Content uploaded by Colin C Williams
Author content
All content in this area was uploaded by Colin C Williams on Jul 01, 2021
Content may be subject to copyright.
RE:SHADE PROJECT
POLICY BRIEF
MEASURES TO TACKLE THE KEY
DRIVERS OF WAGE UNDER-
REPORTING IN LATVIA
April 2021
Colin C Williams
University of Sheffield
1
Contents
1. Introduction ................................................................................................... 1
2. Trust and satisfaction with services provided by the government ........... 2
2.1 Whether society believes in the social insurance system - likelihood of receiving an
appropriate pension ........................................................................................................................ 2
2.2 Satisfaction of the society in general and/or entrepreneurs with services received from the
government; how the tax money is spent. ...................................................................................... 3
2.3 Satisfaction of the society/entrepreneurs with the work of various institutions, such as the
state revenue service....................................................................................................................... 6
2.4. Perception of the level of corruption in the government (various levels) ............................... 9
3. Probability of being caught and/ or punished ............................................ 10
3.1. Probability of being caught. .................................................................................................. 10
3.2. Severity of punishment once caught: legislative level .......................................................... 16
3.3. Rational choice: risk of being caught vs what happens “in reality” once caught. Including
efficiency/ practices of courts, application of the legal framework such as criminalization of
envelope wages. Trust and satisfaction with services provided by the government .................... 21
4. Influence of the tax policy. ......................................................................... 26
4.1. The level of the tax wedge on low wages, also in comparison to neighbouring countries. .. 26
4.2. Overall satisfaction (of entrepreneurs/ society) with the tax policy ...................................... 28
4.3. Complexity of the tax system: easiness to report and pay taxes. Bureaucracy. .................... 29
4.4. Complexity of the tax system: many tax regimes that provide scope for “tax optimization” 31
5. Competition vs tax evasion, tax morale .................................................... 35
5.1. Tax evasion (paying envelope wages) as a self-sustaining phenomenon: widespread wage
underreporting distorts competition, and firms might choose to evade taxes to be able to compete
with their peers. ............................................................................................................................ 35
6.2. Tax morale: whether it can be justified to cheat on tax if there is such a chance. On the side
of employees ................................................................................................................................ 36
6.3. Tax morale: whether it can be justified to cheat on tax if there is such a chance. On the side
of employers ................................................................................................................................. 38
6. Industry and company size specific issues: determinants of the
envelope wages. Includes administrative burden (various levels), specific
mechanisms due to the industry specifics to decrease the envelope wages . 40
6.1. Construction industry ............................................................................................................ 42
6.2. Retail ..................................................................................................................................... 46
6.3. Wholesale .............................................................................................................................. 50
2
6.4. Manufacturing ....................................................................................................................... 50
6.5. Services ............................................................................................................................ 51
6.6. Start-ups ................................................................................................................................ 58
7. Communication of the government institutions with the tax payers ....... 61
7.1. Whether and how communication takes place to have a positive impact on reducing
envelope wages? ........................................................................................................................... 61
7.2. Consult first approach ........................................................................................................... 61
8. Conclusions and recommendations ........................................................... 63
References .......................................................................................................... 71
1
1. Introduction
Wage under-reporting (or under-declared employment) occurs when a formal employer pays a
formal employee an official declared wage but also an additional undeclared (“envelope”)
wage. Given that employers often give this undeclared part of the wage to the employee as
cash in an envelope, the study of wage under-reporting is commonly referred to as the study
of “envelope wage” practices.1
The three key reasons for the formal employer not to declare the full salary of the formal
employee are:
• to evade payment of the full tax contributions owed to the state;
• to evade payment of the full social insurance contributions owed such as pension and
health insurances; and
• to evade having to meet certain legal labour standards, such as minimum wages and
maximum hours.
As such, wage under-reporting is of interest to government authorities responsible for tax,
social security and labour law compliance respectively.
For tax administrations, their main interest in wage under-reporting is the lost tax revenues
that result from formal employers not declaring the full salary of their formal employees to
the state for tax compliance purposes, which result from written contracts with a lower official
wage than the real wage.
For social insurance institutions, and for tax administrations responsible for social security
contributions such as pension and health insurance contributions, their main interest is both
the lost social contribution revenues that result from wage under-reporting as well as the
negative impacts on workers who may have reduced pension and health entitlements due to
this under-payment.
For those charged with ensuring labour law compliance, namely labour inspectorates, their
main interest in wage under-reporting is the negative impacts on workers due to the false
declaration of labour contracts. This can include:
• employers verbally agreeing with employees for them to work longer hours than stated
in their written contract. This can result in: those on a formal part-time written contract
actually working full-time; full-time workers doing more than the maximum hours in
the working hours’ directive; other false calculations of working time that do not
account for night, holidays and/or extra hours of work, and/or the wage paid to
employees is less than the minimum hourly wage.
• employees being asked to conduct different tasks and/or responsibilities to those in
their written contract; and
• employees being asked not to take their full holiday allowance.
To tackle wage under-reporting, two contrasting policy approaches are available to
governments and social partners. A “direct” controls approach ensures that the costs of
engaging in wage under-reporting outweigh the benefits, either by increasing the penalties and
risks of detection, or by improving the ease and benefits of full declaration. An “indirect”
controls approach, meanwhile, asserts that wage under-reporting occurs when the norms,
1 See Franic (2017, 2019, 2020); Meriküll and Staehr (2010); Williams (2008a,b, 2009, 2010, 2013, 2014b);
Williams and Bezeredi (2017); Williams and Horodnic (2017b, 2021); Williams and Padmore (2013a,b);
Williams and Yang (2017).
2
values and beliefs of employees and employers are not in symmetry with the laws and
regulations. Here, therefore, policy measures seek to align the norms, values and beliefs of
employees and employers with the laws and regulations. This is done either by changing
norms, values and beliefs using education and awareness raising campaigns or by
modernising formal institutions to improve trust in government.
Here, the policy initiatives are identified for tackling each determinant of wage under-
reporting by:
(i) explaining why it is important to focus on the determinant and its potential impact
on preventing envelope wages;
(ii) reporting “best practices” in fighting this determinant of envelope wages in other
countries and
(iii) making preliminary suggestions what can be done in Latvia to address this issue in
addition to initiatives already initiated.
2. Trust and satisfaction with services provided by the government
2.1 Whether society believes in the social insurance system - likelihood of receiving an
appropriate pension
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
Many citizens do not believe that they will receive an appropriate pension even if they pay
into the social insurance system. This uncertainty is in part a historical legacy of the
“transition process” and in part a direct product of continuous changes in laws and
regulations. The result is that they do not expect rules that apply today to remain in the future.
They therefore see little point in making social insurance payments. This perceived lack of
permanency of the formal rules therefore leads many to seek to evade social insurance
payments.
Best practices in fighting this determinant in other countries
To improve trust and satisfaction with the social insurance system, and the perceived
likelihood of receiving a pension, there is a need to draw upon wider initiatives elsewhere (i)
to educate citizens on the benefits of making social contributions and (ii) to display to them
the benefits of doing so. Best practices on education and awareness raising initiatives are
outlined in Section 5.
What can be done in Latvia?
• A marketing campaign can be launched (e.g., by SRS) to publicise that the COVID-19
pandemic short-term support measures have been a benefit of making full social
contributions, since they have received 75% of their declared wage (see Box 1).
Box 1: Allowances for idle time for employees during the COVID-19 pandemic, Latvia
The allowance for the idle time is determined by the State Revenue Service, in the amount of
75% of the average monthly gross work remuneration, calculated for the period corresponding
to the last six months before the declaration of the emergency situation, or in accordance with
the actual data declared by employees within the previous six months. It cannot exceed €700
per calendar month. The allowance for idle time is not subject to personal income tax and to
mandatory State social insurance contributions. The employers and taxpayers, afflicted by the
COVID-19 crisis, that can apply for the allowance, are those with:
3
o
An income from economic activity which, due to the spread of COVID-19, decreased by
at least 30% in March or April 2020, in comparison with the respective month in 2019.
o An income from economic activity which, due to the spread of COVID-19, decreased by
at least 20% in March or April 2020, in comparison with the respective month in 2019,
provided that they meet at least one of the following criteria: i) in 2019, the export volume
of the employer affected by the crisis amounts to 10% of the total turnover or is not less
than €500,000; or ii) the average monthly gross work remuneration disbursed by the
employer affected by the crisis in 2019 is not less than €800; or iii) as on 31 December
2019, long-term investments in fixed assets are at least €500,000. The Regulations of the
Cabinet of Ministers No. 165 set forth in total 14 reasons when the allowance should not
be paid, encompassing the existence of a tax debt higher than €1,000, or if the employee
has commenced the employment relationships after 1 March 2020.
• The SRS could also advertise that those receiving envelope wages prior to the pandemic
will be entitled to only 75% of their declared wage, displaying the negative impacts of
accepting envelope wages.
• On pensions, the most important policy in future years is not to make policy changes.
Policy stability and permanency is necessary. If changes are made, they should be clearly
more beneficial for citizens, not less so, and this should be obvious and easily
communicable.
2.2 Satisfaction of the society in general and/or entrepreneurs with services received
from the government; how the tax money is spent.
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
To improve trust in government and therefore prevent wage under-reporting, it is necessary to
improve “redistributive justice”, namely the belief of citizens, workers and entrepreneurs
that they receive the goods and services they deserve given the taxes they pay (Richard and
Sawyer, 2001). Taxes are the price the population pays for the public goods and services that
government provide. The question is whether the price corresponds to the perceived value of
these goods and services (i.e., whether it is “just”). The less the tax system is seen as just, the
more likely they will be to break the social contract with the state and engage in wage under-
reporting. To improve compliance therefore, the compliance system must be seen as just. To
do this, governments need to educate the population about where their taxes are spent and
why social security and labour laws prevail. When they do not know, or do not fully
understand what public goods and services are provided with their taxes, compliance is lower
and envelope wages prevail.
Best practices in fighting this determinant in other countries
In recent years, many governments have begun to pursue education and awareness raising
initiatives to encourage taxpayers to understand how taxes are spent and to believe that they
receive the public goods and services they deserve for the taxes they pay.
In the UK, on completion of a self-assessment tax return, a taxpayer receives a breakdown of
how their taxes are spent (e.g., xxx euros of their taxes have been spent on schools, yyy euros
on health services, zzz euros on policing and fire services). This enables them to understand
how their taxes are spent.
4
To encourage taxpayers to believe that they receive the public goods and services they
deserve for the taxes they pay, many countries have used advertising on posters in physician
surgeries, hospitals, on fire engines, ambulances etc that these are paid for using taxes and
social contributions. Box 2 provides an example from Estonia on how redistributive justice
can be improved.
Box 2: “Thank you for paying taxes”, Estonia
The Estonian website campaign “Thank you for paying taxes” is maintained by the country’s
Tax and Customs Board. It is targeted primarily at employees, thanking them for paying their
taxes and underlining that those funds are the reason that hospitals, schools, roads and
pensions exist. It also shows that personal benefits from paying taxes (e.g. a mother’s pension
or son's school allowance) could be lost if there were no taxpayers. The website contains a
video that illustrates the contribution made by taxpayers, for example, carrying a sick person
inside a hospital:
Source: Video from the Estonian tax and customs information campaign
Box 3 outlines a further example from Estonia developed by the tax authority and other
stakeholders.
Box 3: “Where does my money go?”, Estonia
The Estonian Tax and Customs Board have collaborated with social partners – the Praxis
Centre for Policy Studies and the Open Estonia Foundation – to find a creative way of
showing people that paying tax matters.
The social partners researched labour market issues in Estonia and contributed insights into
the reasons for operating undeclared, namely poverty, taxes, mobility, regional inequality, and
uncertainty about whether tax and social security payments will be used for the public good.
Based on this research, the partners then created a tax calculator called “Where does my
money go?“, so people can see the societal benefits of paying taxes. The calculator is hosted
on the website of the campaign against envelope wages, run by the Estonian Tax and Customs
Board.
5
Source: Screenshots from the “Where does my money go?” campaign
What can be done in Latvia?
• On completion of a self-assessment tax return, a taxpayer could be sent an individualised
breakdown of how their taxes are spent (e.g., xxx euros of their taxes have been spent on
schools, yyy euros on health services, zzz euros on policing and fire services).
• Signs stating “your taxes paid for this” could be put on roads, ambulances and fire
engines, and in hospitals, doctors’ surgeries and schools.
• Introducing in the civics curriculum in schools the issue of taxation and adhering to labour
legislation could improve young people’s understanding of the importance of compliance.
• The feasibility of transferring the “Thank you for paying taxes” campaign from Estonia
could be evaluated.
• The feasibility of transferring the “Where does my money go?” calculator from Estonia
could be evaluated.
• The feasibility of developing an app could be evaluated which displays the negative
impact of the non-declaration of full taxes and social contributions on spending on
hospitals, schools and other areas of spending that citizens view as important to their well-
being. This would show the negative consequences on their lives of accepting envelope
wages.
6
2.3 Satisfaction of the society/entrepreneurs with the work of various institutions, such
as the state revenue service.
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
To improve trust in government and therefore prevent wage under-reporting, it is necessary to
improve “procedural justice”, namely the belief of citizens, workers and entrepreneurs that
the authorities treat them in a respectful, impartial and responsible manner (Murphy, 2005).
This requires a shift away from a “cops and robbers” approach and towards a customer-based
service-oriented approach for enforcement authorities (e.g., SRS, SLI).
It is also important for a more customer-friendly joined-up approach to operations to be
adopted. It is traditionally the case that different enforcement bodies conduct separate
operations in an uncoordinated manner. A more business-friendly and effective approach is to
join-up operations, such as by doing joint and concerted inspections:
• Concerted inspections are inspections undertaken by two or more competent
authorities simultaneously and related to the same case, but perhaps in different
locations.
• Joint inspections of a workplace are when an inspection is conducted concurrently by
several enforcement authorities in the same workplace.
Rather than receive multiple visits from different arms of government (e.g., labour inspectors,
health and safety inspectors, tax inspectors), a joined-up approach can be perceived as a
business-friendly approach that reduces the perceived burden of government regulation.
Best practices in fighting this determinant in other countries
If citizens view government institutions as treating them in a poor manner, the evidence is that
they are more likely to engage in non-compliant behaviour (Murphy et al., 2009). Leventhal
(1980) thus proposed the following six rules for how governments should interact with
citizens to improve the perceived level of procedural justice:
• The consistency rule - procedures should be consistently applied across all people and
over time; nobody should be more favoured, or disadvantaged compared with others;
• Bias suppression rule - egoistic intentions and prejudice on the part of the decision-
makers must be avoided;
• Accuracy rule - all relevant sources of information should be exhausted, in order that
decisions are based on well-founded evidence and information;
• Correctability rule - the possibility that decisions made can be adjusted or revised in
the light of evidence;
• Representativeness rule - the interests and opinions of all stakeholders and individuals
involved should be considered; and
• Ethicality rule - procedures should be in accord with the prevailing moral and ethical
values.
Others additionally consider the importance of interpersonal interactions. Compliance rates
are significantly higher when people are treated politely, with respect and dignity, are given a
say, and have genuine respect shown for their rights and social status (Gangl et al., 2013).
However, if they believe they are being treated unfairly or unreasonably, such as by
inspectors showing disrespect for them, or they believe that taxes are collected and being used
7
to support the interests of powerful private interests who have captured the state, this results
in a lack of trust and lower compliance rates (Murphy, 2008). There is thus a need for
enforcement authorities to treat citizens, workers and employers with respect and dignity. The
overarching goal is to improve the trust and confidence of citizens, workers and employers in
public administrations. Box 4 provides some good practice examples.
Box 4: Customer-oriented advisory approach: good practice examples
“Infoline” – operated by the Information and Customer Services Unit (ICS) at the
Workplace Relations Commission (WRC), Ireland
Assistance on the Spot –
providing support to companies to avoid violations of
labour legislation with respect to bogus self-employment, Czechia
Nationa
l Contactcentre of the Federal Labour Inspection of the Belgian Federal
Public Service Employment, Labour and Social Dialogue, Belgium
Consultation with the State Labour Inspectorate via Facebook Messenger, Lithuania
The Workplace Relations Commission (WRC) in Ireland, which is the Irish State Labour
Inspectorate, operates a “legal advice centre” which is an exemplar of “good practice”.
Inspectors also need to be trained to adopt a more advisory approach. This requires
investment in the education of inspectors. In the Netherlands labour inspectorate, the
following methods have been used to develop a more advisory approach:
• Rather than simply ask the question on the inspection checklist in the form of an
interrogation, inspectors have bene trained to talk to the workers and employers and to go
beyond the questions on the checklist;
• During training, inspectors have engaged in role play, taking on the roles of the different
people involved, to understand what it feels like;
• Inspectors are encouraged to take the worker away from the workfloor and to interview
them elsewhere to build their trust and enable them to tell their story, and
• They record the interview using a body camera and then watch it back later for the
expressions of the worker when asked particular questions.
