This refers to illegal practices to escape from taxation. To this end, taxable income, profits liable to tax or other taxable activities are concealed, the amount and/or the source of income are serpentine, or tax reducing factors such as deductions, exemptions or credits are deliberately overstated (Alma, & Vazquez, 2001 , p. 9). 7. Underground Economy -? All economic activities that contribute to the officially calculated (or observed) gross national product but are currently unregistered (Schneider, & Nest, 2000, p. 78). Also called “shadow” or “informal” economy. 8.
Unemployment -? The failure to use all available economic resources to produce desired goods and services; the failure of the economy to fully employ its labor force (McConnell, Bruce, & Flynn, 201 2, p. 633). II. Review of Related Literature and Studies This chapter presents the related literature and studies after the thorough search done by the researchers. Included in this chapter are the definition of underground economy, the activities involved, its effects and the different ways of measuring it. Defining the Ledgering Economy It may be a shadowy world but everything in it is flitting and alive.
According to Shoshone (2003), it is a world, as old as the government itself, where business transactions, jobs, and services are manipulated by word of mouth and compensated through cash in order to escape any inspection by the overspent. Law abiding citizens aiming for revenge from the government’s injustices are involved in the underground economy. They include both employees and employers who grant services without the presence of a license or an inspection sticker, or fail to report to the authorities their productive activities.
The Underground Economy, also known as “black market”, “shadow economy”, “informal sector” and “parallel economy’, is a part of a nation’s economic activity that is obtained from sources that fall outside of the nation’s rules and regulations in relation to doing business. The ERM “informal sector” was used first in 1972 by the International Labor Organization (ILL) to refer to activities that are unrecorded, unrecognized and unregulated by the governing bodies. From the first definition given by ILL, many researchers have attempted to give the definition of the term.
Smith (1994) defines this economy as a market-based production of goods and services, whether it is legal or not, that were not detected in the official estimation of Gaps- The activities can either be legal or illegal relative on the goods and services that are being exchanged. Activities in an Underground Economy The Gunderson Economy involves economic transactions that are untaxed and not quantified by statistics released by the government. It is comprised by all existing unregistered economic activities that will contribute to a nation’s official gross domestic product if recorded.
The revenues acquired from the activities occurring in the underground economy are not recorded by Bureau of Internal Revenue. In a study conducted by proof. Jorge V. Sibyl, a dean from the UP School of Labor and Industrial Relations, it will be read that the informal sector of the Philippines was officially defined in the Social Reform and Poverty Alleviation Act of 1988 (RA 9485) as: “poor individuals who operate businesses that are very small in scale and not registered with any national government agency, and to workers in such enterprises who sell their services in exchange for subsistence wages or other forms of compensation… According to Ala and Niacin’s study (as cited in Sibyl, 2013) the National Statistical Coordination Board (NCSC) defined informal sector in two manners: conceptual and operational. The conceptual definition states that “the informal sector consists of ‘units’ engaged in the production of odds and services with the primary objective of generating employment and incomes to the persons concerned in order to earn a living. These units typically operate at a low level of organization, with little or no division between labor and capital as factors of production.
It consists of household unincorporated enterprises that are market and non-market producers of goods as well as market producers of services. Labor relations, where they exist, are based on casual employment, kinship or personal and social relations rather than formal contractual arrangements. ” Under the operational definition, “the informal sector consists of ‘units’ engaged in the production of goods and services with the primary objective of generating employment and incomes to the persons concerned in order to earn a living.
These units typically operate at a low level of organization, with little or no division between labor and capital as factors of production. It consists of household unincorporated enterprises that are market and non-market producers of goods as well as market producers of services. Labor relations, where they exist, are based on casual employment, kinship or personal and social relations rather than formal contractual arrangements” (Sibyl, 2013).
However Schneider (2002) said that a precise definition of the underground economy is quite difficult because it develops all the time, adjusting to changes in taxation and regulations. The activities occurring in an underground economy may be legal or not. The common ground in each activity is tax evasion. Different categories have been made by different experts of Underground economy. Becker (2004) claims that the informal economy is largely characterized by a low entry requirement especially when t comes to capital and professional qualifications and the skills are mostly not honed by formal education.
It usually is composed of small scale of operations, labor-intensive methods of production and adapted technology. Petting (2009) also enumerated activities such as crimes like selling of drugs, “laborers paid in cash but not declaring to the taxman”, borrowing money from “loan sharks” with fraudulent interest rates, “prostitution, buying untaxed cigarettes and alcohol”, and “unlicensed taxi services”. Shoshone (2003) grouped the underground activities into four categories: (1 ) Economic activity yielding income that is not reported to the tax authorities. 2) Economic production that violates one or several other mandates such as compulsory government licensing and rate making, inspection and label laws, labor laws, government regulations of agriculture, export and import controls, government control over money and banking, governmental control of energy production and distribution and countless others. Violators may or may not evade taxes, but they all work illegally, hiding from swarms of government inspectors. (3) Productive activity by transfer beneficiaries who raw Social Security benefits or receive public assistance. Their freedom to work is severely restricted. 4) Productive activity by illegal aliens without residence status. They may pay income taxes and other taxes, but must remain underground for fear Of deportation” (p. 4). Briefly, the Underground Economy includes all productive economic activities, either legal or illegal, that would generally be taxable that would add up to the nation’s output if reported to the government. The Growth of the Underground Economy A growing Underground Economy can be seen as the reaction of individuals ho feel overburdened by the state and who choose the ‘exit option’ rather than the ‘voice option’ to express their dissatisfaction (Hiroshima, 1970).
