Underground Economy: Canada Has Second-Lowest Problem

The most recent statistics on the Underground Economy (UE) in Canada are from the year 2012, released in April 2015. The total underground activities were valued at $42.4 billion or about 2.3% of gross domestic product (GDP). A high of 2.7% was reported in 1994 and this fell to a low of 2.2% in 2000. However, after a brief uptick in the early 2000s the proportion remained relatively stable between 2.3% and 2.4%.

According to CRA, “The residential construction industry (28.3%), finance, insurance, real estate, rental and leasing and holding companies industries (13.8%), retail trade industry (12.2%) and accommodation and food services industry (11.6%) accounted for the greatest share of underground economic activity. These four industries together accounted for two-thirds of the total underground economy value added.”

Wages paid under the table and undeclared tips accounted for an estimated $20.3 billion in 2012 – half the value of all underground activities –equivalent to 2.2% of the official GDP estimates of total compensation of employees. This amount represented $1,466 for every job in the business sector in 2012. The largest share of income in the underground economy went to employees (47.7%), followed by corporations (28.8%) and unincorporated businesses (23.4%).

The UE is a significant global problem that causes economic erosion for all participants in the financial ecosystem. However, it also presents an opportunity for professional tax and financial advisors to rise to the occasion in educating their clients on the issue. By definition, when people participate in the UE, they under-report or fail to report sales or income, thereby minimizing or completely avoiding the payment of tax. Think about the disadvantage that this presents for law-abiding organizations and individuals: It’s not possible to provide competitive bids for business against organizations that don’t pay taxes, nor is it possible to maintain employment levels or build community wealth and standards of living.

The Organization for Economic Co-operation and Development (OECD) prepared a good overview of the issue a year ago, in its Statistics Brief #18 of June 2014. Three significant problems associated with the UE on a macro level include: an inability to analyze economic growth, employment and productivity; the abuse of social insurance programs; and the erosion of tax revenues. But most important is the erosion of trust in public institutions, which may, the paper states, lead to “a suboptimal design of policies and institutions.” That’s serious.

Canada is one of 19 countries that provided data to the OECD survey in 2011-12 and participated in a survey by the United Nations Economic Commission for Europe (UNECE) in 2005. Fortunately, Canada is second amongst the countries participating, for the lowest level of underground activity. CRA has announced three strategic themes in the effort to reduce the UE in Canada on a go-forward basis: to better understand the scope of the UE, to reduce social acceptability of participation in the UE, to deploy a range of initiatives to encourage voluntary compliance. To accomplish the first goal, CRA has initiated the following activities recently:

• non-filers: matching information slips and corporate business numbers against tax returns
• informant leads and leveraging third-party information, such as provincial workers’ compensation data
• conducting enhanced audits and other tests
• conducting verification activities to establish awareness, visibility, and presence: letters to educate and provide intent-to-audit notices for items like rental losses and employment expenses, citing 45 days to file adjustments to returns.

The UE has serious consequences for all taxpayers, legitimate business owners and the participants in underground activities themselves.  It is part of every tax specialist’s professional duty to educate and inform their clients of the risks and penalties associated with participation in the UE, as well as the benefits of full compliance.

Additional Educational Resources: Distinguished Advisor Workshops (DAW), DAV Online, Tax Services Specialist Designation.

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