To facilitate greater cooperation on operations, each enforcement authority could set a target
of achieving a share of all its inspections as joint or concerted inspections. It could also be
agreed how the successes of the joint inspections will be distributed (i.e., which enforcement
authority claims the detections and fines), which has previously been a contentious issue in
some countries. Box 5 highlights some examples of good practice in joining-up operations.
Box 5: Good practice examples of business-friendly joined-up operations
Joint operation group between public agencies, Norway.
Action Alliances a
gainst undeclared work and illegal employment between the
Federal Ministry of Finance and the social partners, Germany
Specialised team of labour inspectors to combat undeclared work in the media sector
in Portugal
Multiagency initiative on tackling social dumping – the role of letterbox companies,
Denmark
8
Inter-agency inspections to tackle undeclared work, Czechia
Joint control actions between the Ministry of Labour and the Ministry of Transport in
the transport sector, France
What can be done in Latvia?
To introduce procedural fairness, a more customer-friendly approach is required. First steps in
this direction are for the inspectorates to shift towards:
• A more customer-oriented advisory approach both by creating advisory units within
their inspectorates (akin to a “call centre” with scripted language responses) and
adopting a more advisory approach during workplace inspections. Box 5 formulates a
recommendation for a call centre in Latvia based on the Irish experience.
Recommendation
Creation of Legalisation/Formalisation Support and Advice Centre
in the Senior Labour Inspectorate
Goal
To increase the provision of formalisation support and advice
Implementation
•
Establish a call centre in which operators provide advice to
businesses on labour law (and perhaps also tax and social insurance
matters if it is an inter-ministerial initiative and a “one-stop shop”
across government).
• Head Office staff in the SLI (and SRS if it is an inter-ministerial
initiative) should produce scripted language responses to “frequently
asked questions”
(FAQs), and over time, develop the number and
depth of responses to FAQs that are made available to operators.
•
The responses should not be purely statements of for example the
Labour Code, Tax Code and Civil Code, but should convey the legal
issues in “simple to understand”
ways, as well as provide clear
practical guidance on what needs to be done to operate legitimately.
• Those with work experience in “call-centres”
and adopting a
“customer-friendly” approach to callers should be then employed in
the legal advice centre.
• Most e-mail queries/telephone calls/online messages are dealt with by
these call-centre operators.
• Inspectors should only be used for the small proportion of calls that
cannot be answered using scripted language responses to “frequently
asked questions”.
Responsible
Institutions
SLI and SRS
Indicators of
achievement
• The call centre will have a target of referring only a small proportion
(<10%) of calls to labour (/tax) inspectors. A greater proportion of
referrals displays that the “scripted language responses” are
inadequate a
nd that more work is required on developing these
responses.
• Evaluation of the usefulness of the legal advice provided during a
9
“call” should be by either (i) a simple question at the end of the
phone call that asks “have we answered your query satisfactorily?” or
(ii) a follow-up email or message at the end asking them to rate the
quality of advice provided on a likert scale from 1= very useful, 2=
somewhat useful, 3= neutral, 4= not very useful, 5= not useful at all.
• Training inspectors to adopt a more advisory approach, including:
o Rather than simply ask the question on the inspection checklist in the form of
an interrogation, inspectors could be trained to talk to the workers and
employers and to go beyond the questions on the checklist;
o During training, inspectors should engage in role play, taking on the roles of
the different people involved, to understand what it feels like;
o Inspectors could be encouraged to take the worker away from the workfloor
and to interview them elsewhere to build their trust and enable them to tell
their story, and
o They could record the interview using a body camera and then watch it back
later for the expressions of the worker when asked particular questions.
• To facilitate a more business-friendly approach to inspections, greater cooperation on
inspections could occur. Each enforcement authority could set a target of achieving a
share of all its inspections as joint or concerted inspections.
2.4. Perception of the level of corruption in the government (various levels)
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
Corruption here refers to the “misuse of public office for private gain” (Bardhan, 1997; Pope,
2000; Shleifer and Vishny, 1993; Svensson, 2005). This can refer to the practice whereby
government officials demand or receive gifts, bribes and other payments (e.g., a portion of a
given contract) from private sector firms and provide a service in return. This might include
speeding up the granting of an operating license, not producing a negative outcome from a
workplace inspection, or helping them avoid delays in some other regulatory process
requiring the approval of public sector officials such as the granting of a construction permit.
However, other forms of corruption exist. These include “state capture”, whereby firms
influence the formulation of laws and other government policies to their own advantage
through illicit or non-transparent means, and corruption where consumers use payments and
connections to gain preferential access to public goods and services and/or to circumvent
formal procedures, including the gaining of access to educational and health services
(Williams and Onoshchenko, 2014a, b, 2015).
In Latvia, amendments to the Law on Prevention of Conflict of Interest in the Activities of
Public Officials were submitted to the Cabinet of Ministers in 2019. This prohibits public
officials from accumulating cash exceeding 20 minimum monthly wages (in his/her
household), as well as introducing a new obligation for public officials to submit additional
declarations containing information about it; transactions above 20 minimum monthly wages.
Best practices in fighting this determinant in other countries
One option is to increase the penalties and risks of detection for those engaging in corruption.
Another option is to increase the benefits of not engaging in corruption, such as increasing
10
wage levels. However, altering the costs and benefits only deals with the effects, not the
causes, of corruption. On the one hand, there is a need to change the acceptability of
corruption, such as through educational and awareness raising campaigns. On the other hand,
the formal institutional deficiencies that lead to corruption need tackling, including the
salaries paid to public officials, and the efficiency and quality of governance. Institutions
should be designed in a manner that does not encourage rent-seeking tendencies from public
officials (i.e., by being disorganized, discretionary and taxing firms timewise) and with
enforcement mechanisms and processes that discourage opportunities for corruption.
What can be done in Latvia?
• Increase the penalties for the “misuse of public office for private gain”.
• Increase the risk of detection by providing complaint reporting hotlines for customers.
• Improve the salaries for public officials.
• Improve enforcement processes (e.g., inspections and audits) in a manner that prevents
opportunities for corruption (e.g., more office-based and written rather than face-to-face
oral inspections, use of body cameras during inspection visits turned on and closed down
on entering the physical premises using GPS).
3. Probability of being caught and/ or punished
3.1. Probability of being caught.
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
To tackle wage under-reporting, the dominant policy approach has been to change the cost-
benefit ratio confronting participants by increasing the actual and/or perceived costs of
engaging in wage under-reporting. The first way in which this can be achieved is by
increasing the actual and/or perceived risk of detection. This can involve:
• Improving the effectiveness of workplace inspections;
• Joint inspections with other inspectorates;
• Announced inspections;
• Registration of workers prior to first day at work;
• Data matching and sharing to improve the effectiveness of detection of risky
businesses;
• Use data mining to determine risky businesses for inspection;
• Coordination of data mining and sharing across government departments;
• Use of complaint reporting tools (e.g. telephone hotlines);
• Certification of business, certifying payments of social contributions and taxes;
• Notification letters;
• Mandatory Identity Card (ID) in the workplace, and
• Supply chain responsibility.
Here, a selection of good practices are highlighted that are potentially transferable to Latvia.
11
Best practices in fighting this determinant in other countries
Starting with workplace inspections, identifying wage under-reporting is difficult because
these formal employees have a written contract or terms of employment and a declared salary,
and only one-third of EU employees receiving envelope wages would prefer full declaration,
meaning that there is likely to be limited whistle-blowing from employees. Moreover, even
those employees unhappy who might wish to whistle blow will be reticent about doing so for
fear of losing their job. For this reason, a shift away from workplace inspections and towards
data mining and matching, using dynamic benchmarking to identify anomalies/outliers, is
required to detect wage under-reporting.
Databases are required that can identify wage under-reporting such as by analysing average
earnings in firms, and cross tabulating this with average salaries in their region and/or sector,
or by occupation, in order to identify outlier businesses paying below the average wage for
their region and/or sector, or for particular occupations.
In Greece, “red flags” used to identify wage under-reporting include businesses with a:
High percentage recruiting and redundancies within 2-5 days in relation to the total
number of employees (>20%);
High percentage of labour disputes in relation to the total number employees (>20%);
High percentage of employees with less than 20 hours/week (>30%);
High percentage of altering employment contracts, from full-employment to part time,
within the last semester (>30%);
High percentage of schedule modifications of employees in relation to the total
number of employees (>20%);
High numbers of recruits and redundancies in relation to the total number employees,
within the last semester (>40%);
High percentage of foreign employees or posted workers (>50%);
High percentage of labour accidents in relation to the total number employees (>10%).
Or the business has:
Never been inspected/was inspected a long time ago.
These red flags use data available in the database. However, a more strategic approach to
database design is to ask, “what data do I need to identify wage under-reporting?” rather than
“what do I possess which I could use?”.
To start to do this, various indicators that could be used to identify risky-businesses likely to
be involved in wage under-reporting include:
• Average salary in company compared with average salary in the same sector;
• Average salary in company compared with average salary in region;
• Average salary of a certain occupation/profession in the business does not correspond
with the average salary within the same occupation/profession in the country, sector
and/or region;
• Large proportion of a company’s employees are working part-time compared with
other similar businesses;
• Number of employees/total wages paid is not appropriate to the turnover;
• Complaints have been received about undeclared work;
12
• The business has previous violations related to undeclared work;
• Businesses where a higher proportion of workers receive the minimum wage
compared with other similar businesses.
It is then necessary to use dynamic benchmarking to identify anomalies/outliers (i.e., “risky”
businesses). This identification of potential outlier/anomalous businesses likely to be under-
reporting wages could enable more targeted inspections and notification letters to be sent.
In Belgium, the FPS Social Security using data mining tools, identify twice as many cases of
wage under-reporting as are discovered using random selected audits (see De Wispelaere and
Pacolet, 2017). So too do the Fiscal Administration of the Republic of Slovenia reveal that in
8 out of 10 of the audits selected via data mining, wage under-reporting is found by the
inspector, which is much higher than randomly selected audits (see De Wispelaere and
Pacolet, 2017).
When using data mining and risk assessment to improve the targeting and efficiency of
inspections, however, there is a need to train inspectors in their usage. One good practice in
this regard is Greece where a pilot initiative has trained labour inspectors in three regional
inspectorates to use the ERGANI system during a three-hour training session when the
inspectors learn how to use the system in real time while they are carrying out an inspection.
Data mining and risk assessment can be used not only to improve the detection of businesses
but also to identify targets for preventative activities such awareness raising and notification
letters.
The resultant data needs to be made available to all enforcement authorities. Box 6 provides
an example from Finland of how the traditional problems with sharing data have been
overcome by creating one central unit that provides a data mining and analysis service for all
government ministries involved in tackling wage under-reporting.
Box 6: Grey Economy Information Unit (GEIU), Finland
Aim: To join up the previously fragmented function of data mining and analysis.
Description
: The Grey Economy Information Unit (GEIU) was established in 2011. It
produces and shares information on undecl
ared work. Through its Compliance Report
Service, it provides a single point of access for permitted public authorities to gain
information on organisations and individuals within organisations suspected of engaging in
undeclared work. The GEIU is responsible for gathering and disseminating information on
the grey economy (i.e. producing general reports as well as compliance reports on
organisations and individuals within organisations at the request of other public authorities).
The authorities permitted to request compliance investigations are defined in the enacting
legislation, as are the purposes for which a compliance report can be prepared. A compliance
investigation can also be based on a general phenomenon report.
The service is fully automated with a full web interface which means, for the most part, that
compliance reports are produced automatically and delivered to the information system of
the requesting authority. The GEIU does not charge for the preparation of compliance
reports. It is also entitled to obtain, free of charge, the information it needs to prepare the
reports. The GEIU also operates a public website on the Grey Economy and Economic
Crime for public agencies, companies and individuals providing an overall picture, and
topical information on the phenomena of the shadow economy. There are 24 employees.
Evaluation
: The GEIU’s Compliance Report Service has produced a large amount of
compliance reports (2 million since it was established in 2011). From receipt of a request for
13
a compliance report, it takes the GEIU about one day to complete.
Currently there are 21 authorities with permission to request compliance reports from the
GEIU. The fully automated online web interface which allows compliance reports to be
delivered automatically
to the requesting authority helps improve efficiency, giving those
authorities more time to tackle the grey economy.
The public website content is produced in collaboration with 21 authorities and ministries
involved in the project and is published in three languages including Finnish, English and
Swedish. This provides statistical information on the impacts
of action taken against the
shadow economy and economic crime, as well as providing companies and citizens with
information on how to act or protect themselves against such harm.
Source: https://ec.europa.eu/social/BlobServlet?docId=18511&langId=en
The list of risky businesses produced by data mining can then be used to send notification
letters to both the workers and employers setting out the benefits of paying their full social
contributions, and the consequences if they are caught not doing so.
Box 7 provides an Estonian case study of how data mining by the tax authority led to the
identification of businesses to whom notification letters were then sent either to the employers
and/or the employees, resulting in a reduction of wage under-reporting.
Box 7: Reducing wage under-reporting
using data mining and notification letters,
Estonia
Aim: To identify “outlier” employers and employees using data mining followed up by
notification letters to reduce envelope wages and increase tax revenues.
Description: In January 2008, the Estonian Tax and Customs Board identified using data
mining 1,000 businesses with low wage levels compared to the average level in their region
and respective business sector, which might suggest the payment of envelope wages. They
then sent notification letters to these 1,000 companies and 2,000 employees. Letters were
sent either to employees only, employers only or both employers and employees of the
same company. These notification letters informed the employers of the low
competitiveness of their wage levels compared with average wage levels. Employees were
informed of the risks that accompany envelope wages such as losing social guarantees. The
intention was to provide employers with the opportunity to change their behaviour before
receiving penalties. It also aimed to raise awareness about the impacts of paying envelope
wages among both employers and employees in order to change employers’ and
employees’ attitudes towards under-declared employment.
Evaluation: 46% of the companies receiving these letters adjusted their wage levels and
increased their tax payments. After four months, the notification letters had brought an
additional EEK 10 million (c.€640,000) of tax income, including EEK 8.8 million
(€562,000) from notifications sent to enterprises and EEK 1.2 million (€76,600) from those
sent to individual employees. Comparing different methods of sending notification letters,
the most successful in terms of improved tax behaviour was when both the employer and
the employees received letters;
56% of such enterprises improved their tax behaviour.
Given that the Estonian Tax and Customs Board at the time conducted 2,000 inspections
per annum, and these notification letters resulted in just less than 500 enterprises improving
their tax behaviour, this provides a cheap and relatively effective additional measure that
can be implemented to reduce under-declared employment (Anvelt, 2008; Levit, 2008;
14
Rum, 2008; Tubalkain-Trell, 2008).
Box 8 provides a Lithuanian case study of how data mining by the tax, labour and social
insurance authorities led to the identification of businesses to whom notification letters were
then sent either to the employers and/or the employees, resulting in a reduction of wage
under-reporting.
Box 8. “Warned to choose” and “cherry letters” in Lithuania
“Warned to Choose” model
The State Tax Inspectorate (STI), in cooperation with the State Labour Inspectorate (SLI)
and the State Social Insurance Fund Board (SSIFB), sought to reduce risks related to non-
recording of all
hours worked by employees and payment of a part of wage/salary in
envelopes. In 2015 to 2016, 40 000 risky taxpayers, selected through a comparison of the
databases of the SLI, STI and the SSIFB, were sent warning letters. Companies were
informed that wag
es paid for their employees are significantly lower compared to other
companies operating in that particular sector and/or region.
Outcomes
As a result of the 40 000 letters sent in 2015, average wages increased by 15-17% in 2016
compared with 2015, EUR 68 million was paid in extra wages and EUR 27 million extra
tax was collected.
Cherry letters initiative
In May 2017, the Social Security authority (SODRA) sent 138 000 “cherry letters” to
employees, of which 132 000 reached the recipient. The main purpose was to report to
them that as an employee in the last year, they did not accumulate one year of pension
contributions because it is likely that they were involved in undeclared or under-declared
work. Among the recipients of “cherry letters” were 13 000
heads of companies and
administration, 23 000 engineers, specialists and technicians, 37 000 skilled workers and
30 000 unskilled workers.
Outcomes
The income of 50 000 employees who received the “cherry letters” grew and their salary
exceeded the minimum monthly salary. SODRA earned EUR 17 million more social
security contributions over four months. The average salary reported increased by 55%.
