When the show is on, the audience should automatically be busy with what’s being presented on the stage. At the end of the day, that’s the reason they got there, right? But what if the show’s backstage had more to it than you think it did? That’s exactly what we have seen in the brilliant documentary ZATCA shared in the Fatoora behind-the-scenes documentary.
In this documentary, a very sensitive yet not so often talked about topic was highlighted so that the world could see what consequences the Shadow Economy does to the overall economy, and how regulating all invoices via E-invoicing systems has helped in bringing that down to a minimum. Hence, we hereby would like to tackle this topic and let you on with more details about The Shadow Economy so stick around with us!
Time to shed light on what’s happening in the shadows.
What is “Shadow Economy”?
If you haven’t heard of the term “shadow economy”, you might have heard of other terms such as” informal economy”, “black market”, “parallel economy”, or “underground economy”. And just like all roads lead to Rome, all of these terms lead to the same concept which is economy being done in the shadow and out of the government’s eyes. So, what is it exactly?
The Shadow Economyis a term used to describe the part of the economy where transactions and revenue generated happen under the table without being tracked by the government, hence, not being monitored or set to taxation or regulations of the country. This in turn makes individuals who practice it become non-compliant with the enforced laws of labor and tax. This is due to the fact that these economic activities are not under the legal radar and therefore are not part of the national tax income calculation.
And while we may think little of this, in fact, it’s not, and here’s why.
Shadow Economy: What Are the Consequences?
The shadow economy comes with a long list of risky side effects that could cause actual damage if they continue to happen without implementing corrective measures to flip the outcomes over. Some of the main consequences include the following:
1- Inaccurate Financial Estimations
One of the biggest obstacles governments encounter is inaccurate estimations of the country’s financial statements. This can be attributed to so many factors that play a vital role in agitating this issue. This includes lost revenue that could be obtained from the uncollected taxes associated with these economic activities. As these individuals do not disclose their income in real terms, this is only to be expected. Hence, not complying with regulations that require them to report all sources of income they’re generating.
As a result, this causes yet another issue which is tax evasion. When the income from activities that are being done in the shadow is not detected, not registered, and does not go under the radar of tax authorities, tax evasion is what you expect, or better said, know is the ultimate result awaiting you for a fact.
What does this mean? It means the audit efficiency for the national income is going to be highly affected by inaccurate numbers which in turn will lead to wrong planning built upon inaccurate data, thereby, affecting the results and metrics leaders rely on to make sensitive financial decisions.
2- Injustice in the Social and Economic Sphere
Taxes from registered income contribute to governments’ budget plans for public services offered to individuals in communities. Hence, incomes that go unnoticed in the shadows deprive essential contributions that could be made to sectors like healthcare, education, infrastructure, and more.
On a social level, the impact of the shadow economy spreads its wings to entail serious issues like income inequality, as individuals who aren’t officially registered don’t get privileges like the social security and safety they need. However, from another point of view, they’re also benefiting from public services without being a contributing part of it. In other words, they’re living off of other individuals’ contributions without paying their fair share of taxes.
3- Increased Crime Rates
Some use the shadow economy simply to increase their income and thus they work different jobs to have multiple sources of income to cover their living expenses. But, that’s not always the case. Criminals are now finding their way into the shadow economy to practice their criminal activities without being tracked and this is such a matter of gravity to be cared about.
Not having enough measures that detect and mitigate the shadow economy behaviors paves the way for an environment where illegal activities like money laundering, selling & trading of drugs, stolen goods, counterfeiting, and much more serious crimes like human trafficking, gambling, smuggling, and the list drags down.
4- Lack of Economic Stability
The shadow economy puts countries in a tough position where they’re vulnerable to risks at much higher stakes, as the lack of transparency leads to a lack of data that leads to uninformed decisions. Moreover, this provides fertile soil for “under-the-table” activities and “off-the-books.” transactions.
When sources that play a vital role in nourishing the economy to make better investment decisions are no longer available, the economic state of the country will be hindered by not having sufficient funds and resources to cover the needs. When governments are not capable of fulfilling the financial obligations, they’re obliged to, the result is higher inflation rates and borrowing costs. All of which leads to more and more instability.
Do You Know How It Looks Like?
Shadow economy may not look like what you have in mind and that’s the tricky part about it. It’s the fact that so many of us are practicing it without knowing they’re doing it. Do you happen to know a neighbor who makes delicious foods and sells them to residents in the neighborhood? Perhaps a friend who gives private tutoring sessions?
While it’s true that these people are doing legal jobs, they’re not selling drugs for instance, but what they do falls under the classification of the shadow economy as they’re receiving money in cash or doing activities that bring them income without being registered officially as part of the national economic plan.
With that being said we understand that the shadow economy can include legal jobs or illegal jobs. Such as your aunt selling her cookies or a drug dealer smuggling drugs. Despite the fine line between both, of course, you should know that even innocent acts could give room to criminal ones to rise and fill up the room.
But What Causes its Rapid Increase?
No fire starts without fuel, and if you give it enough gasoline be prepared for big flames coming up your way. The shadow economy was first noticed to be widely spreading in developing countries; however, it’s become a worldwide phenomenon all around the globe.
The main reason lies in the increasing living costs, increasing taxes, and work restrictions that hinder individuals from making enough income to cover their basic needs. Countries with poor planning and unclear regulations enhance the chances for shadow economy participants to grow bigger.
Yet, we do see countries where the shadow economy is still within control, and these are countries that succeeded in drawing up careful plans, placing regulations without suffocating restrictions, as well as building the social security system rules fair and square so everyone’s right is protected.
How Do E-Invoicing Systems Combat Shadow Economy?
An E-invoicing system can serve as a very powerful weapon to combat the shadow economy if properly utilized. The issue with the shadow economy lies in the fact that some financial transactions are taking place off the records due to cash and paper-based invoices. However, this won’t be the case anymore once all invoices of financial transactions are tracked through electronic software integrated with the official authorities in charge. Hence, giving them a deeper look at all invoices to detect suspicious numbers or behaviors.
E-invoicing systems help:
1- Ensure Accurate Audit Trails
Tax authorities can run accurate audits as E-invoicing systems provide detailed records of all transactions happening whether it’s B2B or B2C. Thereby, identifying any tax evasion attempts effortlessly.
2- Conduct Legal Check-ups
Mandatory integration between businesses and tax authorities allows governments to set standards for compliance and reporting. This in turn eases the process of knowing who’s breaching any of these standards.
3- Integration with Local Authorities’ Tax Systems
Integrating E-invoicing systems with the tax authorities’ systems is now becoming a must in so many countries, and for that, E-invoicing systems are being developed in a way that ensures compatibility with your local authorities’ regulations.
Our InvoiceQ system has been developed to meet the constant updates by ZATCA in Saudi Arabia and ISTD in Jordan to reflect all updates immediately without extra hard work from the client’s side because we understand how crucial it is to pick a system that complies with your government’s regulations.
Furthermore, InvoiceQ provides real-time tracking and monitoring to ensure that all taxes are paid on time and accurately. This helps our clients avoid any penalties or fines associated with non-compliance.