Lockdowns drive shadow economy

shadow economy

Normally law-abiding self-employed people claim they are forced to resort to criminal practices to survive.

 A., a veteran hair stylist and owner of a hair salon that ordinarily employs a staff of 12, this week slipped into a client's home - right under the nose of a police officer. Inside a large bag, he carried hair dye, scissors, and a blow-dryer. Salons and barbershops are shut down by law, but A. isn’t shutting down. "We get to our customers like thieves in the night. We pack everything in sealed bags that won’t be noticed and make sure there are no inspectors around," he says.

During the first closure, A. didn’t provide services to his customers, but this time around, he’s no longer obeying the law. "In the first closure, I had zero income for seven weeks. Clients kept contacting me and asking me to come to their homes. At first, I refused because I was law-abiding and didn’t want to be a criminal, but slowly I realized I had no choice. We’d spent all our savings, including funds for our children’s education, we took out a state-guaranteed loan to inject money into the business, to pay suppliers and employees, and there’s nothing left for us."

A. feels there’s no logic to the government's current decisions, and no one looking out for him. "There’s no logic in collective closures or contagion area lockdowns, so we’re no longer obeying the law. The government decided to close barbershops, while businesses that sell thingamajigs from China can stay open because they set up a stand selling masks.

"Another lockdown will be a death sentence for us. This isn’t just harming business, it’s life-threatening. We don’t have security like unemployment benefits, and the government grants make a mockery of those of us drowning in business debts. That’s not money I can bring home to buy food with. I’m married with three children, and up till now, I’ve always supported my family with dignity. Now I have nothing."

The current situation makes A. a double offender: he’s both violating the closure and also not paying tax. But he feels no shame. "I don’t enjoy it. We’re a luxury hairdressing salon, and suddenly I find myself providing pirate home services. It takes me back 25 years, to the time I was a kid, cutting hair as a hobby. And, of course, I’m breaking the law, but I don’t feel guilty about not paying taxes. The state should feel guilty for bringing me into this situation; for years the state has neglected the self-employed - we pay national insurance, but it’s given us no assurance."

Yossi Alkobi, President of the Association of Crafts and Industry (ACI), views the intensification of Israel’s underground economy during the Covid-19 period as a phenomenon born of government mismanagement. "We’re witness to the fact that unfavorable circumstances have led to criminal behavior. Thousands are working like this because they’re hemorrhaging and have to bring food to the table. Staying home doesn’t help get you to the supermarket. Compliance was higher during the first closure. People didn’t work because they still had some savings, and they managed, but there’s no breathing room left in the second closure. They’ve got to work and the only option is to work under the radar, on the black-market."

Alkobi feels particularly sorry for new businesses. "Those businesses that opened over the last three years, took loans, invested in their business, worked on marketing and gaining customers - they entered this crisis at a problematic starting point, with lots of commitments and little revenue.

"In the first round, they could still make do, but in this second round they’ve reached a point where they can’t pay back loans or meet obligations. So, they have no choice but to work under the table. They have homes and families to support. If they don’t pay their bank loans, it will look bad in the future, because anyone marked as a bad credit risk who tries to recover from the ruins of the coronavirus period will have a hard time with the banks. These businesses are at a crossroads, they’re in a bad way. These aren’t people who’ll steal bring home food - these are people who go to work."

Do these people blame the government?

"There’s a lot of anger towards the government. Management on the part of the decision-makers has been a failure, for the most part. They especially don’t know how to take care of new businesses, but older ones are also suffering. This is an economic failure unequalled by any other western country. Businesses have been pushed to the brink. You have to bring home the groceries, so you do what you have to do. That’s what’s these failed policies and mismanagement have led to.

"People are losing their homes. People are threatening suicide. Things are out of control. We at the ACI have seen this mainly in the beauty industry because they were hit very hard and shut down for a very long time, but it’s evident in other professions as well: fitness trainers, gardeners, chefs, and other professions. "

"This time around, I didn’t hesitate for a second"

Indeed, working "black" these days - cash-only, no receipt, and no invoice - isn’t just for hair stylists or beauticians. Almost everyone today knows someone who works off-the-books, or pays under the table for services, from private chefs who come to cook at one’s home, through home remodelers, to personal trainers. This phenomenon - an offshoot of a shadow economy courtesy of the coronavirus - runs across professions and services. Nor is it the domain of mere "tax offenders". People who in ordinary times perceived themselves as normative, law-abiding citizens, today pay on the black-market without thinking twice.