Overall, the finding is that notification letters are a powerful tool and result in a significant
increase in the number of new contracts, of working hours and/or wages, and consequent
increase in social contribution payments.
For instance, in Spain, 81,639 notification letters were sent to companies identified to employ
workers on a temporary basis or having more than 30% of the workforce on part-time
contracts (no more than 12 hours per week). As result, 61,445 fixed-term contracts were
transformed into open-ended contracts (76.3% of the workers) and of the companies contacted
about part-time workers, 8 824 part-time workers witnessed an increase in their working
hours (17.5% of the workers). Box 9 provides an evaluation of their use in Greece.
Box 9: An evidence-
based evaluation of the use of notification letters to change
employers’ behaviour in Greece
Between December 2018 and June 2019, the Hellenic Labour Inspectorate has been
15
conducting an evidence-based evaluation of the impact of using nudge letters in four
regional departments. Using the ERGANI database risk analysis tool, 2 434 businesses in
two sectors (cafes/restaurants and hair/beauty) were subject to either: a gentle nudge letter;
a strong nudge letter; an announced inspection letter, or an unannounced inspection.
Outcomes
To evaluate the impact, the ERGANI employment records system was used to assess
whether the employers receiving each type of letter has altered their records on full-time
and part-time employees, working hours, and overtime.
The analysis showed that personalised strong nudge e-mails were more effective than un-
personalised gentle nudge emails. Announced inspection letters resulted in an increase of
30.95% in full-
time contracts in the first month after the letter was sent, compared with
5.74% in the control group.
What can be done in Latvia?
To improve the detection of wage under-reporting, a shift is required in Latvia away from
workplace inspections and towards data mining and matching, using dynamic benchmarking
to identify anomalies/outliers. A strategic approach is required to database design which asks,
“what data do I need to identify wage under-reporting?” rather than “what do I possess which
I could use?”.
There is also a need for full access to be provided to the database for all inspection services.
Although each of the executive authorities (SLI and SRS) operate separately, they can request
data from other authorities (Article 12, paragraph 4 of SLI regulations and Article 4,
paragraph 17 of SRS regulations ensure co-operation in the form of data sharing —the general
director of SRS can authorize the SRS officials to acquire and share information). Information
is shared between SRS and SLI using an FTPS server where both institutions frequently put
relevant information regarding companies where undeclared work has been discovered by any
of the participant institutions. There are no external evaluations of effectiveness but internally
the SLI evaluates its co-operation with the SRS and other institutions involved as fairly
effective.
Until now, the SLI has had limited access to the SRS database, and this could be improved
through a bilateral agreement to help the SLI improve the risk assessment attached to the
selection of businesses for inspection. Consideration could also be given to overcoming the
problems with sharing data by creating one central unit that provides a data mining and
analysis service for all government ministries involved in tackling wage under-reporting, akin
to the Grey Economy Information Unit (GEIU) in Finland.
Possible indicators that could be used to identify risky-businesses likely to be involved in
wage under-reporting include:
• Average salary in company compared with average salary in the same sector;
• Average salary in company compared with average salary in region;
• Average salary of a certain occupation/profession in the business does not correspond
with the average salary within the same occupation/profession in the country, sector
and/or region;
• Large proportion of a company’s employees are working part-time compared with
other similar businesses;
• Number of employees/total wages paid is not appropriate to the turnover;
16
• Complaints have been received about undeclared work;
• The business has previous violations related to undeclared work;
• Businesses where a higher proportion of workers receive the minimum wage
compared with other similar businesses.
Having identified potential outlier/anomalous businesses likely to be under-reporting wages,
notification letters can be sent to both the workers and employers setting out the benefits of
paying their full social contributions, and the consequences if they are caught not doing so.
For notification letters to be effective:
• the letter should make it easy for the recipient to comply, such as by providing a
hyperlink or stating what is the next step they need to take;
• the letter should highlight the key messages, namely the important information or
actions required upfront;
• personalised letters and language should be used so that people understand why the
message or process is relevant to them;
• letters should inform them about the positive compliant behaviour of others (e.g. “9
out of 10 firms pay their tax on time”) and references in the letter to the situation in
their specific locality increases effectiveness;
• letters should highlight the risks and impact of non-compliance (e.g. the wider impacts
on public services and the personal impacts on them such as their increased risk of
inspections and the consequences for them of being caught).
3.2. Severity of punishment once caught: legislative level
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
To tackle wage under-reporting, the dominant policy approach has been to change the cost-
benefit ratio confronting participants by increasing the actual and/or perceived costs of
engaging in wage under-reporting. One way this can be achieved is by increasing the severity
of punishment.
In Latvia, on January 22, 2013, the Cabinet of Ministers approved (prot. No. 5 30§) the
Concept of Development of the Administrative Penalty System. For the implementation of
this system, the Law on Administrative Violations Procedure has been introduced. On
October 25, 2018, the Law on Administrative Liability was adopted, which came into force on
1 January 2020.
The most common type of sanction is to use administrative or criminal sanctions. However,
there are other types of punishment, including:
Using punishments to transform under-reported wages into fully declared
employment;
Applying punishments to citizens or businesses who buy goods and services from
employers using under-reported wages;
Non-compliance and compliance lists;
Excluding sanctioned businesses from bidding for public procurement contracts and
receiving subsidies, and
17
“Naming and shaming” lists:
Best practices in fighting this determinant in other countries
To show how punishment systems can be designed to help transform undeclared work into
declared work, Box 10 reports how Greece has designed a fines system that encourages an
employer found to underreport wages to reclassify the employment relationship and employ
the worker as a fully declared employee.
Box 10: Designing sanction systems to transform under-reported wages into full declared
employment: lessons from Greece
Background
Before the new punishments
system was introduced in 2018, when a labour inspector
identified an employer using undeclared workers, they could impose an administrative penalty
(fine). For employees over 25 years old, the fine was €10,549.44 (i.e., 18 times the minimum
wage) whilst for employees under 25 years old, the fine was €9,1979.10 (i.e., 18 times the
minimum wage for under 25 year olds). The fines for wage under-reporting were much lower,
which was thought to encourage employers to use wage under-reporting
rather than
undeclared employment. The problem was also that if such penalties were imposed on small
offending businesses, this could result in the end of their business activity. The result was a
rethinking of the sanctions system.
New sanctions system
Greece redesigned its sanctions system. The fine for employers is set at €
10,500 for each
undeclared employee. However, the employer can hire within 10 days the undeclared
employee as a registered declared employee to decrease the fine by the following amounts:
• €7,000 if they hire the employee for 3 months;
• €5,000 if they hire the employee for 6 months, and
• €3,000 if they hire the employee for 12 months.
Outcomes
In 2017, before the new sanctions system, only 32% of detected undeclared workers were
subsequently hired on a declared basis by the employer. Of these, two-thirds were hired on a
part-time basis and only one-third full-time.
For the period August 2018 - February 2019, after the new sanctions system was introduced,
45% of detected undeclared employees were hired by the employer, all of them on a full-time
basis. Of those hired formally:
• 91% were hired for 12 months;
• 3% for 6 months, and
• 6% for 3 months.
Transferability to Latvia
The innovative aspect of this sanctions system is that it can be used to encourage employers to
transfer under-reported waged employees into fully declared employees, rather than simply to
punish employers who underreport wages. This would build on regulation of 1 September
2016 introduced into the Latvian Administrative Violation Code. If an employer agrees they
have engaged an undeclared worker, they must submit proof that they have corrected the non-
compliance before a decision to impose a fine is made, and if they pay the fine within 15 days
18
of the decision, the fine is reduced by 50%. This is measured automatically by checking the
data one month after the inspection to determine whether the labour relationship has been
legitimised, which subsequently reduces the need for follow-up inspections. In 2018, (the base
measurement year for this indicator) following SLI inspections, 69% of workers detected
without a formal labour agreement either received a formal agreement or were formally
registered with the State Revenue Service.
The next step is to ensure that this applies to under-declared workers employed and that fines
are reduced if they employ the worker on a full-time declared basis.
Source: https://ec.europa.eu/social/BlobServlet?docId=22206&langId=en
Sanctions can also be applied to those purchasing from those engaged in wage under-
reporting. An example is the reverse supply chain responsibility initiative in Finland where
businesses at the top of the supply chain are made responsible for ensuring that those
employed further down the supply chain are operating on a fully declared basis (see Box 11).
Box 11:
Making purchasers responsible for information reporting in construction
industry, Finland
To ensure that the tax administration and labour inspectorate have a complete overview of all
workers present at the construction site at all times, the overall responsibility lies with the
buyer and main contractor to report contract and employee details of all parties in the supply
chain - buyer, developer, main contractor as well as sub-contractors. They file
a monthly
report to the Tax Administration.
Every month, each “buyer” must give the names of all companies or people from whom they
have ordered construction services directly to the Tax Administration. This includes details of
the contracts (including contracting parties, total amount, and duration) and transaction data
related to the contract (including the amount invoiced during the reporting period).
The project supervisor (main contractor)
of the construction project is responsible for
collecting information from its sub-contractors on the people who work at the construction
site. Each company operating at the site must submit details of their employees to the project
supervisor. In case of a shared construction site, it is also the project supervisor who is obliged
to file reports on all the people who work there -
including their own employees, the
employees of other contractors, and any independent, self-
employed individual contractors
and leased employees (temporary agency workers) working on the building site.
In case a buyer or contractor fails to fulfil the obligation report, a negligence fee is issued. The
maximum fine is 15,000 euros.
Using non-compliance lists is another means of sanctioning those under-reporting wages,
and these may or may not be made public. These non-compliance lists have been previously
called “blacklists”, but this term is no longer acceptable due to its racist connotations. These
can be used by enforcement authorities or social partners.
In Latvia, since 2017, the promoting openness of information and public participation policy
has used non-compliance lists by providing the opportunity to obtain information about those
officials of the companies included in the “list of risk” (e.g., tax evasion, corruption and other
type of potential risks for their cooperation partners).
19
Enforcement authorities can also use non-compliance lists as a sanction either by (i)
preventing access to public procurement contracts, which can be a major source of funding for
businesses, (ii) encouraging employers not to use these non-compliant businesses to purchase
their services or goods or (iii) preventing access to subsidies for those listed on non-
compliance lists. This provides businesses with an incentive to be compliant. If they are not
compliant, then they are excluded from major sources of income.
If non-compliance lists are used to exclude businesses from bidding for public procurement
contracts, etc, then non-compliance lists need to be kept up-to-date and decisions need to be
taken on how long a business will remain on a non-compliance list after a violation has
occurred. So too is a decision required on which violations mean that a business will be put on
a non-compliance list and which violations will not result in them being put on this list.
Social partners and other stakeholders can also use non-compliance lists. In Czechia, for
example, the Czech-Moravian Confederation of Trade Unions (CMKOS), together with the
Czech Metalworkers’ Federation (OS KOVO), has tackled the issue of illegal temporary work
agencies (TWAs) by introducing a non-compliance list (“blacklist”) of “pseudo” TWAs.
Those named on this list are then not used by employers employing temporary workers.
An alternative to a non-compliance list is a “compliance list” (what was previously termed a
“whitelist”) composed of businesses with no tax, labour or social security law sanction against
them in the recent past.
In Latvia, the “In- depth Co-operation Program” (i.e. White List) started in 2018. The idea
behind introducing the “white list” of companies is to recognise those taxpayers who are
paying (most probably) all the taxes. The list of companies is created following certain
criteria, including whether there is no tax debt, whether companies pay at least average salary
in the industry, etc. Companies included in the list receive certain benefits, including less
audits, personal consultant at the State Revenue Service, additional points in public tenders,
etc. Results are not yet available.
Another option is to introduce business certification schemes and payment certification of tax
and social contributions to create a list of compliant businesses, which a business needs to be
listed on to tender for public procurement contracts. An exemplar of such an approach is to be
found in the agriculture sector in Italy (see Box 12).
Box 12: Quality Agricultural Work Network (rete del lavoro agricolo di qualità), Italy
Aims: To tackle undeclared work in agriculture, its objectives are to:
• Create a “compliance list” of farm enterprises based on their compliance to the rules
(fiscal law, labour law, social security provisions, among others);
• Improve firms’ compliance with labour law, collective agreements, social security
and income rules; and
• Better target inspections in the sector.
Description: The Quality Agricultural Work Network puts
companies operating in the
agriculture and fishing sector that fulfil their statutory obligations on a compliance list. The
initiative was started in June 2016 (Law 199/2016). According to the law, firms which “have
not been convicted for violations of labour law and social legislation, for crimes against
public administration, crimes against public safety, crimes against the public economy,
industry and commerce, crimes against sentiment for animals, with regard to income tax and
value added tax […]” may join the network
20
(https://www.inps.it/nuovoportaleinps/default.aspx?itemdir=46316). Inspections are carried
out mostly on firms not included in the network.
It is managed by the Steering Board “Cabina di Regia”, chaired by the Social Security
Institute (INPS) and includes representatives of the Ministry of Labour, Ministry of
Agricultural and Forestry Policy, Ministry of Economy, Labour Inspectorate, National Tax
Agency, Committee of Autonomous Regions and Provinces, Confederation of Agriculture,
trade unions and other agricultural workers’ organisations.
Evaluation: Just 3,500 of the 1.5 million agricultural companies in Italy have registered
(https://www.inps.it/nuovoportaleinps/default.aspx?itemdir=50213
). In part, this has been
argued to be because even minor administrative sanctions (perhaps paid because it was less
expensive than contesting them) exclude companies from joining.
A further example of using a compliance list is the aggregate tax behaviour rating of business
operators maintained by the Estonian Tax and Customs Board (ETCB). The aggregate tax
behaviour rating consists of five indicators and considers the presence of tax arrears,
declarations filed on time, current penalties for tax or customs related offences, tax
proceedings conducted in relation to the company and the background of the management
board member. This influences the likelihood of inspection of the business and if made
public, to enable businesses to decide which sub-contractors to use.
Finally, “naming and shaming” can be used as a sanction. By making public those business,
workers and/or self-employed who have been sanctioned for working undeclared, the
intention is to shame them as a sanction. Shaming can either simply shame the offender, or it
can shame them and then offer reintegration. Coricelli et al. (2014) show that when cheating
is made public and the perpetrator is not successfully reintegrated, the amount of cheating
significantly increases compared with when cheating is made public but is followed by
reintegration.
Again, this sanction is not limited to public authorities. Both trade unions and employer
federations could hypothetically use “naming and shaming” lists, such as on a sectoral level.
So too can civil society groups use “naming and shaming”. One such civil society “naming
and shaming” initiative is in the city of Bologna in Italy where a 2017 government report
identified that 72.6% of jobs in the city’s food and hotel sector were in the undeclared
economy. In response, a civil society organisation, Padrone di Merda (“crappy bosses”) has
taken direct action staging protests outside the premises of 37 businesses. This has been an
effective form of direct action that has received widespread publicity and stopped customers
using these restaurants, cafes and hotels.
In Latvia, a policy of promoting openness and public participation by providing publicly
available information was established in 2017. The aim of this measure is to foster openness
of information and public participation by providing publicly available information on (i)
those employers who pay low salaries- below average monthly salary in the industry/ country
or even below the minimum monthly wage (envelope wage risk); (ii) those natural persons
and officials of a legal person who have been administratively punished for violation of wage
regulations; (iii) those taxpayers who have not submitted to the tax administration the tax
declarations, if the deadline for submission of these declarations has been exceeded for more
than 15 days. No data on the results is available
What can be done in Latvia?
21
• The SLI has adopted as a core strategic objective the transformation of undeclared
labour relations into declared labour relations. The fines system for undeclared work
should reflect this strategic objective. Transferring the fines system adopted in Greece,
the SLI could decrease the fine when the employer transforms the under-declared
employment into fully declared employment, with the fine reduced by the length of
time that the employee is hired on a full-time declared basis.
• Introduce a reverse supply chain responsibility initiative where businesses at the top
of the supply chain are made responsible for ensuring that those employed further
down the supply chain are operating on a fully declared basis. This could be a
voluntary employer-led initiative to rid the supply-chain of wage under-reporting.
Either the employer at the top of the supply-chain will take responsibility for ensuring
that this is the case, or an initiative based on joint liability could be adopted. This
could be introduced by a selection of circa ten large Latvian businesses in relation to
fulfilling public procurement contracts. Such a voluntary approach allows companies
to influence the future direction of policies in this field and is lighter touch than
legislative obligation. This might involve: developing contractual based obligations
within a specific sector (e.g., construction) for doing business; and bigger companies
providing certain conditions for subcontracting (how many contracting parties,
approval for subcontractors, if irregularities, payment conditions clauses like
deduction/deferring the payment until the irregularity is resolved).
