FICIL: Shadow economy in Latvia thrives on unofficial wages, public procurement rules

The main factors contributing to the shadow economy in Latvia are unofficial wages, issues with public procurement, general corruption and unrecorded revenues, according to the report “Foreign Investors’ Viewpoint on the Shadow Economy in Latvia” presented by the Foreign Investors’ Council in Latvia (FICIL) today.

Unofficial wages, dubbed ‘envelope wages’ because envelopes are usually used to hand to employees part of their wages in cash without paying taxes, were named by foreign investors as one of the main factors contributing to the shadow economy in Latvia. Foreign investors emphasized the need to improve the system of personal income tax calculation as well as the collection and control process in order to curb employee-related tax evasion.

Public procurement was indicated by foreign investors as the second most important aspect of the shadow economy. In many cases, public procurement actually fosters growth of the shadow economy due to the rule to select the lowest price bid as the winner of a tender. With the help of envelope wages, some applicants are able to offer lower prices and thus win the tender.

Corruption in the public administration comes next. Foreign investors recognize two main types of corruption: where officials most often in the controlling institutions are paid to turn a blind eye to some type of violations and large scale corruption that involves public officials or organized groups making decisions that help them extract public funds.

Additionally, it is indicated by foreign investors that the current remuneration in the public administration is not motivational and should be significantly improved to reduce the extent of corruption.

As the fourth aspect of the shadow economy, foreign investors indicated a common practice by the local companies to do business by not recording sales, this way avoiding paying taxes. Foreign investors indicate that the price is highly linked with the size of excise tax and value-added tax.

Foreign investors also provided practical suggestions on fighting the shadow economy in the short and longer term. The primary recommendation is to agree on general tax policy among all involved governmental bodies and stay consistent to see the effects of the system work.

Secondly, foreign investors call for stronger enforcement and increased punishment, noting it should be directed at the companies in the black list, paying taxes at a below average level compared to the industry peers.

Next, foreign investors emphasize the need for creating tangible benefits of paying taxes including introduction of tender qualifying criteria in the procurement law. To continue, foreign investors recommend to continue the transfer to electronic exchange of documents, emphasizing the need for connection between the systems of various government agencies and regulators (e-health, e-education, e-customs etc).

Finally, it has been proposed to decrease the tax burden and simplify payment of taxes for small business in order to motivate them to come out of the shadows. To reach a long term effect it is recommended to focus on educating youth from an early age and changing the image of the State Revenue Service by means of well thought out PR campaigns on paying taxes and employee training.