Europe’s black market economy is booming

Punitive tax regimes, increased labor market regulation and a growing lack of trust in governments are causing many Europeans to abandon formal employment and enter into the murky, illicit world of shadow economies worth billions of dollars, according to a pan-European study published on Tuesday.

Research commissioned by the U.K.-based think tank, the Institute of Economic Affairs (IEA), revealed on Tuesday that Europe's shadow economy employs up to 30 million people across the European Union and that illicit economic activity constitutes up to 20 percent of national income in countries such as Spain, Italy and Greece.

In the U.K., the shadow economy constitutes approximately 10 percent of gross domestic product (GDP), about 14 percent in Nordic countries and between 20 to 30 percent in many southern European countries, according to the IEA.

The study carried out by Freidrich Schneider, professor of economics at Johannes Kepler University in Austria and Colin Williams, professor of public policy at Sheffield University, found the shadow economy in Europe had grown in recent years because of "ballooning tax rates," leading to a lack of trust in the state.

"High levels of government spending and front-loaded tax rises have pushed both individuals and businesses into illicit employment. This is a dangerous cycle," Schneider and Williams stated.

"As more people have been forced into the shadow economy, [government tax authorities have] lost tax revenue. This in turn has pushed up tax rates, stimulating black market employment even more."

Governments Beware

However, rather than trying to deter the shadow economy or "stamp it out", Schneider and Williams suggested that governments had to embrace the entrepreneurship it spawned and actually lower tax rates.

"A reduction in the tax burden is therefore likely to lead to a reduction in the size of the shadow economy. Indeed, a virtuous circle can be created of lower tax rates, less shadow work, higher tax morale, a higher tax take and the opportunity for lower rates. Of course, a vicious circle in the other direction can also be created."

The shadow economy can range from seemingly innocuous activities, such as babysitting and cash for services such as home maintenance of building work, to larger scale illicit drinks and cigarettes markets, according to Philip Booth, editorial director at the Institute of Economic Affairs.

"There will always be some sort of shadow economy," Booth said. "And even countries such as Switzerland have a shadow economy – and there it's around 8 percent of national income – and Switzerland is widely viewed as a country with good labor market regulation which is perceived to have a public that trusts its public institutions," Booth told CNBC on Tuesday.

In the U.K., the shadow economy is equivalent to a "staggering" 10 percent of U.K. gross domestic product (GDP), worth in excess of 150 billion pounds ($230 billion), according to the IEA's report.

Booth said that the U.K.'s high levels of taxes had been a boon for the black market in the country.

"With the shadow economy now worth over 150 billion pounds in the U.K., it's time for urgent action. The government must make legal work easier and more beneficial by providing incentives for those working in the shadow economy to move to the formal sector. At the same time radical action is needed to reduce the burdens of taxation and red tape which led so many into the black market in the first place," Booth said.

Given the opaque nature of shadow economies, the authors conceded that it was "notoriously difficult" to compile data. Yet countries that had attempted to compile data had found surprising results.

Denmark, for instance, recently published a study which suggested that around half the population purchases shadow work and that in some sectors, such as construction, half the workforce was working in the shadow economy.

-By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt

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