The concept of the shadow economy describes the informal part of the economy from which taxes are not honestly paid in accordance with the national legal system. The shadow economy is associated with many risks that hinder national economic growth, promote unfair competition, negatively affect tax collection and reduce state budget revenues. This consequently reduces the funding available to the state, which could otherwise be used to increase general public welfare and quality of life, as well as to develop infrastructure and services provided to citizens.
When receiving various services from the state, citizens often do not consider that paying taxes is an obligation on their part. The tax system in Latvia is made up of taxes whose revenues are also intended for the provision of state or municipal services, respectively.
Some of the taxes collected by the state are personalised and linked to the services received, such as sickness benefits, childcare benefits, pensions, unemployment benefits, etc. Meanwhile, public services from which all citizens benefit, such as education, emergency medical care, and national internal and external security, are financed from general state budget revenues, which are made up of taxes paid by the residents of Latvia.
The risk of a shadow economy is also closely linked to the principle of tax morality. Therefore, when thinking about the general level of prosperity in the country, thoughtful measures must be implemented to raise tax morale in the country as a whole and among groups of the population with different levels of wealth and differing motivations. An individual may not understand the total scale of the risks, looking only at the short term for the specific day and moment, but the most important thing is a future-oriented and long-term perspective. In essence, the non-payment of labour taxes is not only a problem from the point of view of the state budget, but it affects each of us personally in the most direct way, as the payment and amount of taxes affect entitlement to benefits and their size.
Individuals who receive “envelope wages” without paying labour taxes are exposed to the risk of a lack of social guarantees, work safety and social insurance. “Envelope wages” not only negatively affect the social insurance contributions of employees, but also prevent them from receiving state-guaranteed income replacement upon reaching retirement age, acquiring a disability, losing a provider, in the event of illness, during maternity, upon losing a job, as well as when suffering a work accident or contracting an occupational disease.
To successfully reduce the shadow economy, the implementation of a carefully developed policy is required, focusing on reducing the factors that determine the shadow economy. Measures can vary, ranging from reducing the regulatory and administrative burden, promoting transparency, to improving compliance with tax obligations, automating procedures and promoting electronic payments. However, the most essential thing is to promote public understanding of the importance of honest tax payment.
The Ministry of Finance, in close cooperation with sectoral ministries and representatives of non-governmental organisations, has developed the Shadow Economy Reduction Plan for 2024–2027, the priority of which for the next four years is to reduce the shadow economy within the framework of five action directions. It is planned to implement measures to regulate sectoral policies and the legal framework in order to limit the shadow economy, tidy up the business environment and promote voluntary compliance with tax obligations.
The plan includes measures that provide for the use of a taxpayer's overall rating in public procurement, restricting the circulation of cash of unknown origin, promoting the use of cashless transactions, identifying possibilities for improving personal income tax returns, strengthening data analytics in the construction, health and beauty sectors, improving information and data exchange, public education, as well as other measures to increase the competitiveness of companies.
The plan aims to reduce the total volume of the shadow economy in Latvia to 18.9% by 2027 according to the methodology of Professor F. Schneider, provided that the country maintains stable economic development, thereby bringing the shadow economy indicator closer to the average level of European countries.
It should be noted that the plan includes specially developed measures to mitigate shadow economy risks that will not duplicate the tasks included in the Tax Policy Guidelines and other institutional development planning documents, nor the tax administration, operational and supervision measures included in the State Revenue Service's work plan.