Friday, February 29, 2008

Making America more European

Not long ago, I riffed on an episode of Anthony Bourdain's No Reservations set in Greece on my way to asking whether the host of EU-style laws, taxes and regulations that some folks want the United States to adopt would really make Americans more ... well ... European.

Many of the subjects of those laws don't actually obey them, I pointed out. After all, Bourdain's besotted hosts fired illegal guns in the air in full view of TV cameras. While Americans are pretty law-abiding by international standards, it's quite possible that Greek-style laws will turn them into Greek-style scofflaws.

But how to prove that point about subjects of "wiser" regimes elsewhere not quite so placidly submitting to the yoke as is often assumed? I turned to tax compliance rates. Just how likely are Americans to pay what the government demands when compared to other folks? As it turned out, the 84% compliance rate bemoaned by the IRS compares rather favorably with Switzerland's 78% compliance (PDF). But then I got stuck; most tax agencies treat compliance rates as state secrets, so I didn't have much more to go on.

Silly me. I'm not the first one to stumble across this problem, and I'm far from the first person to discover that, while tax compliance data depends on figures closely protected by government officials, the size of underground economies can be measured with publicly available data. The numbers I'm drawing on were compiled by Professor Friedrich Schneider of the University of Linz, one of the recognized experts in tracking unofficial economic activity. He defines the underground economy (he uses the term "shadow economy") as:

The shadow economy includes all market-based legal production of goods and services that are deliberately concealed from public authorities for the following reasons:

(1) to avoid payment of income, value added or other taxes,
(2) to avoid payment of social security contributions,
(3) to avoid having to meet certain legal labor market standards, such as minimum wages, maximum working hours, safety standards, etc., and
(4) to avoid complying with certain administrative procedures, such as completing
statistical questionnaires or other administrative forms.

In Shadow Economies of 145 Countries All Over the World: What Do We Really Know? (PDF), Prof. Schneider estimates the sizes of the underground economies of 145 countries as percentages of their official GDPs. The 21 members of the Organization for Economic Cooperation and Development (developed countries) are listed below by the size of their underground economies, in ascending order:

United States: 8.4%
Switzerland: 9.4%
Japan: 10.8%
Austria: 10.9%
United Kingdom: 12.2%
New Zealand: 12.3%
Netherlands: 12.6%
Australia: 13.5%
France: 14.5%
Canada: 15.2%
Ireland: 15.3%
Germany: 16.8%
Denmark: 17.3%
Finland: 17.4%
Sweden: 18.3%
Norway: 18.4%
Belgium: 21.0%
Portugal: 21.9%
Spain: 22.0%
Italy: 25.7%
Greece: 28.2%

Sure enough, the United States has the smallest underground economy of the bunch. Fewer Americans than their counterparts in Switzerland, Canada or (especially) Italy and Greece choose to conduct their business out of sight and reach of the tax and regulatory authorities.

But why? Why is the U.S so relatively law-abiding?

Dan Mitchell of the Cato Institute thinks the answer is taxes. He points out that high-tax countries generally have larger underground economies than low-tax countries. Mitchell cites research that has "found that a 1 percentage point increase in marginal tax rates is associated with a 1.4 percentage point increase in the underground economy." It certainly makes sense that high tax rates would give people a reason to shield their earnings. And the U.S. has traditionally been a lower-tax country than most other developed nations.

Is that the only reason?

Schneider himself defines the shadow economy as being at least partially motivated by desire to escape "certain legal labor market standards" and "certain administrative procedures." And the United States is often criticized for its "cowboy capitalism" -- supposedly unrestrained market forces, in contrast to the heavily regulated economies of Europe. The extent to which the United States embraces laissez-faire is certainly overstated by Europeans, but there's no doubt that there's less overall government intervention in U.S. markets than in France or Germany. That may well help to explain why fewer Americans choose to take the risks involved in running businesses out of sight of the authorities.

So it's not surprising that when at least some American entrepreneurs do go underground, burdensome regulation -- as well as taxes -- features prominently among their reasons.

For the past few years, the underground restaurant industry -- a particularly tasty segment of the shadow economy -- has been booming. Michael Hale was among the restaurateurs interviewed for a 2005 article on the now-trendy business. Trendy they may be, but underground restaurants went subterranean for very practical reasons.

"It costs $200,000 just for a permit to be allowed to buy water from the city!" exclaims Hale. "You have to get tons of permits from various people. You've got to get a building permit, a permit if you want to remodel, you have to get licenses for beer and wine, and you have to get certified by the Health Board." ...

Hale isn't the only illegal entrepreneur who feels that way.

Their desire to serve high-quality food in a unique setting is now a reality because they don't pay any taxes or licensing fees. "It keeps the costs down, and it's a lot of fun," says Mo.

Well ... that makes sense. Permits, licenses and regulations create new and challenging barriers to entry into any industry. Taxes make it difficult -- and potentially unrewarding -- to stay in business. Restaurants are among the businesses in the United States subject to especially burdensome regulation. So it has become attractive for some people to operate their eateries outside the law -- in the underground economy.

But those are Americans cited in the above article complaining about taxes and regulations, not Belgians or Italians. And the underground industry in which they're operating is especially trendy and dependent on heavy interaction with the public, which could turn them in, but doesn't. That means that not only are Americans willing to go underground if given sufficient reason, but they're capable of doing so with widespread support.

Us denizens of the United States may be relatively law-abiding at the moment, but that is likely situational. So long as taxes are comparatively low and regulations somewhat tolerable, we're willing to play within the system. But if we get European-style laws and taxes, we may well get European-style disdain for the law.

If that means Anthony-Bourdainesque parties on the beach, with meat, booze and guns, so much the better. But I don't think that's what advocates of tighter laws and higher taxes have in mind.



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