Welcome back, old friend --the grey economy

Taxation is theft. We tolerate it because the thief, government, uses at least some of the loot rationally and sometimes we (civil society) get a piece of it back when using a public service such as education, the police and, in a number of countries, basic health care. When the system starts to break this implied promise, or otherwise grossly disappoint or appear to deceive us, society takes spontaneous action to keep more of the wealth it creates under its own direct and, generally, radically de-centralized control.

This is not meant as some kind of libertarian economic tirade, but a forecast that in Latvia, we will very likely see a resurgence of the grey economy -- the kind where most economic activity works as it should, but as much of it as possible takes place outside the tax system.

It is important to understand that the grey economy is nothing but the everyday, legal economy with a strongly diminished or completely absent incentive to make payoffs (taxes) to the state. It is not the black economy, where many activities are malum in se (evil per se) such as knowingly selling guns to criminals, trading in goods stolen or obtained by fraud, selling the fruits of forced labor and the like. Many would include the trade in state-prohibited intoxicants in black market activities, but that is another issue.

Latvia has a history of grey market activity going back to the 1990s and beyond. It stems from Soviet times when most of the population rightly regarded the state as a totalitarian monster(the Gulags, the KGB) and/or a pathologically lying buffoon (Brezhnev, Communist ideology, promises of socialist prosperity) and did everything in their power to deny to the state or expropriate back from it the fruits of their labor. To put it concisely -- stealing from the state was a virtue. It was the only relatively safe form of resistance.

The grey market continued to evolve during the 1990s, in the general chaos of legislation and system transition. Those who had “stolen” from the state under the Communists often saw little reason or incentive to stop. Only as Latvia reformed and rationalized its tax system, as the state bureaucracy became marginally less byzantine, as accession to the European Union approached and was achieved, did the grey economy recede. With lower tax rates and an apparent “return on taxation”(schools were built, roads fixed, hospitals upgraded), there was less to gain from trying to beat the system, plus there were considerable internal costs in doing so. A bookkeeper keeping two sets of books will ask to be rewarded (on or off the books) appropriately. Concealment and evasion strategies must be formulated in addition to the management time needed to run the core business.

By the middle or the end of the 1990s, the superprofitable business of plundering Soviet-era assets for a song and selling them in foreign markets was also drawing to a close. While making 300 % profit on selling the metal from an abandoned Soviet factory (with most of the labor bartered for vodka) was an incentive to keep such transactions off the books, there was less incentive when earning 25 % from a foundry that did most of its work buying legitimate scrap and selling to export customers that did not want to look like they were buying from bandits and insisted the business at least look like it was paying taxes.

What I see happening is that the massive state budget cuts, hitting at core public services such as education, health care, public safety and pensions, will trigger another boom for the grey economy. If anyone has not caught on to this destruction of “return on taxation”, they will catch on when the government raises a whole slew of taxes (the new tax on residences, higher income and VAT taxes -- in short, whatever was dreamed up this week and may be shuffled around next week). It is time to dust off the grey market experiences of 10 years ago.

The government is very aware of what its own actions are inciting in society -- otherwise it would not be urging the State Revenue Service/VID (or what is left of it after planned massive staff cuts), regulatory bodies and the police to crack down on tax evaders and “illegal” business. Instead of becoming more service-oriented and business friendly, the VID will, if government directives are carried out, revert to its worst inquisitorial auditor/punisher face. File your quarterly papers a day late (even if the taxes they refer to were transferred on time) -- fine ‘em, fine ‘em. Misspell your company name, forget a digit of the registration number, whatever -- off with your head! Now that makes deceiving these fuckers an honest sport again!

Aside from reverting to a state of low intensity civil-war-by-deception with the tax-collecting, regulatory and repressive organs of the state, some businesses (I like to think) have other incentives for paying wages by envelope rather than paying them after tax. Business owners see that off-the-books wages have tangible social benefits, while paying the state social tax has the opposite result. Beggars still huddle on downtown streets, hospitals are closed (for whatever reason), teacher’ s salaries are cut to barely above minimum wage, no matter how much taxes and social fees are paid. When paying envelope wages, the employer knows that the money is being spent by Jānis for his sick mother, by Ieva for her child’s education, by Sergey to modestly renovate his apartment. In other words, the enterprise becomes a kind of private welfare space, spending the money denied the state in more visibly and tangibly beneficial ways. This is not to say that all envelope wages are paid with this kind of consciousness, probably in many cases, this arrangement is part of haphazard and often exploitative labor relations. But then again, back when taxes were paid, weren’t they paid to have labor law enforcers do their job?

In a very rough and often uneven way, a functioning grey economy can at least partly replace the missing “return on taxation” from the Latvian government, which has, during the blind and foolish administrations of the “fat years”, painted itself into a fiscal corner in several dimensions. Officially, the IMF and other lenders are telling it to get its act together, save billions in the next couple of years, cost what it may socially, while society and the real economy are saying -- we won’t pay! (but we will pay some of those deserving it). In effect, the collapsing public services are replaced, in an unevenly distributed way, by the funding diverted to the grey economy.

