Income and Expenditure Accounts Technical Series
The Underground Economy in Canada, 1992 to 2011
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As mentioned earlier, CSNA makes both explicit and implicit adjustments to account for UE in the official GDP. This study applies assumptions to derive upper limit estimates of UE based on the various components of GDP. As such, these estimates expand the scope of UE already covered in the CSNA.
In 2011, total underground economy activity was $40.9 billion at an estimated upper bound. This is equivalent to 2.3% of GDP (see Chart 2).Note1 This proportion trended down during the mid- to late 1990’s from a high of 2.6% in 1994. However, from 2001 to 2011, the proportion was relatively stable at 2.3%.
In 2011, UE activity was 4.1% higher (in nominal terms) than in 2010, a slower pace of increase than GDPNote2 (+5.8%). When taking out the effect of inflation, UE activity increased 1.3% in 2011, much slower than the 2.5% measured by real GDP.
From 2001 to 2011, UE activity increased 56% in nominal terms, similar to GDP (+55%). This contrasts with the 1992 to 2000 period when UE activity increased at a slower pace (+37%) than GDP (+54%). The same pattern is observed when removing the effect of inflation. Among the reasons that explain the slower growth in the 1990’s, is the fact that some of the sectors in which UE activity is most prevalent, grew more slowly than the rest of the economy.
To assess how well GDP tracks overall economic activity, including UE, one can compare the growth of the total economy (official GDP plus UE) with GDP alone. When doing this comparison, we can conclude that GDP accurately tracks economic growth. The largest difference between the two growth rates was 0.3% in 1994. For all other years, the difference varies between 0.1% and -0.1%.
4.1 UE activities in expenditure-based GDP
Household final consumption expenditure accounted for about 65% of UE activities in 2011. Business gross fixed capital formation accounted for another 28%, exports 10%, and imports -2.8%.Note3
4.1.1 Household final consumption expenditure on consumer goods and services
UE activities related to household final consumption expenditure represent those outlays on goods and services supplied by firms that practice skimming (underreporting of their revenue and over-reporting of their expenses), contraband tobacco, illegally manufactured wine and spirits, undeclared rental payments and tips.
In 2011, UE activities related to household final consumption expenditure ($26.4 billion) were equivalent to 2.7% of the total household final consumption expenditure estimate at an upper bound, the same as in 2010. Historically, this ratio reached a high of 3.6% in 1993 but trended down in the 1990’s and has stabilized since the year 2000.
Some categories of spending are more prone to UE activities. As much as 14.6% of tobacco related spending could be carried out underground. Other important categories of spending where UE is considered significant, at the limit, include paid rental fees for housing (9.5%), food and beverage services (9.1%), alcoholic beverages (9.3%), and social services, which include child care (7.7%).
UE activities related to household final consumption expenditure could have amounted to as much as $1,948 per household in 2011. The top five categories are food and beverage services ($405 per household), paid rental fees for housing ($369 per household), tobacco ($154 per household), alcoholic beverages ($142 per household) and food ($113 per household). Together these items accounted for 61% of UE related spending in household final consumption.
In 2011, skimming and non-reported UE activity related to household final consumption expenditure was as high as $20.3 billion under the assumptions made in the study. A higher share (71%) of UE from skimming and non-reporting was associated with the acquisition of services as opposed to goods (29%). This reflects the assumption that skimming is more likely in services than goods. It also reflects the fact that small businesses are more prevalent in the service sector and the assumption that skimming is more prevalent for small businesses.
Household spending on illegal tobaccoNote4 was $2.1 billion in 2011, accounting for 5.1% of total UE activities. The share of illegal tobacco in UE is highly volatile; it reached 11% in 1993 before bottoming out at 0.9% in 1996. The illegal tobacco trade accounted for 5.8% of UE activity in 2005, although its share has gradually declined since then.
Household spending on illegally manufactured wine and smuggled spirits in 2011 was $1.7 billion at the upper limit, accounting for 4.2% of UE activities. This activity was more significant in the early 1990s when its relative contribution to UE activity reached 7.6%. Its relative importance declined as per capita drinking consumption fell in the early 1990’s. Since 2004, however, its share grew from 2.5% to 4.2% in 2011.
Households spent as much as $1.0 billion on underground rental of residential units in 2011. Rentals have accounted for about 2.4% of UE activity since 1992.
Undeclared tips paid out by households in 2011 could have been as high as $1.7 billion. This figure reflects tips paid on expenditures on recreational services, personal care, taxis and restaurant and accommodation services. Over half is estimated to have been related to tips for restaurant and accommodation services. Households’ undeclared tips as a percentage of UE have declined gradually since 2001 when they represented 4.8% of UE activity. In 2011, the proportion was 4.2%.