There are considerable factors that drive people to the underground and why the informal economy exists. Shadow Economy has been caused by many different factors resulting to its growth: (1) Increased tax rates and social security obligations especially in the labor markets, (2) Enforced reduction of working hours, growing numbers of early retirees and growing rate of unemployment, (3) Corruption relying in the government leading in the crease of civic virtue and loyalty of the public towards the public institutions (Schneider & Nest, 2003).
The most main and basic reason is to provide income to their families and to create employment for themselves (Alonzo R. , & Mangoes, Ma. A. , 1990). Laming and Sandman (1972) stated that the Underground Economy and Tax evasion doesn’t have any congruent relationship with each other, activities in the Shadow economy In most cases imply that the factors affecting tax evasion will affect the growth of the Shadow economy. Furthermore, Bolivar (2006) stated that high taxes seem to e the most important factors that drive an activity in the Underground economy.
Bolivar was supported by Schneider (as cited in Edwards, p. , Jones T. , & Ram, M. , 2006) when he noted that the high rates of direct and indirect taxes plus social security burdens drive people and micro-enterprises to go underground. In the study of Jeannine et al (2004) it stated that, “Higher taxes unambiguously increase the shadow economy, while the effect of public goods financed by those taxes on the shadow economy depends on the ability to access public goods. ” There is no doubt that the underground economy is essentially an employment phenomenon.
Where government causes disembodiment the underground offers ample opportunities for employment. It does so although it IS besieged and harassed by government officials and their spokesmen in the media. It functions admirably although it is handicapped by a legal system that not only denies protection to its contract parties, but also threatens to fine and imprison them” (Shoshone, H. F. , 2003, p. 9). Baja and Schneider (2009) examine the extent of participation of unemployment rate with the Shadow economy. They proposed that
Shadow economy acts as a ‘substitution’ for the lack of formal employment available. Workers who participate in the underground economy wanted to “maximize their own asset: Labor” (Becker, 2004, p. 14). Also, Loan (1998) argued that since cannot absorb all of the labor that was being offered by workers, the extra labor or the surplus labor serves as a buffer Or an absorber. The lack of attention of the government regarding the Agricultural development of the county regardless that Philippines is an agricultural country could also be a part of the causes why the growth of the
Underground economy rises (Alonzo & Mangoes, 1990). In support of this contention, International Labor Organization (2002) stated that “some developing countries tend to focus on reinforcing laws and regulations that concentrate on foreign investments, large companies, and manufacturing industries disregarding the agricultural sector even though the majority of the country’s population is located in the rural areas and are highly dependent on agricultural subsistence. As Alonzo and Mangoes (1990) put it, the agricultural sector is being burdened by many “public and private monopolies” (p. 89). An interdisciplinary analysis of the causes of the increase of the shadow economy seems necessary, since economic factors can only partly explain the increase. Micro-sociological and psychological approaches can provide interesting additional insights in the decision making process of individuals choosing to work underground (Schneider & Nest 2000).
The Impacts of the underground Economy on Economic Health Underground economy includes different activities that are already part of the people’s everyday living. These activities may cause good and bad effects to the sectors of the economy, such as the government, the private institutions and the common people, and later on to the economy’s gradual growth (Garcia-Bolivar, 2006). The underground economy probably represents the most serious challenges and danger to all government planners and regulators (Shoshone, 2003).
The government could not provide good public services because it lacks financial resources due to unconvertible tax reeve sues from activities that do not have legal and complete documents. Bolivar (2006) stated in his paper that in some vicious circle the government might be pushing businesses to informality due to lack of good public services, such as rule of law. This could be done by imposing higher tax rates to encourage businesses and other activities to violate the legal process of documenting such activities.
On the contrary, underground economy can help the government solve its problems regarding unemployment (Bolivar, 2006). Informal businesses could generate thousands of jobs because they do not follow certain limits. Although they violate government rules, they give opportunities to people, especially the poor, as they create or expand their informal activities. In that way, they could repay, somehow, the damages they created to the government.
According to Schneider (2002), impacts brought by the shadow economy can be seen through: (1 ) Monetary indicators, wherein most transactions in the shadow economy are most likely to be in cash and an increase in the activities may result to higher currency demand, (2) Labor market participation rates and working hours, which implies that an increase of people who work in the informal sector will result to a decrease in the formal sector of the economy, (3) Output statistics, the decrease in the production input may hinder the growth of the economy.
