides an indication of what could be plausible for missing GDP

Assumptions used  Underground activities are conducted only in cash  General government and government businesses are not involved  Large and medium businesses are unlikely to be involved  Imputed components of GDP are unaffected (by definition)  Small businesses and individuals are the major contributors ƒ In Australia, at least 65% of GDP (as measured) is unlikely to be missing underground transactions

Upper bound estimates of potentially missing transactions $m Upper bound estimates of potentially missing transactions % CoE GOS Non fin. corps. Private Public Total Financial corporations 00 General government00 Dwelling owned by persons 00 TOTAL GOS GMI Total factor income Taxes less subsidies on prodn. and imports 00 GDP UPPER BOUND ESTIMATES OF UNDERGROUND ACTIVITY

Upper bound estimate (cont.)  Taking into consideration:  adjustments already made  implicit adjustments in supply-use balancing  the generous upper bounds chosen  Australia's GDP highly unlikely to be understated by more than 2% on account of missing underground transactions, and most likely less

Additional plausibility checks  A high degree of accuracy can be attached to population data from periodic censuses  Make assumptions about upper bounds for involvement and average value of underground income according to labour force status and occupation  Divide derived upper bounds by number of households. This can be compared with after tax household income from household surveys ƒ Results were consistent with that previously described

Could GDP be understated by 15%?  estimates derived from currency demand models as high as 15% of GDP  Implications of 15% can be tested for plausibility ƒ We concluded highly implausible when assessed at the detailed level Large businesses would have to be widely involved in understating both income and wages and salaries paid and this is highly unlikely in the Australian context

Discussion points  Are countries making explicit adjustments for underground transactions?  If so, what order of magnitude?  What data sources and methods are used  Is it an important quality issue for national accountants?  Do countries have a view on the legitimacy of monetary model estimates of the cash economy?