4.1.2 Business gross fixed capital formation – residential structures
UE activities related to gross fixed capital formation in residential structures are assumed to be all related to new residential construction and renovations.Note5
UE in residential construction accounted for as much as $11.5 billion in 2011. After skimming, this is the second largest component of UE. It accounted for 28.1% of UE activities in 2011, its highest share on record (dating back to 1992). It represents $847 per household; or $1,250, if only homeowner households are considered.
New construction accounted for just over half of the UE residential construction estimates since 2005 with the exception of the recession year, 2009, when renovations comprised 54%.
Export-related UE activities accounted for as much as $4.2 billion in 2011. These activities represented 10% of total UE activity; similar to their share in the early 2000’s. Exports of goodsNote6 are estimated at $2.8 billion. UE related exports of servicesNote7 are estimated at $1.4 billion in 2011.
UE imports consist of two estimates: one for contraband spirits and another for contraband tobacco. The estimated value of contraband spirits and tobacco smuggled into Canada in 2011 was $1.2 billion. Illegal imports of tobacco and alcohol have displayed different trends over the period of study, both declined in the 1990’s before climbing back throughout the 2000’s. The trend in each component of imports is closely related to UE household final consumption expenditures in these categories.
4.2 UE activities in income-based GDP
Wages paid under the table and undeclared tips accounted for an estimated $19.7 billion in 2011 at an upper bound, equivalent to 2.2% of the published estimates of compensation of employees. This amount represents $1,406 for every job in the business sector in 2011. Wages and tips had the highest share (48%) of income-based UE activities. Gross operating surplus of corporations (28%) had the second highest share, and gross mixed income, which is the income of unincorporated businesses, was next (24%).
The bulk of UE compensation of employees stems from activities related to skimming and exports. Undeclared tips accounted for 8.8% of the estimate while wages paid to workers related to underground residential construction and renovations accounted for 29% (or $4,108 per job in the business sector construction industry in 2011.)
The UE surplus of corporations involved in construction activities in 2011 was worth an estimated $3.7 billion at an upper bound. Skimming or non-reporting and surplus associated with UE exports accounted for another $7.8 billion.
UE activities contributed $9.7 billion to the income of unincorporated business in 2011. This represented 24% of total UE. Skimming, construction, and contraband tobacco made the largest contributions.
Undeclared income from contraband spirits, illegally manufactured wine, licensee mark-up on illegal alcohol and undeclared rental income together accounted for $1.7 billion in 2011.
4.3 UE activities in industry-based GDP
In 2011, the four most significant sectors in terms of UE activity were construction (28%), finance, insurance, real estate, rental and leasing and holding companies (FIRE) (13%), retail trade (12%) and accommodation and food services (12%). These four industries together accounted for almost 65% of the total UE value added. UE activities in the retail trade industry declined in the last two years. In 2009, the retail share of UE activity was estimated at 14%.
UE is highly concentrated in a few industries with the top four being construction, FIRE, retail trade and accommodation and food services (see Table 1).Note8 However when looking at the share of UE in proportion to the industry GDP, the picture is somewhat different. The top five industries in terms of their share of UE are: accommodation and food services with as much as 12.5% of its output being the result of underground activity followed by other services (except public administration) with a share at most of 9.1%, fishing, hunting and trapping (9.0%), crop and animal production (8.6%) and construction (8.5%).
At the total economy level, the inclusion of UE has a limited impact on the ranking of industries in Canadian economy. As shown in the last column of Table 1, the only change pertains to the accommodation and food industry, which went from 15th to 14th place, compared to the official ranking of industries (Column 3 in Table 1).
- As suggested in the OECD handbook, the UE share of the total economy is calculated as UE GDP divided by (Official GDP + UE GDP). The share should be viewed as an indicator of the true size of UE since an unknown portion of UE is already included in the official GDP. The known portion related to tobacco smuggling is removed from the official GDP in this calculation. Any estimates relating to the out of scope UE activity, namely illegal activity like drug trafficking and solicitation for prostitution would need to be added to this share.
- In Section 4, GDP refers to official GDP.
- In the calculation of GDP by the expenditure approach, imports are excluded to measure only the domestic production (i.e., Y = C+I+G+X-M).
- As of 1997, the estimates for contraband tobacco have been explicitly included in the published GDP numbers. As a result, the published household final consumption expenditure on tobacco products already include this estimate for illegal tobacco as well as estimates for legal expenditure on tobacco products.
- No UE activity is assumed in the case of ownership transfer costs. See Appendix C, Section C.1.2.3.
- These goods are in the following categories: Farm and fishing products [X111], Food and tobacco intermediate products [X112], Food, beverage and tobacco products [X221], Cleaning products, appliances, and miscellaneous goods and supplies [X226]. See Appendix C, Section 1.3 for details.
- UE related to exports of services consist of potential underreporting of selected commercial services as explained in Appendix C, Section C.1.3.
- Official GDP estimates by industry, in nominal terms, are only available for 2009 due to the comprehensive revision of the System of National Accounts.