In connection to the economy’s health, underground economy might reduce he Gross Domestic Product (GAP) because informal activities are not fully accounted by the government and statistics officials (Schneider, 2002). If those activities would be fully recognized and reflected in the economy’s domestic production, economy’s status will be uplifted and different sectors of the economy would benefit from it. Measuring the Underground Economy Analysts and policymakers use different method to measure GAP. Schneider (2002) proposed three ways to measure the informal economy.
The three ways include the following: 1 . Direct Approaches – include estimating the size f shadow economy through information gathered from survey and from audit measurements of undeclared taxable income. 2. Indirect Approaches 3. National Accounting Statistics -? estimates are based from the discrepancy between the income and expenditure statistics in national accounting. A. Labor Force statistics – estimates the growth of the shadow economy based on the gradual decrease in labor force participation in the formal economy, assuming that the total labor force is unchanging, sisters Paramus. B.
Transactions approach – this approach was developed by Edgar L. Beige, an economics professor at the University of Wisconsin-Madison. This makes use of all monetary transactions to calculate for the nominal GAP which comprises transactions from both the official and unofficial economy then estimates the size of the shadow economy by subtracting Real GAP from the Nominal GAP. C. Currency Demand Approach -? assumes that all transactions in the shadow economy are conducted using direct payments of cash, and that the increase in the demand for currency symbolizes the growth of the informal sector. . Physical Inputs – assumes that Electricity consumption is he best physical indicator of overall economic activity. This estimates the size of the underground economy by subtracting the growth rate of real GAP from the growth rate of total electricity consumption. The difference is then credited to the growth of the shadow economy. 4. Model approach – this approach takes into the account the different variables that are assumed to influence the shadow economy – examples are Taxation, Government regulation.
This method is deemed to be advantageous because it considers numerous variables, its causes and effects simultaneously. Ill. Methodology After choosing the topic to be researched on, which is about the flourishing world of the underground Economy, questions related to the topic were discussed and finalized in a classroom setting. As soon as the questions were posted and approved by Mrs.. Elizabeth Acapulco, the researchers went on to ardently ascertain everything about the underground economy.
Each researcher was assigned to gather information that will answer and satisfy the formulated questions. This method Was used by the researchers in order to use the allotted time efficiently and effectively. They were able to gather liable sources from various journals, articles, and books available from the Miguel De Bandies Library. Also, for the paper to be more credible, they used published materials such as online articles and documents from different websites.
The researchers discussed the gathered information. After putting the ideas in an organized manner, the researchers formulated the conclusion and made recommendations. IV. Discussion of Results Based from the gathered information, the researchers were able to come up with the following results: The Underground economy, also called “informal economy’, “shadow economy”, or “parallel economy”, is a portion of an economy that is not accounted and reflected in the nation’s economic output.
The activities and operations occurring in this kind of economy exist beyond the supervision of the government. It involves transactions that are not taxed by the Bureau of Internal Revenue. Revenues from these transactions are not reported in the statistics released by the government. Existing activities in an underground economy may be classified as lawful or unlawful. The unlawful activities entailed in this productive economy are restitution, unlicensed services, borrowing money from loan sharks imposing high interest rates, purchasing untaxed goods.
On the other hand, the lawful activities comprised in the productive economy are trade of untaxed legal services and goods, discounts and additional benefits given to employees, unreported revenues coming from self-employment, as well as assets and salaries from unregistered work or small businesses. The growth of the Underground economy is a way of individuals to cope up with their dissatisfaction with the government and increasing poverty rate. Increasing ax rates and other social security obligations drives other people to work underground to avoid these deductions with their salary and provide the proper needs of their family.
People look into the Shadow economy as a substitution for employment since the government cannot provide jobs to its entire citizen. The standards that are to be followed when hiring a person for the job is also a hindrance for the marginalia people due to their lack of capabilities since the government concentrates only on foreign investments, large factories and manufacturing industries which only pave the way for refashions or individuals having a college degree regardless with the fact that our poverty rate is high.
All the activities that are comprised in an informal economy may bring about good and bad impacts to certain parts Of the economy, especially to the government and to the economy’s health. The government fails to provide the nation with satisfying services because it lacks resources due to supposedly collected taxes from activities in an informal economy. This effect can be seen obviously by many people who are interested in knowing the status of the economy. On the other hand, the overspent was being helped by the informal economy in its problem about unemployment.
Due to flourishing and small activities in an informal economy, different kinds of work are given to people of various ages, even though they lack educational background. Relative to the economy’s domestic production, activities included in the informal economy may lessen the values in the statistics of the economy. Through this, economic heath may have a slow development rate. Analysts and policymakers use different method to measure underground economy, however there is no best method for they are all mere estimates and for each Leeds it owns insights and results.
Different methods include direct approaches who ICC estimate the size of underground economy from survey data and from audit measurements of undeclared taxable income.