The report looked primarily at Bulgaria, the Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovenia, and Slovakia.
"The governments of the new member states in Eastern Europe simply cannot afford a large shadow economy, neither in the short run due to fiscal concerns, nor in the long run due to the shrinking labor force," said World Bank senior adviser, Katarina Mathernova.
Shadow economy accounts for a third of GDP
European Commission statistics estimate Bulgaria's shadow economy as accounting for 32% of GDP in 2012. This is followed by Romania (29%), Lithuania (28.5%), and Estonia (28.2%). Austria is at the other end of the scale, with 7.6% of GDP coming from the black market.
As reported, the proportion of shadow economy in Latvia was 30.2% last year, which is 7.9% less than in 2010, according to the Stockholm School of Economics in Riga.
In Lithuania, the proportion of the shadow economy dropped from 18.8% to 17.1% last year, whereas in Estonia – from 19.4% to 18.9%.
The study measured the amounts of the Baltic countries' shadow economies by analyzing income levels, company staffs, unreported wages, bribery (percentages of income paid to "get things done"), and corruption (percentages of contract amounts paid to win public procurement tenders).
The number of unreported employees in Latvia dropped from 14.6% in 2010 to 11.6% last year. Lithuania registered a reduction from 7.9% to 7.3%, whereas in Estonia, the proportion remained unchanged, 9.7%.
The proportion of unreported wages also decreased in Latvia, from 35.5% to 29.1% last year. Lithuania registered an increase from 15.8% to 17.4%, whereas the proportion of unreported wages in Estonia decreased from 19.6% to 19.4%.
The amount that businessmen paid in bribes in Latvia decreased from 10.8% to 8.9% last year. In Lithuania, the figure increased significantly, from 9.3% to 12.9%, and remained practically unchanged in Estonia – 5.6% and 5.5% respectively.
WB: reward formal work
According to the experts, difficult economic situation emphasizes the need to end the untaxed and unregulated work.
The World Bank recommends a series of policy initiatives, including a friendlier tax system coupled with a viable social and employment protection schemes.
In particular, the report notes that the shadow economy often involves low-paying and casual part-time jobs. Therefore, concerned states' officials need to design "smarter social benefits that reward formal work" for those engaged in the shadow economy.
The World Bank recommends the states cultivate better practices to encourage unregulated businesses to declare their income and employ declared workers. It also says social norms need to change.
"Building trust in government is a key factor in convincing citizens paying taxes is useful," says the report.
Meanwhile, the shadow economy creates problems on three different levels, says Truman Packard, World Bank lead economist and co-author of the study.
According to Truman, at the household level, workers and families are unable to properly manage their income risks because they have no formal access to social security.
Businesses that operate outside regulation also lack access to credit protection of property rights while formal companies "are overburdened due to tax revenue losses and unfair competition from informal firms."