• Non-compliance lists can be used by enforcement authorities as a sanction either by (i)
preventing access to a major source of funding for businesses (i.e., public procurement
contracts), (ii) encouraging employers not to use these non-compliant businesses to
purchase their services or goods or (iii) preventing access to subsidies for those on
these non-compliance lists. This provides businesses with an incentive to be
compliant. If they are not compliant, then they are excluded from major sources of
income. Social partners and other stakeholders can also use non-compliance lists with
those named on this list not used by employers or customers.
• Compliance lists can be also used of businesses with no tax, labour or social security
law sanction against them in the recent past, such as the aggregate tax behaviour rating
of business operators maintained by the Estonian Tax and Customs Board
(ETCB). These can be used to determine the likelihood of inspection and if made
public, to enable businesses to decide which sub-contractors to use.
• Use “naming and shaming” by publicising those business and/or workers who have
been sanctioned for under-reporting wages.
3.3. Rational choice: risk of being caught vs what happens “in reality” once caught.
Including efficiency/ practices of courts, application of the legal framework such as
criminalization of envelope wages. Trust and satisfaction with services provided by the
government
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
What happens in reality when attempting to sanction those identified as engaged in wage
under-reporting is important. Identifying good practices in the process of implementing
sanctions is therefore crucial.
22
Best practices in fighting this determinant in other countries
In executing sanctions, five key steps are involved which need to be analysed to ensure that
good practices prevail.
Step 1: Information exchange on the offence and the offender
The relevant authorities such as labour and tax inspectorates, social security/welfare agencies,
police and prosecution, as well as social partners (where permitted and appropriate), share
details about a case (within conditions set by the law, thus preserving the legal validity of
evidence obtained). For example, a case can prompt administrative fines imposed by labour
inspectorates, the recovery of taxes by tax authorities and the request of unpaid contributions
by social security bodies. Each of the authorities involved needs to know the information that
can be collected and shared and the type of information their collaborating partners need.
This sharing follows an inspection. Immediately after, a debriefing (held that day or shortly
after) clarifies how to proceed. There can be unexpected findings or issues about which other
public authorities, such as health and safety bodies, should be informed. An inspection report
allows for the sharing of information on confirmed and suspected infringements, including
recommendations for further action (issuing of a warning or sanctioning). Possible elements
of an inspection report that could lead to sanctioning are presented in Table 1.
Table 1. Possible key elements of an inspection report
Inspection report
Analysis of the violation
Actions recommended
General information on
the enterprise (name, legal
status, subsidiaries,
address, CEO/manager,
contact person, number of
employees, etc.)
Working conditions
(minimum wages and
allowances paid, weekly
rest periods and holidays,
etc.)
Inspection details (nature
of the inspection - routine,
special, follow-up,
investigation; uncovered
violations)
Detailed information on
the detected violation(s) -
its seriousness and nature
(labour law infringement;
social security evasion/
fraud; income tax evasion/
fraud; bogus self-
employment, etc.)
Information on the duty-
holder’s compliance
record
Define responsible authority to execute
the sanction
Recommendations for corrective action
and/or sanctioning, based on
enforcement priorities, the existing legal
base, and the
likelihood of achieving
results. The penalties and recoveries
could include:
o
Penalties (administrative, civil
and/or criminal);
o
Tax/social contribution recoveries
and back payments
(administrative, civil and/or
criminal);
o
Payment of outstanding
remuneration;
o
Administrative advices, warnings
or ordinances etc. issued to
companies.
Informing other relevant authorities,
e.g. tax and social security
Guarantee of the right of defence and a
fair trial
Source: based on ILO (2006) and European Labour Authority (2020)
23
Step 2: Deciding on a sanction and procedure for appeals
The type of sanction depends on the legislation in an economy. Most countries use
administrative or criminal procedures2 to sanction wage under-reporting:
Administrative sanctions most often refer to monetary fines. Often (but not always)
they go hand-in-hand with increased/recovered tax and social security contributions
and repayment of salaries. However, they can be complemented by secondary
measures such as exclusion from public tendering and withdrawal of operation
licences. In addition, sanctions can be made public to encourage future compliance
(“naming and shaming”);
Criminal sanctions usually refer to prison sentences (sometimes suspended sentences
or punishment with deferral) or to criminal monetary fines. These could also be
applied in parallel with secondary measures such as freezing of assets, confiscation,
deprivation of the right to be employed in a certain job or to hold a certain position,
labour law-related sentences or business closure. They are usually connected to more
severe cases (organised crime, higher numbers of workers involved, in conjunction
with other crimes against basic human rights).
Table 2 presents the considerations for authorities when deciding on the type and severity of
the sanction, applicable within the respective national legal base.
Table 2. Considerations when deciding on sanctions
Consideration
Further details
Priorities of the
government,
judicial
authorities and/or
enforcement
authority
The government, social partners, general prosecutors and enforcement
authorities have action plans against wage under-reporting
. These plans set
priorities for sanctions, depending on the gravity of the fraud encountered. The
plans usually also foresee a combination of “random” inspections (which aim
to prevent the feeling of impunity) with targeted inspections based on risk
assessments.
Wider impact on
society and
public finance
Depending on the seriousness of the offence, inspectors are allowed to take
more stringent action and opt for stricter penalties, within the sanctions’
minimum and maximum threshold values set in the legal base.
Size and
economic
circumstances of
the enterprise
Inspectors could apply discretion, if foreseen within the legal framework,
towards small enterprises, in particular regarding deadlines for compliance with
minor violations. Inspectors ideally consult with social partners.3
Combination of
sanctions
For risk sectors, repeated offenders or more severe cases, consideration can be
given to combining administrative and/or criminal sanctions (if the legal base
allows it) with:
Withdrawal of operating licences;
Introducing joint liability of contractors and subcontractors;
“Naming and shaming” non-compliant companies;
2 In general, administrative procedures are based on administrative law and criminal procedures on criminal law.
However, there is also a formal (not necessarily legal) criterion to distinguish between the two: administrative
procedures are applied by an administrative authority that imposes sanctions. In some cases, the general basic
principles of ordinary criminal law are applied in this administrative procedure. In the case of criminal
proceedings, a penalty is imposed by a judge competent in criminal cases, after prosecution by the public
prosecutor.
3 ILO (2006). A toolkit for labour inspectors, ILO, Geneva.
24
Introducing progressive sanctioning or lectures for companies on the
correct application of the employment act (e.g. instead of paying a
fine);
Exempt the company from increased social contributions if they start
declaring workers (e.g., in Belgium);
Making the use of IDs and photos at construction sites mandatory; and
Making procedural improvements for faster processing of registration
of special groups of workers (e.g. migrants).4
Each time a sanction is imposed, the offence needs to be clearly communicated,
together with instructions for future compliance.
Step 3: Ensuring that the information is recognised as evidence
It is crucial that the information collected in Steps 1 and 2 can be recognised as evidence,
especially if the case is taken to court. Documentation needs to present the facts clearly and
precisely, be sufficient and follow the right format. Some legal considerations related to the
gathering of evidence are presented in Table 3.
Table 3. Legal considerations when gathering evidence
Considerations
Further details
What documents are
needed?
The most common documents checked by inspectors are work contracts,
staff registries, internal company regulations, registries of working hours
and overtime, payslips and timesheets, payments of social security
contributions, permits and licences (e.g. of temporary work agencies). In
addition, any other (paper or digital) information may also prove useful,
such as emails, texts, personal notes (e.g. to prove cases of envelope
wages).
Fiscal documents and commercial contracts are also collected to compare,
for example, the declared workforce with the size of deliveries to clients,
or to identify the owner and subcontractors and any possible bogus self-
employment.
5
What format?
The format of the documents relating to imposed sanctions must comply
with the legislation in the country.
What other forms of
evidence are needed?
Additional evidence should clarify the facts of the case: what, who, when,
where, how, how long, since when, etc.
Circumstances uncovered during on-site visits should also be verified (e.g.
observations by inspectors, photos, video, audio, surveillance recordings,
signatures of inspectors/witnesses/ employees/managers, physical objects
seized, official documents in legally accepted formats). These could relate
to:
Existence/status of labour
relationship (hierarchical elements,
proven authority of the employer);
Proof of activity, established personally by the inspectors, and
not only on paper;
Verified place where the infringement was committed and place
where it was established; and
Time and period within which the infringement was committed.
Are witnesses
required?
Witnesses could also be asked to provide statements/testimonials/
interviews - either by the enforcement authority (if it has such authority)
4 OECD, (2014). Regulatory enforcement and inspections. OECD best practice principles for regulatory policy,
Paris.
5 ILO (2013a). Labour inspection and undeclared work in the EU, ILO, Geneva.
25
or through cooperation by relevant law enforcement bodies. Interviews on
the spot with employers and employees confirm the inspector’s own
findings and make a stronger case.
The possibility to bring the employer and employees as witnesses needs to
be clarified at an early stage.
Step 4: Clear agreements on responsibilities, costs and recovered funds
Clarifying roles
Once the evidence and types of sanction are confirmed, a clear role distribution between all
authorities involved helps to enforce the sanction efficiently.
Joint responsibilities can be also clarified in the “sanction report”. Depending on the case, it
can be helpful to think about other relevant stakeholders. For example, social partners could:
support the process and follow-up activities by filing civil suits in cases of labour law
violations;6
act as witnesses in court;
offer support in respect to collective agreements, leading to better compliance;
provide alerts to authorities about (possible) wage under-reporting practices;
provide support for workers during inspections and interviews of witnesses;
provide contacts, advice, and logistical support for cross-border collaboration (in
particular for umbrella organisations and EU level trade unions federations).
Clarifying costs and recovered funds
When deciding on tasks and responsibilities, cooperation partners need to clarify how costs
will be covered. These can include authentication of documents or staff time needed to gather
certain types of information or evidence. Furthermore, partners need to decide on procedures
for who will claim any fines for their authority.
Step 5: Enforcing sanctions
Administrative route
As a first step, enforcement authorities notify the offender to pay a fine. A quick direct
notification can lead to instant compliance, saving resources for the authorities. The content
and form of the notification letters can have a substantial effect on the efficiency of sanction
procedures (see Box 13).
Box 13: Possible wording of notification letters
A notification letter can be sent by registered post or with electronic verification that the
letter was delivered. Many enforcement authorities
recommend the following as likely to
result in the instant payment of fines:
Legal reminders about the obligations of the employer with respect to paying taxes
and social security for employees;
Normative information about compliance and the risks of non-compliance;
6 Based on ILO (2013b). Labour inspection sanctions: law and practice of national labour inspection systems,
ILO, Geneva.
26
Tips to improve compliance (e.g., simple ways to declare workers);
Offering options to pay the fine in instalments, and
The possibility of a visit/audit in the foreseeable future or a follow-up visit shortly
after the compliance deadline.7
It is good practice to inform other relevant enforcement authorities of the sanctions imposed,
as they may also need to undertake parallel actions.
Criminal route
Criminal sanctions, such as criminal fines, prison sentences, freezing of assets, confiscation,
or business closure, are less frequent in undeclared work cases. For example, in Belgium,
25% of the infringements are prosecuted by labour prosecutors (criminal proceedings) and
75% result in administrative sanctions. If the uncovered violations are criminal in nature, the
labour or tax enforcement authorities transfer the case to the police, directly to the prosecutor
(specialised or general), and/or the courts. These authorities then become responsible for
notification and execution of the sanction.
What can be done in Latvia?
• The enforcement authorities in Latvia could analyse each of the following five steps in
the execution of sanctions to identify the obstacles to the effective and efficient
implementation of sanctions and formulate proposals to overcome the obstacles
identified:
o Information exchange on the offence and the offender;
o Deciding on a sanction and procedure for appeals;
o Ensuring that the information is recognised as evidence;
o Clear agreements on responsibilities, costs and recovered funds, and
o Enforcing sanctions.
4. Influence of the tax policy.
A common assumption is that reducing tax rates is a principal way of tackling wage under-
reporting. However, a more nuanced approach is required for two reasons. On the one hand,
there is no evidence that decreasing tax rates reduces wage under-reporting. Indeed, the
opposite is the case. Undeclared practices are higher in economies with lower tax rates, not
least because such countries have a lower trust in government (Bird and Zolt, 2008;
Vanderseypen et al., 2013; Williams, 2013, 2014a,b; Williams and Horodnic, 2017).
Secondly, the problem with using general tax reforms to tackle wage under-reporting is that
they have broader impacts. For this reason, targeted measures are required.
4.1. The level of the tax wedge on low wages, also in comparison to neighbouring
countries.
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
The tax wedge is the difference between before-tax and after-tax wages. The tax
wedge measures how much the government ostensibly receives from taxing the labor force. It
7 European Platform tackling undeclared work, (2018). Practitioner toolkit: information tools and approaches to
reach out to workers and companies in the fight against undeclared work. Available at:
https://op.europa.eu/en/publication-detail/-/publication/97fa5fc6-4c55-11e9-a8ed-01aa75ed71a1
27
is the sum of personal income tax and employee plus employer social security contributions
together with any payroll tax less cash transfers, expressed as a percentage of labour costs.
This determinant argues that if the tax wedge is high on low wages, then wage under-
reporting is more likely.
Best practices in fighting this determinant in other countries
An argument is that reducing the tax wedge on labour and shifting it to a tax on consumption
(Value Added Tax) is a way of reducing wage under-reporting. Figure 1 displays the sources
of tax income in Latvia compared with other EU member states in 2017. This displays that a
similar proportion of total taxes are gathered from labour in Latvia as in Estonia and
Lithuania. As Figure 2 displays, in 2018, tax wedge reductions for average income earners
were most significant in Estonia. For low income earners, labour tax reductions were notably
large in Estonia and Latvia, reducing the tax wedge by more than five percentage points.8
Figure 2 reveals the higher overall tax burden in LV compared with EE and LT, as well as the
lower level of the income tax burden as a percentage of labour costs in EE and LT compared
with LV in 2015.
Figure 1 Taxes as a % of GDP.
8 https://www.consilium.europa.eu/media/42557/eg-thematic-discussion-on-growth-and-jobs-tax-wedge-on-
labour.pdf
28
Figure 2. The tax burden on labour for a single person at low wage (2018-2015)
One option is to shift from labour taxes to consumption taxes. However, higher consumption
taxes are often associated with lower tax progressivity.9 While reduced VAT rates are
sometimes introduced to support low-income households, they have been found to be a poorly
targeted and costly way of achieving this aim.10 Moreover, a rise in consumption taxes could
increase prices and feed into wage increases that, at least partly, counteract the reduction in
labour costs resulting from the tax shift (referred to as the “second round effect”).11
Given that reducing the tax wedge on low wages to reduce wage under-reporting has wider
impacts, the usual approach adopted in most countries is to focus upon more targeted tax
policy measures that directly address wage under-reporting (e.g., tax rebates for customers of
services where undeclared work is prevalent).
What can be done in Latvia?
• Reducing the tax wedge on low wages, possibly by reducing income taxes on low
wages, is an option but it has a wider impact beyond preventing wage under-reporting.
4.2. Overall satisfaction (of entrepreneurs/ society) with the tax policy
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
When citizens and entrepreneurs are not satisfied with the tax policy, the likelihood of non-
compliance is higher, including participation in wage under-reporting. It is therefore
importance that citizens and entrepreneurs believe that there is procedural fairness.
Best practices in fighting this determinant in other countries
Procedural fairness refers to whether citizens and entrepreneurs feel that they are being
treated in a fair manner relative to others and that they pay their fair share compared with
9 Pestel, N. and Sommer, E. (2015). Shifting Taxes from Labor to Consumption: More Employment and more
Inequality, ZEW Discussion Paper No. 15-042.
10 OECD (2014, updated 2018) "The distributional effects of consumption taxes in OECD countries." (OECD
Tax Policy Studies No 22/2015), http://www.oecd.org/ctp/the-distributional-effects-of-consumption-taxes-in-
oecd-countries-9789264224520-en.htm.
11 https://www.consilium.europa.eu/media/42557/eg-thematic-discussion-on-growth-and-jobs-tax-wedge-on-
labour.pdf
29
others. Those who perceive that they receive procedurally fair treatment are more likely to
trust the authorities and to adhere to the formal rules (Murphy, 2005). The fairness of the tax
system is one of the most important determinants of whether they do so (Molero and Pujol,
2012).
Conversely, if they perceive that they are not receiving fair treatment, non-compliance
increases (Bird et al., 2006). As Molero and Pujol (2012) find, where there is grievance either
in absolute terms (e.g., they feel taxes are too high or public money wasted) or grievances in
relative terms (e.g., they perceive others to be cheating), non-compliance is the outcome.
Indeed, they justify their non-compliance using their perceptions of the activities of others.
