Reducing Shadow Employment: Russia and Ukraine

In Tax wedge, labor market and the shadow economy (CASE Network E-brief 02/2010) CASE-fellow Mateusz Walewski assesses the impact of tax reforms on the shadow economy in Russia and Ukraine. Flat Personal Income Tax Rates might have boosted government budget incomes, but fiscal and social reforms missed by and large their target of reducing shadow employment.

Finding that workers in the shadow economies in both Russia and Ukraine do not receive higher net incomes than those in the formal sector, CASE Fellow Mateusz Walewski concludes that the incentives driving workers to join the shadow economy in both cases are not based on tax evasion but rather the lack of formal employment opportunities. Therefore, the carrot of social benefits is negligible in both countries; it is the lack of registered jobs, which remains painstakingly high especially for blue-collar employees, and maintains high levels of employment in the shadow economy.  Tax reforms have not addressed the causes of shadow employment as hoped; they only resulted in minor shifts of skilled workers out of the shadow economy, but failed to have the same effect on unskilled labor. 

A policy choice aimed at improving general employment and social benefits for unskilled workers has better chances of curbing shadow employment, suggests Walewski.