07/20/2015 12:37 EDT | Updated 07/20/2016 05:59 EDT

Ontario Can Look to Greece to See the Dangers of an Underground Economy

Stephan Bock via Getty Images
Greek 1 Euro coin, Flag of Greece

"If you pay cash, there's no tax." It's the closing refrain at many nail salons, it's how 56 per cent of Ontario homeowners pay for renovations, and these cash transactions are the fuel of the underground economy, worth $42.4 billion in Canada.

Tax evasion is a criminal offence that places a higher burden on law-abiding Canadians who responsibly pay their taxes. Those who participate in unreported cash-only businesses also undermine the competitiveness of other legitimate businesses by operating on better margins and offering lower rates.

The Greek example proves instructive of the dangers of a thriving underground economy. Greek deficits are the result of both rising public sector spending and stagnating tax revenue, which is caused, in part, by endemic tax evasion.

Estimates place unreported Greek income at 28.2 billion Euros (CDN$39.7B current rate), for a country with 11 million people compared to Canada's 35 million. This places Greece at the lower end of the spectrum of former soviet countries. In 2013, Greece had a tax revenue per capita of USD$7,148, less than half that of Canada, at USD$15,956.

The Greek failure to successfully address tax evasion should also prove instructive to Ontario Premier Kathleen Wynne, who in 2014 pledged to crackdown on tax cheats. Greek measures to tackle evasion with enforcement have resulted in only small improvements. Despite the intensification of audits and enforcement of penalties since 2012, tax arrears in Greece have remained a problem. Since the end of 2011, Greek tax arrears have increased from €44.9 billion to over €70 billion (CDN$63.3B and CDN$98.8B current exchange rate) at the end of 2014.

An enforcement only strategy should not be the model Ontario follows for tackling the underground economy.

Relying on enforcement and punishment squeezes legitimate businesses who are already faced with high compliance costs and tax and regulatory burdens. Anyone who runs a business in this province dreads the prospect of Canada Revenue or WSIB audits and the cost of those audits on their business can be punitive. A pure enforcement approach punishes both compliance and non-compliance.

The real problem is businesses that operate wholly outside the tax and regulatory system. And the key to addressing these businesses is to lower the burden on all businesses, to bring the underground economy into the fold of legitimacy. When the cost of compliance is lower, compliance becomes easier and the incentive to participate in the underground economy will drop.

A prime example of this approach is contraband tobacco. The overall contraband tobacco trade in Ontario costs governments upwards of $1.1 billion annually. The contraband industry is fueled by extremely high levels of sin taxes. The tax on cigarettes is over $50 on a $30 carton. The tax rate is so high, otherwise law abiding citizens resort to the black market.

When excise taxes on cigarettes were lowered, contraband seizures by the RCMP dropped to a low in 2001 of 29,000 cartons. When Ottawa then began to raise taxes again in 2001 and Ontario followed suit in 2006, contraband seizures rose with the taxes. There was an increase by 34 times between 2001 and 2009, with an obvious link between tax increases and contraband rates.

There will always be people who will want to save a few bucks by paying cash for their manicures, home renovations or auto repairs. But the Greek example shows the dangers of a thriving underground economy. The solution to this problem is to stop the incentive for businesses to evade by making taxes low, efficient, fair and equal. The result will be savings on enforcement, and ultimately a larger revenue base.


Bailout Fallout: Greece After EU Deal