If undeclared work, including wage under-reporting, is viewed as widespread, this justifies
their non-compliant behaviour. This has important implications. If governments publicise that
wage under-reporting is prevalent, therefore, they create the conditions for widespread
grievance and even wider participation in wage under-reporting by those who might not
otherwise have done so.
What can be done in Latvia?
• Government should not publicise that wage under-reporting is a prevalent
phenomenon. If they do, citizens and entrepreneurs will perceive others as cheating
and will do so themselves. Government must therefore highlight how wage under-
reporting is a small exceptional occurrence and that the vast majority abide by the law.
4.3. Complexity of the tax system: easiness to report and pay taxes. Bureaucracy.
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
When it is difficult to comply, there is not only greater unintentional non-compliance, such as
due to the complexity of the law, but also greater intentional non-compliance due to the
problems involved in complying with the rule of law. Making it easy to comply by
simplifying procedures (e.g., easier registration procedures; simplified forms; reducing
duplication) is a way in which government can reduce wage under-reporting.
In Latvia, and example is the Amendments to the Law on Taxes and Duties in 2017 which
provide for the introduction of a single tax account by SRS, starting in 2021. Reducing
bureaucracy, easy and transparency of paying tax are recognised as important factors that can
help to reduce wage under-reporting. This policy aims to do that, providing that taxes and
certain regular payments to be paid by companies (and administered by the SRS) will be
credited to one account.
Another example in Latvia is the improved process of repayment of state fees introduced in
2017. This policy stipulates that the amounts of overpaid and incorrectly paid state fees shall
be refunded without the application of the taxpayer. This also builds the trust and cooperation
of the taxpayers with controlling institutions. No data available on the results
Best practices in fighting this determinant in other countries
One solution, especially for those who unintentionally engage in undeclared work, is to
provide better advice and easier access to information in a simple format on how to comply
(see section 5).
Another solution is to simplify compliance. This involves simplifying the administrative
framework (e.g., easier registration procedures, simplified self-assessment) but may also
involve increasing the benefits of compliance (e.g., access to buyers, more favourable credit,
legal protection).
30
Simplifying compliance is important because not only does complexity increase the likelihood
of misreporting (Alstadsæter and Jacob, 2013), but also because when the costs of full
administrative compliance are higher, compliance rates are lower (Adams and Webley, 2001;
Matthews and Lloyd-Williams, 2001). Indeed, examining 45 economies, Richardson (2006)
reveals that regulatory complexity is the most important determinant of non-compliance.
Overall, his regression results display that the lower the level of regulatory complexity, the
greater is the level of compliance.
A way forward is to implement Regulatory Impact Assessment (RIA) tests for all proposed
formal regulations and to even use a “wage under-reporting regulatory impact assessment”
test. However, and as Hart et al. (2005) reveal, RIAs vary in: the clarity with which the policy
objectives are stated; their assessment of the risks; the use of stakeholder engagement;
consideration of non-regulatory alternatives; estimates of the expected costs and benefits of
the proposed regulations; and discussion of the sanctions for non-compliance.
Simplifying the number of procedures and forms is another way forward. Simple registration
procedures for employees that make the full data on wages paid easily available to everybody
is essential, as has been introduced in Latvia.
To make it easier to comply and incentivise compliance, businesses can be offered help with
record keeping. This can include the provision of free record-keeping software to businesses,
the provision of fact sheets on record keeping and/or free advice or training such as telephone
hotlines or educational courses.
Indeed, Alm (2011) investigates the effects on compliance levels of services that allow
taxpayers to calculate their tax liabilities. The results indicate that uncertainty reduces both
the level of filing as well as the degree of compliance. The clear lesson is that reducing
uncertainty on tax liabilities by providing a service to enable businesses and workers to
calculate their liabilities reduces non-compliance.
Finland has two calculators available that are actively used by workers and employers – the
Gross Income Calculator and Tax Percentage Calculator. They are intended to encourage
taxpayers to learn the process of correct tax calculation and raise their awareness on workers
and employers’ obligations. The Gross Income Calculator, launched in June 2013, is used in
situations where the employer and the employee have agreed on the net amount of wages, but
they need an estimate of the correct gross income in order for the employee to obtain a tax
card, and for the employer to prepare correctly their annual payroll report. The Tax
Percentage Calculator, launched in December 2002, can be used to estimate whether a person
needs a change in the withheld tax percentage rate in case there have been changes in the
labour status or circumstances – e.g. if the person is no longer employed or has recently
started working. The Finnish Tax Administration is constantly receiving suggestions for
improvements, including requests for more features for the calculators, although even the
current calculators cover the most common situations exhaustively. See:
• Tax Percentage Calculator & Gross Income Calculator (Veroprosenttilaskuri &
Bruttopalkkalaskuri), Finland
What can be done in Latvia?
• Implement Regulatory Impact Assessment (RIA) tests for all proposed formal
regulations and use a “wage under-reporting regulatory impact assessment” test.
31
• help with record keeping. This can include the provision of free record-keeping
software to businesses, the provision of fact sheets on record keeping and/or free
advice or training such as telephone hotlines or educational courses.
• provide a service to enable businesses and workers to calculate their tax and social
insurance liabilities.
4.4. Complexity of the tax system: many tax regimes that provide scope for “tax
optimization”
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
Tax optimisation involves searching for and identifying the legal and organisational
frameworks that provides the lowest possible level of taxation for a company. These can be
legal (i.e., tax avoidance) or illegal (i.e., tax evasion). When there is a lack of belief in the
benefits of paying the full taxes owed, tax optimization practices prevail. The solution,
therefore, is to improve tax morale (see section 5).
Another approach is to introduce tax policies that make it easier and more beneficial for both
employers and workers to fully declare their employment and make it disadvantageous to
accept envelope wage cash payments.
Best practices in fighting this determinant in other countries
In Romania, there was a perception that many part-time employees are really on full-time
contracts which are under-declared. To solve this, Romania increased the costs of these part-
time contracts so that it is no longer so advantageous for employers to under-declare
employees. The Emergency Governmental Ordinance no. 4/2017 from July 2017 amending
the law no. 227/2015 of the Fiscal Code, states that when the gross monthly income from
part-time employment is below the level of the national minimum gross wage (calculated for
full-time contracts), the level of social contributions due by employers is equivalent to where
the national minimum gross wage is paid. As such, regardless of the number of hours worked,
the tax due is calculated at the level of a full-time contract (8 hours per day). This was applied
starting from August 2017.
When this policy measure was implemented in Romania, the number of part-time contracts
decreased by 119,254 (an 11% reduction in part-time employment in August compared with
July). Full-time contracts, meanwhile, increased by 61,053 in August compared with July. It
might be that a share of the part-time contracts concealed de facto full-time employees which,
under the new legislation, were transformed into full-time contracts. However, the total
number of employees, which until August increased every month, decreased by 58,201 in
August compared with July. What proportion of these jobs moved from under-declared
employment into wholly unregistered employment is not known.
Another approach is to incentivise electronic payment and deter cash payments. Given that
envelope wages are usually paid in cash, deterring cash payments and incentivising electronic
payments seeks to reduce the cash available to pay these envelope wages. Box 14 summarises
the options available for doing so.
Box 14: Incentivising electronic payment systems and deterring cash payments
Aim: to transfer from cash to electronic payments to
reduce the cash available to pay
envelope wages.
32
Description: several options exist:
• Introduce a ceiling for cash transactions and therefore the cash available for paying
envelope wages in cash;
• Make point-of-
sale (POS) terminals available across all sectors, such as bars and
taxis. Introducing them can reduce the use of cash and therefore cash available for
paying envelope wages;
• For governments to shift more fully towards electronic payments;
• Discourage easy access to cash. The presence of no-fee automated teller machines
(ATMs) provides uninhibited access to cash and subsequent cash payment at the
point-of-sale; and
• Provide incentives for using cards at the point-of-sale. Many day-to-day transactions,
especially those worth less than €15, remain cash based. Developing incentives for
individuals to use cards is a way forward. Argentina for example, offers a 5% VAT
discount on debit card transactions and 3% on credit card purchases.
Evaluation: In Greece, the Foundation for Economic & Industrial Research (2015) estimate
that the tax revenues increase by 0.24 percentage points for every percentage point growth of
the use of payment cards (see ILO, 2016 for an in-depth review).
In Latvia, the Amendments to the Law on Taxes and Duties in 2016 specify restrictions on the
use of cash by natural persons - persons that are not involved in business activities.
Amendments specify how responsible organizations should report to the State Revenue
Service about suspicious transactions involving cash as well as determines threshold that
natural persons can use for cash payments (7200 euros).
Another option is to enable those who voluntarily disclose to the state authorities their past
wage under-reporting to have the penalties waived (or reduced) that would have applied, if
they are compliant in the future. There are several options for such a voluntary disclosure
scheme:
• Disclosure could be with or without penalty for past non-compliance.
o If penalties are used, the level of the penalty could be on a sliding-scale
reduced by set amounts depending on whether the employer agrees to employ
the under-declared worker on a (full-time) declared basis for at least 3, 6 or 12
months.
• The scheme could be universal, or it could be targeted at:
o specific sectors, such as:
Tourism industries;
Construction sector;
Personal and household services, or
Agriculture.
o specific population groups or types of wage under-reporting, such as:
understating wages;
understating hours worked;
• Access to the COVID-19 short-term financial support could be offered as an incentive
to come out of the shadows, or not offered.
o Access to such short-term support could be conditional on the business
offering the under-declared workers voluntarily disclosed a full-time contract
for at least x months, or not.
33
Box 15 presents a voluntary disclosure initiative offered in Kosovo* during the current
pandemic.
Box 15: Voluntary disclosure initiative, Kosovo*
Aim: E
mployers who voluntarily disclose that they previously employed unregistered
employees are provided with access the short-financial financial assistance available during
the 2020 coronavirus pandemic, if they employ the workers on a declared contract for at
least one year.
Description: In Kosovo*, a cross-government group established an operational plan with 15
measures. Measure 14 of this operational plan provides financial support of €130 per month
per employee for two consecutive months providing businesses put workers on contracts of
at least one year. The Kosovo tax authority has offered businesses access to this short-term
support if they voluntarily disclose that they employed unregistered workers, and they then
employ the workers on declared contracts for at least one year.
Evaluation: On May 6, the Finance Minister Besnik Belsemi reported that 10,597 new
employees have so far registered, which is an increase of 2.6% in total official employment
(Bami, 2020). This provides a tentative indication of the potential impacts and effectiveness
of this voluntary disclosure scheme.
To see how a voluntary disclosure programme can be announced to the public more
successfully, Box 16 below provides the transcript of a video used by the Canadian Revenue
Service. This could be replicated in other countries.
Box 16: Transcript of Video: “Make Things Right”
voluntary disclosure initiative,
Canada
Second chances don’t often happen in life, but if you have ever made a tax mistake, or left out
details about income you reported on your tax return, the Canada Revenue Agency is offering
you a second chance.
You can correct your tax affairs now—through the CRA’s Voluntary Disclosures Program.
This is your opportunity to come forward and make things right.
It’s so easy to do and it lifts a great weight off your shoulders.
You don’t need anyone, you can do it all yourself.
Anyone can take part in the Voluntary Disclosures Program, but you have to file your
application with us, before you become aware that the Can
ada Revenue Agency is taking
action against you.
The mistake or omission you want to correct must be at least one year overdue, it has to be a
mistake or omission that could be subject to a penalty, and you have to include details about it
when you report it to us.
Coming clean is an easy way to achieve peace of mind.
By making a valid disclosure you may avoid penalties and prosecution.
And, in some cases, the Canada Revenue Agency might reduce the interest you owe.
The vast majority of Canadians pay their taxes in full.
That means we all benefit from
government-funded services and programs that make our lives better.
More and more Canadians are coming forward to correct their tax affairs, why not you?
34
Second chances don’t come along every day.
Take advantage of this one through the Voluntary Disclosures Program.
Make things right and have peace of mind.
For more information: www.cra.gc.ca/voluntarydisclosures
Video available at:
https://www.canada.ca/en/revenue-agency/news/cra-multimedia-library/businesses-video-
gallery.html#vdp
Preventative measures can also make it easier and provide incentives for established
businesses to make the transition to legitimacy by offering formalization support and advice.
The business advice and support needed to help businesses formalize differs to that given to a
formal start-up or growth businesses (Caianello and Voltura, 2003; Copisarow, 2004;
Copisarow and Barbour, 2004; Meldolesi and Ruvolo, 2003; Williams, 2005). Box 17
provides an example of a formalisation service provided by a non-governmental organisation.
Box 17: Street (UK) formalisation service, UK
Aim:
To help businesses make the transition to formality by providing a formalisation
support service.
Description: Street (UK) was established in 2000 to offer loans, advice and business support to
self-employed people and micro-enterprises making the transition to formalisation (www.street-
uk.com). Their approach is to monitor progression of clients in 12 areas:
• Moving from part-time to full-time work;
• Moving from home to business premises;
• Keeping basic level records;
• Keeping higher-level accounts;
• Purchasing public liability and employer liability insurance;
• Hiring employees on a PAYE basis;
• Using a bank account for their business transactions and/or opening a separate business
bank account;
•
Obtaining the required licenses and permits to operate the business (e.g., health and
safety inspection certificates, driver instructor license);
• Graduating off all non-work benefits;
• Graduating from majority cash revenues to majority invoiced revenues;
• Incurring formal business tax liability; and
• Becoming VAT registered.
Street (UK) attempts to ensure that in any 12-month period at least three steps are taken with
each client, although the order in which they are taken is tailored to the specific business.
Evaluation: No formal evaluation has been conducted.
What can be done in Latvia?
• When there is a lack of belief in the benefits of paying the full taxes owed for the
wider society, tax optimization practices prevail. The solution, therefore, is to improve
tax morale (see section 5).
35
• Introduce tax policies that make it easier and more beneficial for both employers and
workers to fully declare their employment, such as making social insurance
contributions for part-time employment the same as for full-time employment.
• Incentivising electronic payment systems and deterring cash payments to reduce the
cash available for paying envelope wages in cash (e.g., ceiling for cash payments,
make point-of-sale (POS) terminals available across all sectors, governments to fully
use electronic payments, discourage easy access to cash such as no-fee automated
teller machines, provide incentives for using cards at point-of-sale)
• Enable those who voluntarily disclose to the state authorities their past wage under-
reporting to have the penalties waived (or reduced) that would have applied, if they are
compliant in the future There are several options for such a voluntary disclosure
scheme:
o Disclosure could be with or without penalty for past non-compliance.
If penalties are used, the level of the penalty could be on a sliding-scale
reduced by set amounts depending on whether the employer agrees to
employ the under-declared worker on a (full-time) declared basis for at
least 3, 6 or 12 months.
o The scheme could be universal, or it could be targeted at:
specific sectors, such as:
• Tourism industries;
• Construction sector;
• Personal and household services, or
• Agriculture.
specific population groups or types of wage under-reporting, such as:
• understating wages;
• understating hours worked;
o Access to the COVID-19 short-term financial support could be offered as an
incentive to come out of the shadows, or not offered.
o Access to such short-term support could be conditional on the business
offering the under-declared workers voluntarily disclosed a full-time contract
for at least x months, or not.
5. Competition vs tax evasion, tax morale
5.1. Tax evasion (paying envelope wages) as a self-sustaining phenomenon: widespread
wage underreporting distorts competition, and firms might choose to evade taxes to be
able to compete with their peers.
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
When wage underreporting is seen by workers and employers as widespread, firms might
decide to follow their peers and evade taxes themselves. This results from a lack of
“horizontal trust” (i.e., trust in others to adhere to the formal rules). If workers and
employers view others as under-reporting wages, they might also do so. Indeed, laboratory
experiments of taxpayers reveal that compliance is conditional on their perceptions of the
behaviour of other taxpayers (Narsa et al., 2016; Traxler, 2010). If taxpayers believe that
there is widespread compliance, they too are more likely to be compliant (Alm, 2011).
However, if taxpayers believe that non-compliance is common, they too are more likely to be
36
non-compliant (Hallsworth et al., 2017). For instance, a laboratory experiment of taxpayers in
Belgium, France and the Netherlands discovered that if taxpayers were given information that
the level of compliance was high, they reacted in compliant ways themselves (Lefebvre et al.,
2015). Participation is therefore conditional on the perceived behaviour of others.
Best practices in fighting this determinant in other countries
To address this lack of horizontal trust in others to comply, it is necessary for state authorities
to display that compliance is widespread. If they advertise that there is widespread non-
compliance, such as by publishing figures on the extensiveness of wage under-reporting, then
they will make horizontal trust worse. As such, it is necessary to develop messages for
workers and employers about the high rates of compliance with the formal rules and to create
narratives about how non-compliance is an exception and overall low. This is the opposite
message to what is sometimes put out by state authorities who tend to put out press releases
on the high rates of non-compliance.