The grey economy is no replacement for a functioning modern moderate welfare state (as Latvia has tried to pass itself off as being), nor is it a rational step in consciously moving toward a night-watchman state or minarchy (which Latvia seems to be stumbling toward, whether it knows it or not). It is an improvised solution based, not on a reform of the system of governance, but is a symptom of chronically bungled and incompetent governance.

The next developments in Latvia’s economy are going to be pretty rough. European countries with labor markets accessible to Latvian citizens will recover ahead of Latvia. There will be another wave of labor emigration, numbering in the tens of thousands, in the period 2010-2013. Like their predecessors to Ireland and Great Britain in the late 1990s and the first decade of the 2000s, these Latvian economic immigrants are unlikely to ever return permanently to Latvia. Their presence, however, will generate additional repatriated funds, which will be of some limited benefit to Latvia. The Latvian economy, however, will be deprived of much of its best, brightest, most skilled and entrepreneurial labor, increasing the demographic burden on those remaining beyond the mere numbers of those emigrating. Not only warm bodies, but productivity will emigrate, and with that, there will be less value generated by the domestic Latvian economy to reallocate to pensioners and already depleted public services. As for basing an economic recovery on exports, it will be pretty hard when many of the best export producers will have “exported” themselves.

So where will those remaining behind go? Not abroad, obviously. It is a bit exaggerated to think that there will be a day when the last Latvian shuts off the lights at Riga Airport. But in terms of economic and demographic tipping points, there may well be a point at which a sufficient number of “the best and the brightest” have departed, effectively switching off the lights at the end of any tunnels.

So where will the remaining ones go? I think they are already moving into the virtual, tentative, experimental, not-as-disfunctional-as-the-official-economy space that is the burgeoning, resurrected grey economy. And I do not blame them at all.

The disaster continues...

I have just returned from being in the US for just over two weeks and, due to sporadic internet access, I have been following developments in Latvia sporadically. The main events/news/rumors concern the continued collapse or hapless reduction of health services, including emergency medical care. The so called First Hospital in Riga (Pirmā Slimnīca) is being reduced to a day clinic and private medical facility, with an apparent sharp reduction in emergency medical services. So don't fall ill or have an accident in downtown Riga, which the hospital used to serve. Some 570 medical and non-medical staff are being laid off, effective almost immediately. There are now stories circulating of Latvian physicians applying for seasonal harvest work in Great Britain (through a company in the news because of dubious recruitment practices).

A couple of years ago, I was informed of a Scandinavian-based project to set up a commercial, state of the art hospital in Riga (or buy one of the existing ones) to provide offshore care to foreigners as well as paid and pro bono care for locals. This seems to have come to naught, as a foreign acquisition could be one way to "save" the First Hospital or Hospital No. 1 (a better translation?). One wonders why the government isn't putting up most of Latvia's hospitals, especially the better equipped ones, for sale rather than turning them into skeleton-staffed clinics? Is the government ineptly covering up that it is, in effect, privatizing health care? So why not do it openly and say -- we are selling our "superfluous" hospitals in an international tender. concession or whatever. In other words, allow international health care corporations to bid for these hospitals with certain conditions for providing low cost care to all citizens (or setting up private insurance schemes) rather than closing or downgrading the places as day clinics and letting (some) heart surgeons pick vegetables in Ireland?

Some of the wildest rumors claim that the hospital will be torn down to make room for a casino, a story that could have been fueled by Riga mayor Nils Ušakovs reported statement that he would like to see "a little Las Vegas" in the Latvian capital (gambling and entertainment resorts for tourists, mainly from Russia where the casino business has been shut down or exiled to the edge of the Siberian tundra).

Meanwhile, there are reports that under the still-confidential new agreement with the International Monetary Fund (IMF), Latvia may be raising its value-added tax (VAT) again to 23 %. There are very optimistic predictions that additional tax revenues from this and possibly a progressive income tax should reduce the need for budget cuts in the 2010 budget to LVL 260 million from the previous assumption that LVL 500 million would have to be cut. OK, there is a report that tax revenues in recent weeks have been trailing planned amounts by only 1 %. But I firmly believe that further VAT hikes will not increase revenues and shift transactions in certain items to the gray market. Tax evasion is a normal and, I think, morally justifiable form of resistance to an inept government that has broken the promise of rendering basic services for the taxes it extracts from the population. The government, by suddenly and seemingly irrationally (state of the art hospitals closed or downgraded, pensions cut--although Sweden has done that, too-- other services attacked with a percentage-guided axe swung in the dark) reducing the return on citizen's taxes will inevitable decrease the tax base through salary cuts, unemployment, and tax evasion. The sums to be cut from future budgets will increase, rather than decrease as government revenues spiral downward, spurred by the government's own policies.

