Nova workboard

a blog from young economists at Nova SBE

Light up the Darkness

Economics can be understood as the branch of knowledge concerned with the production, consumption, and transfer of wealth. It involves to study how consumers act in a market, in an exchange economy through a sequence of actions aiming to maximize their utility – and well-being – given the limitations they face. This study can assume many different forms and deals with different situations. Among those we have taxation. Nothing new so far.

But do economists and politicians account for the human nature factor? I’m sure many times they don’t, at least not carefully enough. It doesn’t take a nuclear physicist to understand that human nature should be in the very center of any attempt to explain human economic behavior. Sociological works, such as that of one of the first sociologists – Thomas Hobbes – suggests that “each of us is motivated to act in such ways as we believe likely to relieve our discomfort, to preserve and promote our own well-being” (Hobbes, 1651) – in an animal way and not having a natural concern with other’s conditions and well-being.

Shadow or underground economy can be defined as “all currently unregistered economic activities that would contribute to the officially calculated gross national product if the activities were recorded” (Feige, 1989). How to measure the economic and financial size of this parallel set of economic activities is not easy, and one can only imagine how it could impact (in amount of money) on national accounts and tax revenues if brought to the “daylight economy”. Failing to understand the incentives agents face towards this parallel economy will for sure result in inefficient measures. If taxation measures are not designed taking into account that agents can deviate from the standard behavior, predictions will fail; Intentions to give incentives towards any reform or change will be biased. Ultimately the entire economy will suffer the consequences of naïve measures and may be the case when “being in the shadow”, becomes the new standard.

Laffer Curve – an economic ‘tool’ that establishes a relationship between possible rates of taxation and the resulting levels of revenue – explains that increasing tax beyond a certain point will have a negative effect on tax revenues (being that increase counterproductive). It doesn’t mean that beyond that point many of the economic activity is extinguished, most of the times it means that now that activity is in the shadows.

In Portugal every year thousands of new university students go to Lisbon. Every year, mostly between August and October, there is a lot of agitation in real estate – housing – rental market. Many real estate owners want to make some money and thousands of students want a nice place to stay and live in. Demand always exceeds supply and prices adjust accordingly.

But this isn’t surprising, I know. What’s surprising is that – in my opinion, and I am pretty sure its accurate – this is one of the most exposed yet untouched underground activity in the country. Taxes are such that the majority of landlords do not even consider paying taxes. Students, whom want to pay as low prices as possible, having a receipt at the end of the month doesn’t real help in anything.

Basic and pure economic and sociological behavior arises: no one pays taxes, those who rent may see a small price cut and landlords (who have market power) can increase profits by tax evasion. It is an exchange exercise: I give away my right to legally rent a house and have the benefits and protection, if doing it so allows me to pay less. Transactions are made when there is an equilibrium of how much each agent value the good under this paradigm. Nothing a priori prevents this negotiation from being efficient and desirable. Nothing except for the fact that all economic, social and government institutions are counting on people to comply with taxes, which many times they don’t.

In Portugal it is estimated to exist 400.000 houses being rented without any registers being done and related taxes being paid. “Losses” of millions we do not account for in the actual national accounts methodology. A recent study estimates that Portuguese parallel economy – in 2012 – represented more than €44.100 million (26.74% of GDP).

Can we blame the landlords? Can we blame the ‘consumers’? It is true that one can criticize their lack of “tax morale” and unethical behavior, but what agents really do is what they can to make themselves better off – that is what human nature is all about. Governments must put some serious though on this matter. Either about possible measures to avoid this growing phenomena and preventing it’s hazardous effects on economy, or stopping complaining and blaming economic agents for doing what they find possible, within criminal laws, to make themselves better off.

“Underground economy is an unavoidable ingredient of a country’s” (Voicu, 2012) – and under any circumstance shall it be forgotten if policy effectiveness is a primary objective. Governments must enforce legislations, penalties, inspection and surveillance in order to guarantee a feeling of fairness and equality among citizens.

Rodrigo Pina Cipriano | #692


Author: studentnovasbe

Master student in Nova Sbe

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