What can be done in Latvia?
• The messaging of government in relation to wage under-reporting needs to be that
such a practice is rare and/or confined to a few sectors/occupations/businesses but that
overall, compliance with the formal rules is high. The message needs to be that those
who engage in wage under-reporting are the exception and that there is a high
likelihood of their detection due to government investment of resources in data mining
(i.e., an all-knowing “big brother” depiction of the SRS and SLI).
6.2. Tax morale: whether it can be justified to cheat on tax if there is such a chance. On
the side of employees
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
Over the past decade or so, it has been realised that even when the benefits of participating in
wage under-reporting outweigh the costs, many do not make the rational economic decision to
engage in wage under-reporting (Alm et al., 2010; Kirchler, 2007; Murphy, 2008). They are
not rational economic actors. To explain their adherence to the laws and regulations even
when the rational economic decision would be not to do so, a view has emerged that the
decision on whether or not participate in wage under-reporting is related to actors’ level of
vertical trust (in the state).
This social actor view of participation in wage under-reporting has been explained using
institutional theory (Baumol and Blinder, 2008; Denzau and North, 1994; North, 1990).
Viewed through this lens, institutions are the rules of the game that govern human behaviour.
All societies possess both formal and informal institutions. Formal institutions are the legal
rules of the game and are manifested in the laws, codes and regulations. Informal institutions
are the unwritten rules of the game and are manifested in the socially shared norms, values
and beliefs about what is acceptable (Helmke and Levitsky, 2004). Wage under-reporting
therefore takes place outside the formal rules but adheres to the informal rules about what is
acceptable.
Wage under-reporting occurs when the social norms, values and beliefs of citizens, employers
and workers about what is acceptable are not in congruence with the formal rules (Godfrey,
2015; Webb et al., 2009; Williams et al., 2015, 2017). This lack of congruence or asymmetry
is explained as a direct outcome of their lack of vertical trust (in formal institutions), which
can be measured in terms of their intrinsic motivation to pay taxes, or what is often referred to
as tax morale (Alm and Torgler, 2006, 2011; Torgler and Schneider, 2007; Torgler, 2011).
37
Lower tax morale (i.e., less vertical trust in the state) leads to a higher probability of
participation in undeclared practices (Williams and Horodnic, 2021). Hence, the aim of policy
is the improvement of vertical trust in the state, namely tax morale, to promote voluntary
compliance with the formal rules of the game.
Best practices in fighting this determinant in other countries
The primary way in which the tax morale of employees is improved is through education and
awareness raising campaigns. For employees, such a campaign could be targeted particularly
at the employee groups identified in Reports 1 and 2 who are more likely to engage in wage
under-reporting, especially those in small firms and the sectors where envelope wages are
prevalent. This campaign could focus upon the benefits of fully declared employment and the
costs of receiving envelope wages in terms of the future benefits foregone.
An awareness raising campaign in Lithuania, entitled “No country for shadow”, involved
cooperation between NGOs, business and the public sector in a joint action. More than 80
towns and cities participated with over 1000 participants from different organisations in 2016,
2017 and 2018. Postcards, handed out to citizens in the streets and main squares of Lithuanian
cities, informed every citizen how they could contribute to preventing wage under-reporting.
The aim of this campaign was to draw public attention to the problems caused and to spread
the message that “everyone can choose a transparent way” and can contribute to their own and
public welfare by refusing envelope wages.
More widely, initiatives are also required to educate employees about the benefits of taxation
in terms of the public goods and services that they receive in return for the taxes they pay.
Such policy initiatives might range from introducing into the civics curriculum in schools the
issue of taxation and adhering to labour legislation, through letters to employees as taxpayers
about how their taxes are being spent, to signs stating “your taxes paid for this” on fire
engines, roads and ambulances, and in hospitals, doctors’ surgeries and schools.
In Bulgaria, an “envelope wages” awareness raising campaign (http://www.zaplatavplik.bg/)
developed an online app tool for employees to calculate the negative costs of accepting
envelope wage payments. Employees can input their envelope wage and see how much they
are losing in maternity pay, sick pay, unemployment pay and pension contributions. It also
shows how much they will lose in total over the next thirty years.
What can be done in Latvia?
• Education and awareness raising campaigns should be launched on the benefits of
fully declared employment and the costs of receiving envelope wages in terms of the
future benefits foregone. The recent awareness raising campaign, #Atkrāpies
(#FraudOff!), could be again launched, again targeting young people aged 16-24 years
old who start a job, with a focus upon using social media including YouTube videos
and vlogs, Instagram and Facebook, including e-klase. Some of the main messages
should be again not to accept envelope wages because the envelope wage often
disappears or decreases, and the use of YouTube vloggers as key influencers of young
people, talking about their own negative experiences of envelope wages, should be
again used.
• More widely, campaigns should be launched to educate employees about the benefits
of taxation in terms of the public goods and services that they receive in return for the
taxes they pay. The issue of taxation and adhering to labour laws could be introduced
in the civics curriculum in schools, letters could be sent annually to employees as
taxpayers about how their taxes are being spent, and signs put up stating “your taxes
38
paid for this” on fire engines, roads and ambulances, and in hospitals, doctors’
surgeries and schools.
• An online app tool could be developed for employees to calculate the negative costs of
accepting envelope wage payments. Employees would input their envelope wage and
see how much they are losing in maternity pay, sick pay, unemployment pay and
pension contributions. It would also show how much they will lose in total over the
next thirty years. In addition, to embed learning, a student competition could be
organized to develop this online app, with the data provided to those entering the
competition to develop the app so that learning is reinforced among them. An I-Phone
could be offered as the prize.
• A re-run of the SMARTS student competition run in Latvia in 2011 and 2012 by the
Free Trade Union Confederation of Latvia (Latvijas Brīvo arodbiedrību savienība,
LBAS) could be organized. This aimed at increasing student’s awareness about labour
rights and safety at work issues and could include wage under-reporting.12
6.3. Tax morale: whether it can be justified to cheat on tax if there is such a chance. On
the side of employers
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
Although campaigns targeted at employees are useful, it is largely employers who instigate
the proposal to pay an envelope wage. Therefore, action is required to change the social
norms, values and beliefs of employers about what is acceptable so that they are in
congruence with the formal rules.
Best practices in fighting this determinant in other countries
The primary way in which the tax morale of employers is improved is using education and
awareness raising campaigns on the benefits of fully declared work. Such an awareness
raising campaign should target small businesses in those regions and/or sectors where salary
under-reporting is more prevalent, namely the agricultural, construction, hotel and restaurant,
transport, repair services and retail sectors.
The advantage of pursuing voluntary co-operation, rather than enforced compliance, is that
this is potentially a cheaper, more effective and sustainable means of tackling violations of
tax, social security and labour law related to undeclared work than having an army of
inspectors to police non-compliant behaviour and using incentives to effectively “bribe” the
population to operate on a declared basis.
The reason for pursuing campaigns is that many employers (and employees) do not fully
understand why they pay their taxes and/or what these taxes are used for by governments, and
nor do they fully understand the rationales for abiding by labour laws and social insurance
rules. Put another way, they do not fully make the connection between the public goods and
services that they receive (e.g., hospitals, schools, transport infrastructure) and the taxes that
they pay.
To achieve this, two broad forms of tax education are required. On the one hand, and to
prevent unintentional evasion, employers need to be educated and informed about what the
current system requires of them. This requires the provision of easily understood information
12 Karnite, R. (2013) SMARTS student competition, Latvia. Available at:
https://www.eurofound.europa.eu/data/tackling-undeclared-work-in-europe/database/smarts-student-
competition-latvia
39
regarding their responsibilities regarding the rules. A large body of research is critical of the
complexity of tax systems for instance and the problems this poses for achieving high rates of
compliance (e.g., Natrah, 2013). A significant portion of non-compliance is unintentional,
arising from a lack of knowledge, misunderstanding and ambiguous interpretation of the law
(Hasseldine and Li, 1999). In consequence, providing easily understood information is a
solution (Internal Revenue Service, 2007; Vossler et al., 2011). Another way forward is to
simplify compliance to make it easier to comply, as already discussed in section 4.
On the other hand, and more broadly, employers need to be educated about the benefits and
value of adhering to the rules, not least by educating them about what their taxes are used for,
to develop their intrinsic motivation to do so and facilitate greater self-regulation. If citizens
are informed and knowledgeable about the current and potential public goods and services
which they are receiving for their money, and the benefits of adhering to the rules, they will
be more willing to do so (Bird et al., 2006; Saeed and Shah, 2011). One direct way of doing
this, as has occurred in the UK, is to provide information to taxpayers regarding where their
taxes are being spent and how much they are contributing to which activities of government.
When using awareness campaigns informing employers of the risks and costs of wage under-
reporting and benefits of full declaration, a key issue is to persuade the target audience to
see the campaign as being about them. This is because such employers (and employees)
often rationalise their behaviour in ways that lead them to view such campaigns as being
about others rather than them, and they neutralise their guilt, such as by seeing themselves as
small players with little impact compared with the big players. If an awareness-raising
campaign focuses upon the risks and costs of wage under-reporting, therefore, it needs to
ensure that the messaging is appropriate, for example by advertising the average level of non-
compliance so that people will not view their own activity as “minor” compared with others.
Indeed, Thurman et al. (1984) highlight the various rationalisations employers use to
neutralise their guilt, and which thus reduce the effectiveness of campaigns focused upon the
costs and risks of participating in wage under-reporting:
• Denial of responsibility. Employers can interpret the publicity about the negative impacts
of wage under-reporting to be the result of others, who could be bigger players than
him/her, rather than a result of their own actions. This means that campaigns should
advertise the extent of non-compliance among the average employer (in the realm being
targeted) and how this aggregates into a sizeable amount;
• Denial of injury. The employer can deny that their wage under-reporting has had
negative impacts on others and rationalise their non-compliant behaviour by asserting that
without them underreporting wages, customers would have had to pay a higher price or
would have been unable to afford to receive the services provided. This may require
examples of the societal impacts of wage under-reporting (e.g., higher class sizes in
schools, fewer intensive care beds in hospitals);
• Denial of victim. The suppliers may accept the negative impacts of their wage under-
reporting but believe that the victims deserve it. This may require that campaigns provide
human stories of individual victims and the consequences of them accepting envelope
wages (e.g., limiting their ability to access mortgages and loans for cars);
• Condemnation of condemners. The employers may assert that the law, the lawmakers
and law enforcers are to blame for an unjust system, and believe that the community to
which s/he has a sense of belonging should not succumb to these formal rules and that
this makes wage under-reporting a socially legitimate activity. To tackle this requires for
40
example stories of the “progress” being made towards a “just” system and the significant
benefits of them operating on a fully declared basis;
• Appeal to higher loyalties. The employer using wage under-reporting may justify his/her
actions in terms of some alternative set of loyalties or social order, believing that this
justifies his/her actions, such as that they are doing it for the benefit of their own family
rather than society. This can be countered by showing how these “higher loyalties”, such
as his/her family, can be also negatively affected by wage under-reporting;
• Metaphor of the ledger. The employer may believe that their actions, although bad, do
not reflect their true and good nature as a person, and regard these actions as temporary
deviations from what is otherwise good behaviour. This may require examples of how a
person who has a true and good nature would respond when confronted by opportunities
to engage in wage under-reporting;
• Defence of necessity. The employer may justify their actions to be the outcome of
personal circumstances, such as that they cannot afford to fully declare wages. This may
require for example that information is provided to such employers on any organisations,
resources and/or procedures that they can access so that they do not have to engage in
undeclared work out of necessity.
Awareness raising campaigns targeted at employers using wage under-reporting therefore
need to ensure that the above possibilities are not open to participants by pursuing the
campaign tactics mentioned.
What can be done in Latvia?
• employers need to be educated and informed about what the current system requires of
them. This requires the provision of easily understood information regarding their
responsibilities regarding the rules.
• awareness campaigns informing employers of the risks and costs of wage under-
reporting and benefits of full declaration.
6. Industry and company size specific issues: determinants of the envelope
wages. Includes administrative burden (various levels), specific
mechanisms due to the industry specifics to decrease the envelope wages
It is important to recognise that the policy tools used to tackle wage under-reporting in general
are the same as those targeted at specific industries and businesses of different sizes. Indeed,
the European Platform Tackling Undeclared Work defines a “sector specific approach” as:
“an approach where the direct and indirect policy measures used to tackle undeclared
work are specifically designed and targeted at one sector whose characteristics in terms
of undeclared work are different from other sectors and whose problems and risk factors
require a specific approach.”
Therefore, it is the weighting given to specific measures that differ when one seeks to
tackle wage under-reporting in a specific sector or firm size. These policy tools are:
Direct policy measures: policy measures that enhance the power of authorities by using
either a deterrence approach and/or incentives.
41
Deterrence approach: the enforcement of compliance by increasing the perceived or
actual risks of detection (through for example more effective joint workplace
inspections) and/or by increasing the actual or perceived sanctions.13
Incentives: these measures make it easier to undertake, and reward, participation in
declared work. Measures used include: purchaser incentives (such as service vouchers,
targeted direct taxes, targeted indirect taxes), and supplier incentives (such as society-
wide amnesties, voluntary disclosure and business advisory and support services).14
Indirect policy measures: these aim to align citizens and businesses attitudes and behaviour
with the laws and regulations. This can be achieved either by changing their attitudes and
behaviour, or by establishing trust in the formal institutions.
Table 4 provides a full list of the policy tools available to tackle wage under-reporting in
specific sectors.
Table 4. Full range of Policy Measures
Implementing more effective sanctions
Penalties and fines for employers or companies to deter participation in wage
underreporting
Penalties that transform wage under-reportinginto declared work
Penalties for citizens or businesses who buy goods or services from the undeclared
economy
Non-compliance lists (“blacklists”) for employers
Exclusion of sanctioned businesses from bidding for public procurement contracts
“Naming and shaming” lists
Improving the risk of detection, including developing data mining, matching and
sharing
Data mining and matching
Data sharing
Risk assessment (e.g. how identify risky businesses)
Improving effectiveness of workplace inspections
Registration of workers prior to starting work or on first day / week of work
Coordination of operations across departments (e.g. joint operations / workplace
inspections)
Coordination of data mining and sharing across government departments
Complaint reporting tools (e.g. telephone hotlines to inform about abuses / cases)
Certification of business, certifying payments of social contributions and taxes
Mandatory ID in the workplace
Supply chain responsibility
Improving ease and benefits of engaging in fully declared work
Supply-side incentives
Simplify compliance (e.g., easier registration procedures; simplify forms; reduce
duplication)
Notification letters
Advisory inspections
Compliance (“white”) lists
Society-wide amnesties
13 Eurofound (2013), op cit.
14 Eurofound (2013), op cit.
42
Voluntary disclosure/regularisation schemes
“Formalisation” advice to start-ups
“Formalisation” support services to existing businesses
Direct tax incentives (e.g. exemptions, deductions)
Targeted VAT reductions
Provide free record-keeping software to businesses
Provide fact sheets on record-keeping requirements
Provide free advice/training on record-keeping
Gradual formalisation schemes
Initiatives to ease transition from unemployment into self-employment
Initiatives to ease transition from employment into self-employment
Access to free marketing
Demand-side incentives
Service vouchers
Targeted direct tax incentives (e.g. income tax reduction/subsidy)
Targeted indirect taxes (e.g. VAT reductions)
Initiatives for customers to request receipts (e.g. lottery for receipts)
“Black box” cash registers
Implementing education and awareness raising campaigns
Information and advice units (e.g., advice “call centres” within enforcement authorities)
Campaigns to inform suppliers of wage under-reporting of the risks and costs of working
undeclared
Campaigns to inform suppliers of wage under-reporting of the benefits of formalising their
work (e.g. informing them where their taxes are spent)
Campaigns to inform users of wage under-reporting of the problems of purchasing goods
and services from the undeclared economy
Campaigns to inform users of wage under-reporting of the benefits of declared work (e.g.
informing citizens of the public goods and services they receive with the taxes collected)
Campaigns to improve horizontal trust in others (e.g., competing firms, other citizens)
Campaigns to improve vertical trust in government
Modernising formal institutions
Improving the degree to which customers of enforcement agencies believe they have been
treated in a respectful, impartial and responsible manner (e.g. some more customer-friendly
initiative)
Information on the work and achievements of the enforcement authority
Information to taxpayers on how their taxes are spent
Actions to tackle wider structural economic and social determinants of undeclared work
Below, examples are provided of best practices in fighting wage under-reporting in each
sector and what can be done in Latvia.
