The shadow economy

Voluntary disclosure
Another policy option is to offer amnesties on an individual basis to those voluntarily disclosing that they have been working in the shadow economy. An example of voluntary disclosure is the ‘VAT short-term incentive’ scheme in the UK, offering people the opportunity to regularize their value added tax (VAT) situation. From April to September 2003, it ran a short-term one-off incentive scheme for businesses that should have registered for VAT but had not. The government forecast that 6,300 businesses would take advantage of the scheme and raise £11 million in additional VAT and interest. Penalties would be waived so long as the business continued to comply for twelve months. The scheme cost £500,000 in advertising costs and an estimated £2.7 million in penalties forgone from businesses which would have registered anyway. When the scheme closed, the department had received 3,000 registrations which raised £11.4 million in tax and interest or an average of £3,800 per case. Around 55 per cent of businesses taking advantage of the scheme subsequently failed to submit a VAT return, causing the department to impose £2.5 million in penalties. This had a return-to-cost ratio of 23:1 compared with 4.5:1 overall for all hidden economy compliance activity in the UK (NAO, 2008).
Another voluntary disclosure initiative, again in the UK, involved offshore bank accounts. In 2006 and 2007, the UK government won a ruling that required financial institutions to disclose the details of offshore bank accounts held by UK residents. As a result, Her Majesty’s Revenue and Customs (HMRC) received details of 400,000 bank accounts from which it is estimated that up to 100,000 people should have included income and/or the resulting interest from those accounts on their tax return but had not. HMRC used a voluntary disclosure initiative to encourage people to come forward and disclose and pay all tax owed on their foreign bank accounts. By June 2007, the closing date of the scheme, HMRC had received 64,000 notifications and around 45,000 people came forward to disclose under the arrangements, bringing in a return of some £400 million at a cost of £6 million, or a return of 67:1 (ibid.). Belgium ran similar voluntary disclosure schemes on offshore banking in both 2004 and 2005, as has the Australian Tax Office.

Voluntary disclosure schemes could be introduced in other spheres such as home repair, maintenance and improvement, as well as among landlords. These might be generic campaigns or might also involve more targeted campaigns whereby information is obtained through data matching on potentially non-compliant groups and then that information is used to contact those who might wish to consider taking advantage of the voluntary disclosure option. Lessons could be learned from other countries regarding the use of appeals and notification letters (see further below).

There is a strong economic case for amnesties and/or voluntary disclosure in terms of the incentives they create. There may be individuals who wish to regularize their business activities after they have started their business in the shadow economy. To approach the tax authorities to do so, however, would involve tacitly admitting to previous evasion and could lead to harsh (and unpredictable) penalties. Of course, amnesties cannot be used with predictable regularity or there would be fewer incentives to work in the formal economy: small businesses could begin by evading tax knowing that an amnesty could be granted at some stage.