Source: Valor Econômico

The expansion of the economy favors the legalization of activities

An important and innovative index has been prepared by Ibre / FGV at the request of the Brazilian Institute of Ethics in Competition (Etco). This index is an estimate of the magnitude of the underground economy in Brazil, understood as all activity not registered with the competent authorities. Its update released at the end of last November indicates that the importance of illegal activities in the Brazilian economy, which has been declining since 2003, has stopped falling in recent years.

The data show that, from 2008 to 2010, the participation of unregistered economic activities remained at the level of 18,6% of the Gross Domestic Product (GDP). Now, as there was significant economic growth in this period, this stability means that illegal activities also registered marked dynamism. What can explain this phenomenon?

Economic growth impacts the underground economy in two antagonistic ways. First, the institutional modernization that accompanies economic development has a moralizing effect favorable to the legalization of activities. For example, the growth of financial intermediation, whether through loans or via the capital market, stimulates the formalization of companies and individuals. The granting of credit requires documents for guarantee analysis, which requires companies and individuals to formally register their activities. Likewise, the growing importance of foreign trade in the Brazilian economy, imports and exports favors formalization, as this trade, by its very nature, requires extensive documentation of commercial transactions. Both the amounts of credit and the volume of international trade have grown vigorously in recent years, which must have been a strong stimulus for the reduction of informality.

There is, however, another impact of economic growth on the shadow economy. It is the income or demand effect. When there is an increase in income there is an increase in demand, either for goods produced by the registered economy, or for those produced by the unregistered economy. The strong growth of the shadow economy observed in recent years indicates that this income effect has been greater than the moralizing effect generated by institutional modernization. What can explain this predominance?

An important advantage of the underground economy is its great flexibility and agility. Not respecting the requirements imposed by the various existing regulations for formal activities, it is free from legal bureaucracies and can thus respond quickly to variations in demand for its products. The immediate appearance of street vendors selling umbrellas when it starts to rain testifies to the rapid response of informal activities to growth, even in the occasional case, of demand.

Umbrella sellers when it starts to rain are proof of the industry's rapid response.

This speed of adjustment is an inherent advantage of activities that do not respect the law. But this advantage is amplified by the excessive and growing bureaucracy that has characterized, over time, the Brazilian economy. Recent research published by the World Bank on the ease of doing business in 183 countries (Doing Business 2011) places Brazil among those that most require bureaucratic procedures for the development of productive activities. Worse, Brazil lost positions in relation to the previous survey, from 124th to 127th.

One item of this research has a clear positive relationship with the size and growth of the underground economy in Brazil: it is the time spent to pay taxes. In this regard, Brazil is the world champion of bureaucracy. 2.600 hours per year are required to pay taxes. The runner-up was with Bolivia: 1.080 hours. To be envious, in Switzerland it takes only 63 hours a year. Nobody likes to pay taxes, because otherwise they would not be taxes, but volunteers. If this enormous predisposition is added to this enormous time and an endless number of difficulties to comply with tax obligations, it is even surprising that tax evasion is not even greater in the country. It remains thus explained the great resistance of the underground economy to the efforts expended, in particular those of modernization of tax collection and tax inspection, to reduce the magnitude or, at least, to reduce the growth of tax evasion in the country.

There is no doubt that the high value of taxes in force in Brazil is a strong stimulus for illegality and informality. However and without prejudice to a desired lower tax burden, the reduction and simplification of bureaucratic requirements and procedures for the payment of tax obligations appear to be a priority to increase the systemic competitiveness of the Brazilian economy and to reduce the underground economy. The body of tax and administrative rules and requirements in a constant state of change is the great torment of taxpayers. Companies are obliged to maintain teams and hire specialists just to keep up with so many changes in obligations, be they the main obligations and especially the ancillary obligations.

In this direction, the solution to the problem is simple. Just forbid so many changes. Or rather, set a deadline for these changes to take effect. Minimally, it would be the previous fiscal year so that the taxpayer enters the year knowing what rules he must obey and knowing that they will not change. This requirement will certainly meet many opponents. But it has a great advantage. Its implementation does not require financial resources. Just political will and administrative persistence.

* André Franco Montoro Filho, Ph.D. in Economics from Yale University, is a professor at FEA / USP and a member of the advisory board of the Brazilian Institute of Ethics in Competition (Etco).