6.1. Construction industry
The construction industry is one of the sectors in which wage under-reporting is prevalent.
Beyond Latvia targeting this sector using the policy instruments available to enforcement
authorities (e.g., data mining, workplace inspections), Latvia has adopted several measures
specific to this sector.
Since 2018, state companies adopt standard construction contracts. This policy states that the
standard construction contract will be used by two state-owned companies – State Joint-Stock
43
Company “Valsts Nekustamie īpasumi” (Real etate) JSC «Augstsprieguma tīkls»
(Electricity). The standard construction contract has been prepared on the basis of the terms of
the Construction Works Agreement developed by the International Federation of Engineering
Consultants (FIDIC - Fédération Internationale Des Ingénieurs-Conseils). Standard contracts
are successfully applied in the construction industry (and beyond) in many countries.
Providing a “standard approach” (i.e. setting clear rules, allowing for less interpretation) is
intended to have a positive impact on undeclared practices as it reduces the scope for
corruptive behavior, amongst others. Applying such a principle would be beneficial across all
sectors (as done in various countries), yet doing this in big state companies, as in this case, is
a positive first step.
In 2019, therefore, and more widely, standardized construction contract terms for use in
public works contracts were introduced to decrease undeclared practices.
Moreover, amendments to the Law On Taxes and Fees in 2016 and amendments to the
Latvian Administrative Violations Code in 2019 introduced “electronic working time system”
accounting requirements in the construction industry in order to ensure better control on the
real hours that employees in the industry spend on the construction sites. This measure aims
to establish a common data base and transfer of data to ensure information flow for a
electronic working time accounting system
Best practices in fighting this determinant in other countries
The policy tools used to tackle wage under-reporting in the construction sector are in general
the same as those more generally used. However, due to the unique situation of the
construction sector with high sub-contracting and the difficulty of identifying who is meant to
be working on a construction site, some measures are more important. To improve the
likelihood of detection of those engaged in wage under-reporting on construction sites, nine
countries have introduced social ID cards in the construction industry.15 The Belgian
example is outlined in the box below.
Box 18: Social ID cards, Belgium
The fundamental premise behind social ID cards is that they confirm whether people on a
construction site are meant to be there or not. In this way, they help to improve the detection
of wage under-reporting. Many different enterprises send workers to a construction site and
they do not necessarily know each other, thus ID cards help to overcome this. They can also
be used for other purposes (e.g. training, safety certificates, to control driver licences, access,
presence registration).
In Belgium, ID cards were introduced on a phased basis, following an initiative of the social
partners, starting with a test phase on eight construction sites in 2013. Today, they are widely
used on (large) construction sites but are not mandatory. The intention is to make the cards
mandatory for all construction workers.
The Belgian ID cards enable both visual (via a photo) and digital (through an electronic chip
and RFID- antenna) identification of the workers.
They are highly secured against
counterfeiting.
The production process for the ID cards is fully automated. Data is collected from the social
security network and the cards are produced at one central point (Constructiv).
15 https://www.efbww.eu/stream/18f9e8f5-6e7e-47a1-8d86-93440a189e9e
44
Other countries have targeted the construction industry in relation to sending notification
letters regarding potential non-compliance. The finding is that harder notification letters are
more effective than softer letters. The box below provides the different content of the hard
and soft notification letter used in Estonia.
Box 19: Notification letters in the construction sector, Estonia
In Estonia, 13% of all employees receive envelope wages and 30% of all employees view
envelope wage payments as acceptable. The tax loss from envelope wages is EUR 149 million
per year and as such, the Estonian Tax and Customs Board’s (ETCB) strategic objective is to
reduce the share of envelope wages to below 4% by 2021.
The ETCB used “nudge”
theory to increase employers’ payroll tax compliance. Focusing
upon the construction industry, employers were targeted if declared wages were below 70% of
the industry’s average. Co-operating with the Praxis Centre for Policy Studies, anthropologists
conducted interviews with employers to understand their reasons for paying envelope wages.
Between January to September 2018, notification letters which built upon these findings were
then sent to the above construction businesses.
The notification letters significantly increased declared payroll taxes by 12.1%-13% compared
with the control-group over a three-month (June-August) follow-up period. The e-mail
outlining possible penalties (
the strict letter) had a significantly greater effect than the
cooperation-oriented one (softer letter).
Content of the soft and hard notification letter used in the Estonian construction sector
[English translation from Estonian]
Dear, [Full Name]!
Our aim is to ensure that you and other entrepreneurs in the Estonian construction sector could
compete on a fair market. That is why we will now be paying more attention to undeclared
payroll taxes.
We are deploying new initiatives to combat payroll tax evasion. In addition, from 10th of July
we will start thoroughly auditing a random selection of companies. The audits will concern
entrepreneurs whose employees earn less than 70% of the industry average. Our selection may
include [recipients company name]. In that case, we will analyse your tax data and together
with you, we will figure out whether all this year’s wages have been declared and payroll
taxes payed.
E-mail version A (softer): If not, then we will discuss together with you whether these
problems are temporary or more permanent and how can we help you so that in the future,
[company name]’s pays all tax due.
E-mail version B (strict): If not, then you have to: (1) pay any tax unpaid; (2) pay interest on
any unpaid tax; (3) pay a fine for keeping tax you owe to yourself; (4) take into account that
you may have restrictions to participate in state-commissioned projects.
We are glad to see that evasion of payroll taxes has become steadily rarer in Estonia over the
recent year – 92% of all workers in Estonia earn wages for which payroll taxes have been paid
in full.
Every year, Estonia loses out on EUR 100 million in unpaid payroll taxes. This is the
45
equivalent of the annual budgets of ambulance and fire services combined.
We kindly ask you to review [company name] upcoming payroll declarations to be sure that
taxes are paid in full from June onwards. By doing this, you contribute to fair competition as
well as maintaining crucial public services in Estonia.
We thank you if you have paid your payroll taxes in full.
Tax and Customs Board
In the construction industry, there are also key challenges revolving around increasing the
probability of detection, including the identification of sub-contractors in supply chains and
whether there is wage under-reporting in these supply chains. The box below presents the use
of joint or several liability in construction supply chains.
16 The tools mentioned also apply to the security services and meat processing industry.
17 An animated film about Checkin@Work is at: https://www.youtube.com/watch?v=tDlTwS4wDQQ
Box 20: The Belgian liability system for social security debts and non-paid wages in the
chain of sub-contractors
In Belgium there are a number of tools and applications to tackle undeclared work within
chains of sub-contractors. In the construction sector16, the following tools apply.
Declaration of Works is an electronic declaration of all construction sites, contractors and
sub-contractors (small assignments, with a total value of less than EUR 30,000, are exempt).
The information which must be declared is as follows:
Start / end of the construction site,
Start / end of activities of each contractor and sub-contractor,
Identification of each contractor & sub-contractor,
Description of the works.
Checkin@Work17 helps to tackle fraud by showing who is present at the construction site,
when, for whom work is carried out and under which status (employee or self-employed).
This enables targeted inspections to be made. The following data must be recorded for all
works on construction sites with a total value of EUR 500 000 or more:
Identification of the natural person,
Address of the construction site,
Capacity in which the person carries out his activities (employee, self-
employed, project
supervisor, employers, coordinator,…),
Identification of the employer or of the person by whose order the work is being carried out,
Identification number of the declaration of work,
Time of recording.
Efforts have been made to make Checkin@Work
as accessible as possible. Data can be
entered in various ways, including via a laptop or Smartphone. In terms of sanctions /
liabilities, if the non-declaration is not an administrative error, then there is a penalty of 5%
of the total value of the work (this 5 % relates to only “one level in the chain”, i.e. the
liability is only calculated on the value of the contract between contractor-subcontractor (or
between subcontractor and subcontractor-level-1) and not on the value of the whole
46
The example from Belgium shows how the authorities have tried to make their tools and
applications accessible and user-friendly to employers.
Some countries, including Belgium, Spain and Norway, now also limit the number of sub-
contractors in construction chains. In other countries, including Bulgaria, there is an
obligation on the main contractor to keep all records, for their employees but also for sub-
contractors. There is generally a consensus across the construction industry that limiting the
number of sub-contractors to 2-3 was a key to tackling wage under-reporting in construction
industry supply chains.
What can be done in Latvia?
• Evaluate the feasibility of introducing social ID cards on construction sites. This could
in the first instance be a voluntary industry-led initiative.
• Use data mining to identify risky construction businesses and send notification letters.
There should be experimentation with different types of notification letters to see what
is effective and what is not using a “test, learn and adapt” approach.
• Use reverse supply chain responsibility making those at the top of the supply chain
responsible for their sub-contractors.
• Limit the number of sub-contractors in construction chains to 2-3
6.2. Retail
Although many of the policy tools discussed elsewhere in this report can be used to tackle
wage under-reporting in the retail sector, two specific measures are highlighted here.
Use of certified cash registers
Wage under-reporting requires businesses to have cash available to pay cash in envelope
wages. Certified cash registers not only reduce non-declaration of turnover but also reduce the
amount of cash available to businesses to pay envelope wages.
Certified cash registers are being introduced in many EU member states. For example, since
2010 in Sweden, businesses selling goods and services in return for cash payments must have
a certified cash register. A certified cash register consists of two parts: a cash register with a
manufacturer declaration and a special control unit, a black box, connected to the cash
register. The black box reads registrations made by the cash register. Only the Swedish Tax
Agency can access the data in the black box. In Sweden, the businesses bear the costs of the
cash registers, which totals some SEK 15,000 (€1,785). Companies not complying are fined
SEK 10,000 (€1,190) by the Swedish Tax Agency. If the company once again fails to comply
with the law within a year, a fee of SEK 20,000 (€23,800) is charged. Cash payments also
include payment by debit (bank) card and it is mandatory for the trader to give the customer a
construction site). For sub-contractors with social security debts, their status is checked
before payment of any invoice on the social security portal site (www.socialsecurity.be). If
they have social security debts, a deduction of 35% is made on each payment and transferred
to the National Social Security Office (NSSO). The benefits of the Belgian approach include
for example the possibility to carry out targeted inspections, the use of the databases for data
mining projects, the exclusion of fraudulent or financially viable companies from the market
and the protection of workers’ rights. However, there are also some threats: for example,
there is a danger of formalising fraud structures – it is easy to “tick the boxes”
, make
deductions and then simply replace one fraudulent sub-contractor with another.
47
receipt. The tax agency conducts unannounced “undercover” visits to see if all transactions go
through the register and that receipts are given. Failure to issue receipts or register
transactions can result in the trader being fined and lead to a full audit.
In 2010 in Poland, the Ministry of Finance introduced a similar scheme making electronic
fiscal cash registers mandatory for various professions, including doctors, lawyers, tax
advisors, physicians running private practices, funeral homes and translators. Before this, they
were allowed not to register each sale and instead were allowed to pay income tax in the form
of a lump sum. The decision to register and report each sale made, using a certified cash
register, ended controversies regarding the unequal treatment of these groups. Nevertheless,
these groups continue to avoid recording sales. For example, physicians only have to use cash
registers during official opening hours, even though patients may be seen after hours, they
may not record home visits on cash registers, claim the cash register is out of order or
negotiate the price with the patient who is offered a lower fee if no “paperwork” is involved
(Williams and Renooy, 2013). This measure is transferable across both sectors and countries,
as displayed by the fact that in taxis, a taximeter can be required to register the fare and print
receipts.
Recommendation
Introduction of certified cash registers in all retail outlets
Goal To transform wage under-reporting into fully declared employment by
reducing the cash available to employers in the retail sector to pay
employees an envelope wage
Implementation
All legal and natural persons that perform cash transactions (or cash
e
quivalent transactions) and are obliged to keep books and records
must use certified tax registers.
The certified cash registers are connected to the central information
system of the financial authority via the internet, so processed invoices
are verified and saved in real time, enabling traceability and effective
control over invoices, thus helping to reduce unrecorded transactions.
The invoice information submitted to the Financial Administration
contains information on the tax number of the person who actually
issued the invoice. In this way, the Financial Administration can
compare data on the actual working hours and working hours declared
for the payment of social security contributions. This effectively
prevents the occurrence of unregistered emplo
yment and declaring
workers as part-time when they are full-time employees.
A pilot study might be conducted introducing cash registers in a
specific geographical region or a branch of the retail industry where
wage under-reporting is prevalent (e.g., restaurants).
Responsible
Institutions
State Revenue Service
Outcomes
• Provides a measure to ensure compliance in the retail trade.
Indicators of
achievement
• Reduction in number of transactions that are not recorded
• Increased in level of reported turnover in retail businesses
• Increased tax revenue
48
Receipts Lottery
In many countries, to encourage transactions to be put through the certified cash register,
initiatives have been pursued to encourage customers to ask for receipts.
The idea of a receipt lottery is to reduce undeclared transactions by limiting unreported
exchanges through the greater issue of receipts in business-to-consumer transactions.
Consumers have an incentive to ask for a receipt because it acts as a free-of-charge ticket to
enter lotteries, therefore giving its holder who has requested it a chance to win a lottery prize.
As such, in the longer-term, this measure aims to encourage consumers to get in the habit of
asking for fiscal receipts. The assumption is that after a time, citizens will develop this habit
(e.g. by making asking for receipts socially acceptable and desirable, or by raising awareness
of the benefits of combating undeclared transactions) and will therefore continue to ask for
fiscal receipts even if there is no additional monetary incentive.
In Romania at the beginning of 2015, the National Agency for Fiscal Administration (ANAF)
launched a toll-free telephone number where customers can report cases where they have not
received a receipt for their purchases. See Box 21.
Box 21: Receipts lottery, Romania
Aim: to encourage purchasers to ask for receipts so that (“black box”) cash registers record
all transactions.
Description: In Romania
at the beginning of 2015, the National Agency for Fiscal
Administration (ANAF) launched a toll-free telephone number where customers can report
cases where they have not received a receipt for their purchases. The receipts lottery measure
builds on this measure by encouraging consumers to ask for receipts.
Evaluation: A press release by ANAF (September 2015) reveals an increas
e in declared
VAT of 5.85% in the cumulative seven months in 2015 compared with the same period in
2014, prior to the lottery. Moreover, “The consumption of paper rolls for cash registers has
increased by 80% since the Receipts Lottery began. So, there are almost two times more
receipts being printed” (press release by MasterCard director for Romania, Cosmin
Vladimirescu, quoted by Mediafax, October 2015).
Moreover, in Croatia, in parallel with the introduction of certified cash registers, the Croatian
Tax Administration launched a national competition in collaboration with the Croatian
Lottery (see Box 22).
Box 22: “Can I have a receipt please?”, Croatia
Aim: to
encourage purchasers to ask for receipts so that fiscal cash registers record all
transactions.
Description:
The Croatian Tax Administration (Ministry of Finance) launched a prize
competition "Can I have the receipt, please?" (1 August until 2 October 2015). The
competition aimed to encourage foreign customers to ask for receipts. Specifically, it offered
foreigners the chance to win a paid summer vacation for two in 2016. For this they needed to
post to the Tax Administration 20 receipts for purchases made in Croatia.
The lottery-like initiative is behaviourally inspired as it leverages on individuals' over-
weighting of small probabilities
. Moreover, in communicating the prize competition, the
Croatian Tax Administration relied on behavioural levers, such as framing ("Every receipt
you take is an assurance of a more organised society and a more secure future") and social
49
norms (i.e. "call us at our toll-free number and report the fiscalization subject who doesn’t
respect the rules, in contrast to a large majority of others").
Source: “Can I have the receipt please?,” Croatian Tax Administration. [Online]. Available:
Http://www.poreznauprava.hr/en/Documents/LetakEng20150804.pdf. [Accessed: 15-Dec-
2018].
Below, therefore, a proposal for a receipts lottery is briefly summarised.
Recommendation
Receipts Lottery
Goal To provide a demand-side incentive for customers to request receipts
and therefore reduce undeclared transactions, thus reducing the cash
available for retailers to pay envelope wages.
Implementation
Individuals request and keep purchase receipts issued by traders. For
each monthly lottery, two numbers are extracted: a) a number from 1-
999, representing
the amount on the receipt (to the nearest whole
number); b) a number representing the day of issue of the relevant fiscal
receipt. For an occasional lottery an additional number representing the
calendar interval (i.e. month) is extracted. Receipts must meet
cumulatively the following conditions: correspond to the two criteria
mentioned (1 and 2 above); be issued by an electronic cash register in
accordance with the law; all the mandatory information listed on the
receipt be legible; be issued to an indivi
dual (i.e. not to mention any
buyer tax ID).
To claim the prize, individuals who hold receipts that meet these
conditions must submit them within 30 days of the draw. The prize is
determined by dividing the prize pool for each extraction by the number
of winners. If the number of winning receipts exceeds 100, an additional
draw from the tickets which meet the winning criteria is organised and
100 winning tickets are drawn.