That’s why, Y., 47, from North Tel Aviv, doesn’t hesitate to pay cash-in-hand these days. "I am usually a law-abiding person who insists on full payment including VAT, with a receipt, from all tradespeople. But the last time I hired a plumber and he quoted a price in cash that was, of course, lower than the price I would’ve gotten if I’d paid by check, I didn’t hesitate for a second," she says. Her change in attitude, she says, is due to the government's unequal treatment of its citizens.

"What stood out to me was that, at a time when the ultra-Orthodox - who pay far less tax and work under the table a lot - allow themselves to behave in a way that endangers me and my family, and hampers our national health and economic recovery. I don’t need to be ‘more righteous than the Pope’. I handed him the cash without feeling guilty at all - maybe even the opposite. Of course, it's irrational, because I know that if everyone were to act like me, things here would be even worse. But that’s how I felt."

The data: Cash use on the rise

These stories are not extreme cases. Today’s self-employed have been in deep crisis in recent months, especially during the prolonged lockdowns, and are seeking solutions in order to survive. With them are also employees who have been furloughed or laid-off; they do benefit from a state-sponsored safety net and received monthly payments of up to 70% of their income. However, these sums aren’t always enough to live on - which also shortens their entry into the shady black-market economy.

It’s a challenge, of course, to pin down in numbers this feeling: that the volume of undeclared income has increased during the Covid-19 period. This "shadow economy," as it’s called, is hidden from view and very difficult to quantify. But the Bank of Israel (BOI) does have data about a recent increase in the use of cash.

A BOI survey published last month shows that during the Covid-19 crisis, cash turnover in the economy has increased significantly: at the end of August this year, cash turnover was NIS 100.9 billion - an increase of 15.7% since the crisis broke out in early March. This increase is six times greater than the annual increase measured at the beginning of 2020, before the Coronavirus outbreak, when cash turnover increased 2.7%.

The BOI attributes the high demand for cash to the fact that keeping paper money on hand contributes to Israeli citizens’ sense of security. Other BOI surveys show that this sense of security is evident among population groups that are in any case biased towards using cash, such as the Arab sector and ultra-Orthodox communities, as well as people who have been more affected by the economic crisis, such as those on furlough or are otherwise no longer employed.

The bank does not attribute the use of cash to the shadow economy engendered by the Covid-19 period. As mentioned, there is a built-in methodological problem that arises whenever one tries to evaluate black-market capital in Israel (and in the world in general). What is clear is that the shadow economy is based on cash, whose use has now indeed increased significantly.

"People respond to incentives"

Prof. Omer Moav, professor of economics at the IDC Herzliya and the University of Warwick in England, believes that the current situation is a rare intersection of many "bad" things. "One side of the issue is the ease of committing the offense, paralleled by a reduction in the strength of social norms against the offense. In committing the offense of paying off-the-books, we need the cooperation of two parties, buyer and seller, and this is where the social norm that condemns these offenses should come in."

In fact, according to Moav, what we have here a combination of "a government that is perhaps the worst functioning one in the history of the State of Israel, and an epidemic that’s unprecedented. So, normative people, who in ordinary times feel uncomfortable paying under the table, are now saying ‘The government is, in any case, operating out of political considerations instead of practical ones, so there’s no reason why we should obey the law.’"

The flip side of the same coin is the incentives provided by the government. "People respond to economic incentives," he notes, "and the government’s serious failure is that they created a mechanism that guaranteed unemployment benefits for a whole year. There’s a great deal of evidence that shows people don’t want to work and prefer to receive unemployment benefits, and that, of course, enables ‘win-win’ deals where one side says, ‘I’ll pay in cash, so you’ll get paid and also maintain your unemployment benefits.' They’ve created an insane incentive here that’s fertile ground for the coronavirus shadow economy. This is compounded by the fact that when economic activity is made illegal, it immediately creates an incentive to do it illegally."

Behavioral economics expert Prof. Ori Heffetz, of the School of Management at Cornell University and The Hebrew University of Jerusalem - who was invited to advise the prime minister in formulating an economic aid program for the current crisis - is not jumping to the conclusion that Israel's shadow economy is on the rise.

"It sounds logical to me that the volume of black-market economic activity has increased recently, but that’s just a feeling. In difficult economic situations, people will try to survive in any way they can. This isn’t surprising, it’s not unique to Israel, and it’s not new. When you’re in danger of drowning, you make fewer judgements about what’s proper and what’s not. The main thing is to keep your head above water.

"But let's not be naive. The black-market economy here in Israel wasn’t created today, nor is it because of the current crisis. It’s true there’s a terrible crisis here - economic, health, political, social, institutional as well as a great crisis in trust and solidarity. But the black-market economy, bless its soul, has been alive and kicking since long before that. There are deep, ingrained norms within Israeli culture - you can’t blame everything on the coronavirus."

