Hidden economy hits $130B: study
High taxes blamed for grassroots economic 'revolt': Independent analysis finds 16% of country's production has shifted underground

Eric Beauchesne

National Post

Saturday, February 23, 2002

OTTAWA - A new study says a growing tax burden has led to a boom in Canada's underground economy, to the point where it accounted for 16¢ of every dollar in goods and services produced by the mid-1990s.

Canadian governments were losing $44-billion a year to tax cheats and other criminals, up from $2-billion a quarter of a century earlier, according to the 270-page study published by the Canadian Tax Foundation.

"An increase in the tax rate leads to an increase in the relative size of the underground economy, other things being equal," the foundation's study says.

The study estimates the size of the underground economy at $130-billion in 1995, the last year for which figures on it were available. That would make the underground economy equivalent to the gross domestic products of Saskatchewan and British Columbia combined.

David Perry, the chief economist and researcher for the independent tax research organization, said that while governments have been cutting taxes since the late 1990s, it has not been enough to reduce the overall tax burden.

He said that burden -- measured as taxes as a percentage of gross domestic product -- is still growing. "They're much higher than they've ever been," he said.

And a growing proportion of it is made up of personal income taxes, which the study says are much more likely to encourage cheating than any other type of tax.

The study says an increase in personal income taxes has 10 times the impact on the growth of the underground economy as an increase in corporate income taxes and 2 1/2 times the impact of an increase in sales taxes.

In 2000, the overall tax burden was a record 36.5% of GDP, up from 35.3% in 1995. The personal income tax burden increased to 13.6% of GDP from 13% over the same time.

Those figures did not include the impact of federal income tax cuts introduced in 2000.

The study also found that the introduction of the GST in 1991 did a lot more to feed the underground economy than would have been expected.

One reason was the timing of its introduction, during a recession. Another was its visibility, which angered consumers, said David Giles, the University of Victoria professor who co-wrote the study.

"Since 1991, with the introduction of the GST, I don't think there's any doubt that there's been something of a tax revolt," said Mr. Giles. "They're responding in a particular way to what they perceive as an unfair burden."

Mr. Giles said that even if the overall tax burden does come down, there is no guarantee that will reduce the underground economy.

"Nonetheless, cutting taxes is still the single most important thing governments can do to at least try and reverse the growth in the underground economy," he said.

A survey last May suggested that two-thirds of Canadians would cheat on their taxes if they knew they could get away with it.

A poll of 1,000 adults by Toronto-based CF Group Inc. found the GST was the tax most likely to be evaded -- 37% of those polled said they would pay a contractor with cash to avoid the GST.

The 2001 poll also found the number of taxpayers who would evade income taxes remained steady despite federal tax cuts. About 17% said they would neglect to report some income on their tax returns, while 16% said the same in 1995.

The growth in the underground economy is also being fed by other factors, including the increase in self-employment and moonlighting, both of which provide increased opportunities to hide income from the taxman, he said.

Growth in the economy as a whole feeds the growth in the underground economy, according to the study, entitled Taxes and the Canadian Underground Economy, which found that both economies have business cycles.

The study includes in the underground economy all income that is hidden from governments, whether it was generated by legal or criminal activities.

"Given this definition, our estimates suggest that the Canadian underground economy grew steadily between the mid-1970s and the mid-1990s both in nominal terms and as a percentage of measured gross domestic product," the report stated. "We estimate that it amounted to about 3.5% of measured GDP in 1976 to almost 16% of GDP in 1995."

About half -- or $22-billion -- of the tax revenue lost to the underground economy results from the non-reporting of income from legal activities, such as home repairs.

That is nearly double the $12-billion a year the auditor-general estimated in 1999 that governments were losing to tax cheats.

The auditor-general also found the taxman was "much less" successful in recovering some of that money than it had been claiming.

"It doesn't matter how well policed, some people will still act in a criminal way," Mr. Giles said.

Nonetheless, the study suggests the growth in the underground economy can be slowed, if not reversed, by cutting taxes and by educating the public that tax evasion is not a victimless crime.

"Instead of pointing out to people that they have an obligation to pay taxes, point out that it's costing them and everybody else when the tax base is eroded," he said.

The office of Elinor Caplan, Minister of National Revenue, did not respond to requests for an interview.

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