Dazed and confused and swingin' that axe

Information has been reaching Latvian media about the government's so-called structural reform plans, but it is somewhat contradictory and confusing. It was announced that of 77 state agencies, 50 % would be eliminated. It was not clear why 50 % and not 25 % or 80 %. Nor were the selection criteria any clearer. Some of the changes would affect agencies that were, in fact, museums (like the one at ex-president Karlis Ulmanis* former country home), others were aimed at merging or reshuffling agencies related to the Ministry of Health. Something called the Pharmaceutical Pricing Agency and some other health-related agency would be merged into something called the Health Care Economics Agency (I translate loosely from the Latvian). Whatever any of that means...

What the point of this is evades me. It is clear that by this fall, there will be little or no government funded health care -- no elective surgery, many regional hospitals reduced to day health centers with little or no funding, no more emergency health care except for some remnants in bigger cities (without a national medical helicopter service, private or otherwise, victims of serious highway and other accidents are simply going to die more often.)

As opinion makers and experts queried by the national daily Diena pointed out, there are goals in terms of numbers and percentages for cutting this, that or the other thing (wages, staff, number of agencies) but no vision of why this is being done and what, exactly, it is that the Latvian institutions of governance are supposed to do.

I have raised the issue of reducing Latvia to a minarchy, which is where the reforms and massive budget and government salary cuts all point to, But there is no conscious plan and long term, socially responsible scheme for doing so. As I write, there are reports that the government (the Ministry of Economics) is looking into raising taxes -- imposing a new capital gains tax, a dividends tax and perhaps even raising VAT on top of one failed VAT increase earlier this year (VAT revenues are down). If you are going to completely gut such services as health and education, the right thing to do is to slash taxes and give people more money to buy these services on the private market or to toss their share into a cooperative and non-profit venture such as a cooperative school. It should also promote private health insurance and various mutual insurance schemes to fund what will be within a few months geographically limited pay-as-you-heal health care.

The US is not a shining example of publicly funded health care nor does the US system work all that well, but when my dad fell ill last year and passed away after nearly six months in various kinds of care -- hospital, home assistance, a rehabilitation home -- he didn't leave my mom with a mountain of debt. His private insurance and Medicare/Medicaid/ whatever took care of it.

According to one news report, some small enterprises are taking things into their own hands and switching from on-the-books, taxpaying mode to the grey/barter economy. When agents of Latvia's State Revenue Service raided an auto repair shop, they found it busy with people fixing cars, but no books or records had been kept for many months. Those questioned claimed they were swapping favors with friends. A mechanic working on a car said he was doing the job without pay because the owner of the car had just helped him weed and hoe his garden. If that was true (which it may not have been) what is the Revenue Service's problem? No money changed hands, there was no classic economic activity.

I see a distinct economic and social logic in the grey/barter economy. Why can't a cooperative of auto mechanics trade hours of work (of different complexity) for hours of medical care for their families or repair tractors in exchange for vegetables and milk? The medium of exchange is not money, though it can (and has in some experiments around the world) be reduced to a virtual currency equivalent. Tax that! And at the same time as there is no way presently to extract tax cash from standardized barter transactions (as far as I know) -- one hour of engine tuning = one tooth cleaning at the dentist's or whatever, this system can make up for state failure. The auto repairshop works on the cars of most of the health care workers in their area and, theoretically, builds up a surplus of doctor visit hours, which it can distribute to families of its staff or, as a gesture of solidarity and good will, pool into a "free" health care fund for the indigent in the local area. It is patchwork, but maybe better than the nothing the goverment is pushing toward.

It is really, really hot for a Latvian summer night, so I may be rambling here. Comments are welcome.

The ultimate clusterf**k?

Latvian media are reporting that because of administrative and reporting delays, so-called working pensioners who quit their jobs in June because of new laws cutting their pensions by 70 % will receive neither their salaries nor full pensions in July.

Apparently, this is the result of a combination of cut-off dates for preparing pension pay-out lists and reporting delays to the appropriate social services agencies. In some cases, the disparity (being treated as a 30 % pensioner when one has, in fact, quit work) may extend into August. In any case, a number of people who drew both a salary and a full pension they had earned legally earned until retirement age will be effectively destitute for several weeks this summer. Even the State Social Insurance Agency admits this will happen. Those with mistakenly reduced pensions will be compensated in August.

This is an event that adds insult to both the insult and injury of the 10 % pension cuts mandated for all pensioners as well as the 70 % cut for those still working. There is reason to regard pensions as entitlements equivalent to a personal property interest and the reductions amount to a confiscation (without compensation or recourse) of vested property rights.

It is something that further deteriorates the already badly shaken remnants of public trust in the Latvian government and the state as an institution. It will stimulate further tax evasion and recourse to non-state means of financing one's "retirement" (saving from an off-the-books salary, registering a young relative as working while the retired person, in fact, continues to work and collect a full pension). Under present circumstances, there is no "moral" reason to condemn any means by which people affected by these measures retaliate by ripping off the state. One can only say-- Right On!