Nonetheless, he admits, "When you issue a decree that the public is unable to follow, it makes criminals of us all. And that’s terrible, in my opinion, because it erodes norms even more."

What about the incentive created by the guaranteed unemployment benefit policy for a year, decided on by the government? You advised the prime minister and supported this decision.

"It’s true that if unemployment benefits are given to anyone who has lost their job, there’s an incentive to claim eligibility - meaning, they can either not work, or work illegally and lie about it. That’s always the cost of unemployment benefits, not just during corona times."

Tax Authority sympathetic but won’t give in to tax evaders

These days, Eran Yaacov, Director General of the Israel Tax Authority and Deputy Director General of the Ministry of Finance, is busy paying grants to the self-employed and reducing the restrictions imposed on businesses during the closure. But the shadow economy, whether the old breed or the new Covid-19 type, isn’t something he can ignore.

"Globally, in periods of unusual events, like wars, levels of compliance with tax laws decline," he says. "And this is war. We’ve never been in a period like this before and we’re also trying to figure out how to deal with it."

No doubt these are complicated times. In addition, the Tax Authority is operating with a limited staff. Are you even dealing with the shadow economy right now, or setting it aside for more normal times?

"The Tax Authority, as the entity which provides grants, is also choosing its battles these days. A large part of our workforce is dedicated to helping businesses and distributing grants. We treat employers and the general public with a very high level of sensitivity. We understand that businesses are experiencing hardships and cash flow problems, and therefore, we’re more understanding: we agree to payment in installments, we don’t rush to foreclose, and we’re considerate of businesses that are on the verge of bankruptcy. But along with that sensitivity, we have not for one moment neglected enforcement against economic crime.

"When the first lockdown was eased, very quickly we saw there were ‘corona nouveau riche’ - people who used Covid-19 as an opportunity to commit crime. We’ve never stopped taking action against fake invoices and large-scale tax evasion, constantly collecting evidence, and pursuing medium and large-scale criminal activity. And whoever is taking advantage of the coronavirus to commit economic crime is being observed by our investigation unit. We’re deeply involved in handling ‘corona scams’ - scams related to the sale of pandemic-related accessories and medical equipment."

You mentioned medium and large-scale crimes, but what is your approach towards self-employed people currently getting paid under the table?

"Regarding small business - the hairdressers or beautician making house-calls, the chef making home-cooked meals, and others getting paid off-the-books - they’re experiencing a different reality today from what they’re used to, and we’ve adapted ourselves to this situation. We’re reasonable and sensitive on one hand, but we’re still gathering information about these businesses, and we won’t overlook them out at the end of the crisis.

"Complying with the law and paying taxes means that it has to be done, even at a time like this. We don’t come down on just anyone. When it comes to people experiencing hard times, we act sensitively, but that doesn’t mean we’ve stopped collecting evidence. We’ll get to the big criminals as well as a portion of those working off-the-books. When Covid-19 ends, we’ll get to the others as well, and that could cause damage to their grants benefits."

The Ministry of Finance responds

In response to "Globes", the Ministry of Finance stated: "The program dealing with the economic impact of the coronavirus includes a number of tools designed to provide an economic safety net for employees, the self-employed and businesses, with a budget that is unprecedented. These tools include, among other things, extending furlough benefits, encouraging employment, social welfare benefits for the self-employed, participation grants for fixed business costs, state-guaranteed loans, and more.

"Regarding financial assistance - the grant to the self-employed provides up to NIS 15,000 for two months, based on the past income of each self-employed person, if the business activity has been damaged by at least 40%. This tool confers entitlement to government assistance, even if the business is operational, in order to preserve the incentive to reopen or continue its activities. The grant comes in addition to a fixed costs benefit, in the thousands of shekels and up to half a million shekels, once every two months.

"Regarding unemployment benefits for the self-employed - these cover a range of difficulties, including the obligation to close the business in order to receive eligibility, a qualifying period that would have prevented new businesses from being eligible for assistance, difficulties in calculating the amount of assistance, and more. Due to these and other difficulties, unemployment benefits for the self-employed are not customary in most developed countries, neither before nor during the Corona crisis.

"Regarding the case in your article that mentions a sales turnover of NIS 300,000 per year: in general, a business of this size is entitled to NIS 6,000 once every two months from the fixed costs grant, as well as up to NIS 15,000 per month, depending on prior taxable income, and additional relief. This business can receive an amount of up to NIS 21,000 for two months, and entitlement can be maintained, even if business activity has not stopped completely. "

Published by Globes, Israel business news - en.globes.co.il - on November 8, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

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