Responsible
Institutions
State Revenue Service
Outcomes • Provides an incentive to customers to request a receipt (i.e., “I want
to win the lottery”).
Indicators of
achievement
• Reduction in unregistered and unrecorded transactions.
• Increase in consumption of paper rolls for cash registers
• Increase in reported turnover of businesses
• Increased tax revenue
Finally, data mining can take place to identify wage under-reporting in retail outlets, as
described in section 3.1 using the earlier suggested “red flags” to identify risky retail
businesses. Using dynamic benchmarking to identify “outliers”, either workplace inspections
and/or notification letters can be then pursued.
What can be done in Latvia?
• Introduce certified cash registers in all retail outlets
• Establish a receipts lottery
50
• Engage in data mining targeting wage under-reporting in retail outlets
6.3. Wholesale
Although many of the policy tools discussed elsewhere in this report can be used to tackle
wage under-reporting in the wholesale sector, one specific measure is highlighted here.
Data mining is important to identify wage under-reporting in the wholesale sector. As
described in section 3.1, various indicators that could be used to identify risky wholesale
businesses likely to be involved in wage under-reporting include:
• Average salary in a company compared with average salary in the wholesale sector as
a whole;
• Average salary of a certain occupation/profession in the wholesale business does not
correspond with the average salary within the same occupation/profession in the
wholesale sector as a whole;
• Large proportion of a company’s employees are working part-time compared with
other wholesale businesses;
• Number of employees/total wages paid is not appropriate to the turnover, compared
with other wholesale businesses;
• Complaints have been received about tax, social security and labour law violations in
the business;
• The business has previous violations related to tax, social security and labour law
violations;
• A higher proportion of workers receive the minimum wage in a business compared
with the wholesale sector as a whole.
It is then necessary to use dynamic benchmarking to identify anomalies/outliers (i.e., “risky”
wholesale businesses). This identification of potential outlier/anomalous wholesale businesses
likely to be under-reporting wages could then be used either to conduct workplace
inspections, audits or notification letters could be sent.
What can be done in Latvia?
• Engage in data mining using dynamic benchmarking to identify anomalies/outliers
(i.e., “risky” wholesale businesses).
• Follow-up with either workplace inspections, audits and/or notification letters.
6.4. Manufacturing
Although many of the policy tools discussed elsewhere in this report can be used to tackle
wage under-reporting in the manufacturing sector, one specific measure is highlighted here.
Data mining can take place to identify wage under-reporting in the wholesale sector. As
described in section 3.1, various indicators that could be used to identify risky wholesale
businesses likely to be involved in wage under-reporting include:
• Average salary in a manufacturing company compared with average salary in their
manufacturing sub-sector as a whole;
• Average salary of a certain occupation/profession in the manufacturing business does
not correspond with the average salary within the same occupation/profession in their
51
manufacturing sub-sector as a whole;
• Large proportion of a company’s employees are working part-time compared with
other businesses in their manufacturing sub-sector;
• Number of employees/total wages paid is not appropriate to the turnover, compared
with other manufacturing businesses in their sub-sector;
• Complaints have been received about tax, social security and labour law violations in
the business;
• The business has previous violations related to tax, social security and labour law
violations;
• A higher proportion of workers receive the minimum wage in a business compared
with businesses in their sub-sector as a whole.
It is then necessary to use dynamic benchmarking to identify anomalies/outliers (i.e., “risky”
manufacturing businesses). This identification of potential outlier/anomalous manufacturing
businesses likely to be under-reporting wages could then be used either to conduct workplace
inspections, audits or notification letters could be sent.
What can be done in Latvia?
• Engage in data mining using dynamic benchmarking to identify anomalies/outliers
(i.e., “risky” manufacturing businesses).
• Follow-up with either workplace inspections, audits and/or notification letters.
6.5. Services
Here, evaluation is confined to a range of service industries in which wage under-reporting is
prevalent where initiatives can be introduced specific to the service industry.
HORECA industry
A very simple initiative is that in restaurants in Romania, it is a statutory responsibility for
restaurant menus to include on their front page a statement that it is compulsory for the
restaurant to issue a till receipt for the price of the meal. If this is not produced, then the
purchaser has the right not to pay for the meal. Indeed, this initiative could be transferred
easily to Latvia.
The idea of a receipt lottery is to reduce the use of envelope wages by limiting unreported
exchanges through the greater issue of receipts in business-to-consumer transactions. This
limits cash available to businesses that they can use to pay envelope wages. Consumers have
an incentive to ask for a receipt because it acts as a free-of-charge ticket to enter lotteries,
therefore giving its holder who has requested it a chance to win a lottery prize. As such, in the
longer-term, this measure aims to encourage consumers to get in the habit of asking for fiscal
receipts. The assumption is that after a time, citizens will develop this habit (e.g. by making
asking for receipts socially acceptable and desirable, or by raising awareness of the benefits of
combating the undeclared economy) and will therefore continue to ask for fiscal receipts even
if there is no additional monetary incentive. An example is found in Slovenia (see Box 15).
Box 23. Encouraging consumers to check invoices have been declared, Slovenia
Aim: to encourage consumers to check invoices have been declared to the tax authorities.
Description: In Slovenia
, a conventional deterrent measure has been designed so that
purchasers are incentivised to purchase in the declared economy. Similar to other economies,
52
certified cash registers which automatically report transactions to the tax administration have
been introduced. In 2018, 54,213 taxpayers were using fiscal cash registers, that issued
1,019,669,639 invoices (2.8 million per day).
What is innovative in Slovenia is that the purchasers can electronically check whether the
invoice has been verified, using a “Check the invoice” app by scanning the code on the
invoice. To incentivise purchasers, those doing so are automatically entered into a receipts
lottery with a prize fund which pays up to 25,000 euros.
Evaluation: The outcome is that the number of offences detected have increased from 1,978
in 2016 to 3,135 in 2018, resulting in fines totalling 2.9 million euros in 2016 and 5.9 million
euros in 2018.
One of the main ways of improving the effectiveness of inspections in the HORECA sector is
to enhance the ability of enforcement authorities to identify “risky businesses” in this sector
using better data mining and risk assessment. One simple initiative might be to use a proxy
indicator such as the minimum staff required for different types of HORECA business (e.g.,
a restaurant). A data mining exercise to identify risky businesses might also seek to identify
HORECA businesses that are “outliers” on other indicators, including those:
Who have higher than average expenses;
Higher ratios of credit card to cash payments compared with other similar businesses;
Lower than average wage levels, or
A relatively low number of full-time registered employees for their turnover.
Indeed, this outlier approach has been further extended in some inspectorates (e.g., Belgium,
UK). Dynamic benchmarking is used to identify risky businesses. This allows the data to
dynamically determine what the norm is, and this changing norm is used to identify outliers.
An example is the hotel sector in the UK where turnover to credit card transaction ratios
have been used to identify outlier hotels where turnover to total credit card transactions
deviates from the norm. This dynamic benchmarking of the hotel sector occurs on an
individual city level or for a particular type of accommodation provider (e.g., small hotels),
since credit card to turnover ratios are higher in cities and larger hotels than in smaller hotels
and in smaller towns. A too high share of payments by credit cards in total declared turnover,
in comparison to the benchmark determined for the specific area, results in an alarm/red flag.
This data mining initiative requires that third party data is available from banks on credit
card transactions, which can be compared with reported turnover on tax returns, to identify
“outlier” hotels who deviate from the norm. This could also be similarly applied in the
restaurant sector to identify “outlier” restaurant businesses and many other tourist industries
(e.g., tour guides, tour operators) who appear to have turnover to total credit card transactions
that deviate from the norm.
In 2017 in Latvia, a policy was introduced to improve efficiency of the State Revenue Service
by giving the SRS the right to access the information held by the financial institutions (e.g.
banks) in order to ensure the exchange of information on financial accounts. Prior to that SRS
had very limited access to such information. A related policy is that in 2017, to improve the
tax monitoring of natural persons, credit institutions and payment service providers were
obliged to submit to the State Revenue Service information (once a year) on those clients, for
which the total amount of debit or credit turnover of demand deposit accounts and payment
accounts within one credit institution or payment service provider is EUR 15,000 or more.
This suggests that the SRS might already have the powers to access bank accounts of hotels
53
and restaurants to collect data on credit card transactions which can be compared with
turnover on tax returns to produced turnover to credit card transaction ratios for individual
HORECA businesses and identify whether they are “outliers”.
Notification letters are postal or email communications from enforcement agencies to
companies or workers, giving information on applicable legal obligations and systems of
control in place. Although these have been widely applied in tax compliance (Beeby, 2017;
Hasseldine et al., 2007), notification letters have also recently been used by labour
inspectorates (see Williams, 2019).
To highlight their use in tackling undeclared work in the HORECA sector, Box 24 highlights
the use of notification letters and follow-up inspections targeted at the hotel and catering
sector in Estonia.
Box 24: Notification letters and follow-up inspections in the hotel and catering sectors,
Estonia
Aim: To use notification letters and follow-up inspections to encourage full declaration in the
hotel and catering sectors.
Description: On 24 November 2011, the Estonian Tax and Customs Board (ETCB) started
sending out notification letters to 1 300 companies, asking them to revise their accounting and
tax-related information and give feedback to the tax authority on the results of their business
activities. In addition, 1 000 letters were sent to people whose average wages in the company
were considerably lower compared to the average of the region and economic sector.
According to the ETCB, an estimated EUR 30.2 million in tax income was owed by these 1
300 companies. As a result of these notification letters, additional control was initiated in 500
companies who did not change their declarations.
The ETCB visited company sites to inspect business activities and the actual number of
employees working. In March and April 2012, tax officials visited 150 accommodation and
catering companies to find out the reasons why declared wages were considerably below the
average wages in the region. The main measures of control included interviews with the
members of the management board and employees, checking documentation, observing
business activities and controls in real time. In the 20 accommodation and catering companies
not changing their tax behaviour after the inspections, the ETCB undertook additional
controls in May and June 2012.
Evaluation: The companies receiving notification letters in November 2011 were requested to
revise their declarations for December. By January 2012, almost 800 of the 1 300 companies
had reacted to the notification letters and changed their declarations accordingly.
As a result of the control visits, 22 catering and 25 accommodation companies improved their
tax behaviour. Before the controls, the average declared salary in the catering companies was
EUR 277 and EUR 308 in the catering and accommodation companies. After the control
visits, the average declared salary increased to EUR 325 (by 17.3 %) in catering and EUR 348
(by 13 %) in accommodation companies. The number of employees increased in 13 catering
companies (by a total of 35 employees) and in six accommodation companies (by a total of
eight employees). However, 69 companies did not make any significant changes in their tax
behaviour or did not present their tax declarations on time.
Source: https://www.eurofound.europa.eu/data/tackling-undeclared-work-in-
europe/database/targeted-control-of-enterprises-for-undeclared-work-estonia
54
A further example from Estonia is that data mining revealed 150 companies in the hotels and
catering sector in 2012 where the declared wages of staff were considerably below the
average wages for the region (Äripäev, 2012). After the inspections, the average declared
salary increased by 17.3 per cent in catering and by 13 per cent in the hotels (Estonian
Employers’ Confederation, 2012).
A further issue specific to the HORECA sector is the wage under-reporting that occurs due to
the non-declaration of tips received. Indeed, there is a perception that if tips average 10%,
then waiters and waitresses should declare only an extra 10% of their earnings as tips.
However, receiving an extra 10% on bills from customers is far in excess of an extra 10% on
wages, meaning that there will be a considerable under-reporting of tips earned if only 10% of
wages is reported as the value of tips received. In Canada, this has been addressed. Box 25
describes the use of notification letters to encourage the full declaration of tips received by
hospitality workers in Canada.
Box 25: Using notification letters to encourage the full declaration of tips received by
hospitality workers, Canada
Aim:
To use notification letters to encourage the full declaration of tips by hospitality
workers.
Description
: When tips were mostly paid in cash, the level of tip income was difficult to
confirm. However, with widespread debit and credit-card payments, exact tip figures can now
be traced using point-of-sales-machine records.
A Canada Revenue Agency (CRA) audit of income earned by 145 wait staff in St. Catharines,
Ont., revealed C$ 1.7 million in unreported tips and gratuities. On average, this amounts to C$
12 000 in unreported income per person audited, and the audit uncovered that wait staff were
only reporting between zero and 10 % of their tip income, whilst actual tip income was
between 100 and 200 % of wage income. That is, wait staff earn up to double t
heir wage
income in tips. These assumptions led the CRA to estimate that undeclared income from tips
by wait staff amounted to between C$ 2.7 - 6 billion.
One result was that in January 2018, 200 employees of the Murphy Hospitality Group on
Prince Edward Island were sent notification letters by the CRA notifying them of potential
underreporting of their tips earned in 2014 and 2015. The letter noted that the CRA was
considering the imposition of penalties up to 50 % of the taxes owed.
An intention of the notification letters was to address a decades-old informal guideline used in
the hospitality sector that service staff should declare circa 10 % of their official income as
gratuities on their tax returns. Murphy Hospitality Group had a
dvised their employees to
adopt this informal guideline. The notification letters sought to educate wait staff about the
tax system, their obligations and the penalties for under-reporting income.
Evaluation: No known evaluation is available of the increased declaration of tips by wait
staff resulting from the notification letters. However, debate has ensued about the accuracy of
using debit and credit card transactions of point-of-
sale (POS) machines to calculate
individual tip income.
On the one hand, wait staff argued that tip income is lower than suggested by the use of POS
transactions because this ignores “tipping out”
(i.e. dividing any tips earned during a shift
with kitchen and other staff).
55
On the other hand, the CRA has argued that tip income and under-reporting could be higher
than POS transactions suggest. This is for two reasons. Firstly, this audit method does not
include cash tips received. Secondly, “zapping devices” are sometimes used
to eliminate
transactions (including cash tips) from POS systems. This is a software programme, often run
from a USB flash drive that accesses the POS system records and allows the owner to alter the
records to make it appear that there have been fewer transactions than is actually the case.
Whatever the accuracy of using POS to calculate individual tip income, the intention of these
notification letters to educate hospitality staff to declare their full tip income (rather than use
the decades-old informal guideline of 10 % of their income) was effective. These notification
letters generated widespread media coverage, therefore educating the wider population of
hospitality staff about their tax obligations.
Sources:
https://www.feigenbaumlaw.com/personal-tax-planning/canada-revenue-agency-focusing-
undeclared-tips-hospitality-industry/
https://www.theglobeandmail.com/report-on-business/economy/economy-lab/tipping-point-
ottawa-loses-billions-in-undeclared-income/article4418504/
https://www.theglobeandmail.com/report-on-business/small-business/talent/cra-cracks-down-
on-undeclared-tips-for-restaurant-and-bar-staff/article38025478/
When applying notification letters in the HORECA sector, for notification letters to be
effective:
The letter should make it easy for the recipient to comply, such as by providing a
hyperlink or stating what is the next step they need to take;
The letter should highlight the key messages, namely the important information or
actions required upfront;
Personalised letters and language should be used so that people understand why the
message or process is relevant to them;
Letters should inform them about the positive compliant behaviour of others (e.g. “9
out of 10 firms pay their tax on time”) and references in the letter to the situation in
their specific locality increases effectiveness;
Letters should highlight the risks and impact of non-compliance (e.g. the wider
impacts on public services and the personal impacts on them such as their increased
risk of inspections and the consequences for them of being caught).
A further initiative is to reward HORECA businesses (e.g., hotels) that are compliant and on
“compliance lists”. Box 26 illustrates how this could be achieved.
Box 26: The “Just Tourism” social labelling initiative, EFFAT
Aim: To introduce social labelling of hotels to help tourists make appropriate choices when
selecting a hotel that they respect workers’ rights.
Description: EFFAT-IUF have launched the website Just Tourism
to help tourists make
appropriate choices when selecting a hotel that they respect workers’ rights. This initiative
has been introduced in Cr
oatia, Denmark, Ireland, USA/Canada, Norway, Slovenuia and
Sweden.
56
For example, in Slovenia, there is the fairhotels.si campaign, an initiative of the trade union
which represents hotel workers. Fair Hotels are defined as hotels that treat their staff fairly
which are covered by collective agreements. The objective is to support and promote quality
employment in the hotel industry in Slovenia by encouraging consumers to choose Fair
Hotels for leisure, m
eetings and conference. In Croatia, meanwhile, there is
www.fairhotels.com.hr
, an initiative by the Union of Tourism and Catering of Croatia
(STUH). This provides an online list of hotels in Croatia where collective agreements have
been negotiated and worker rights are respected. The union is seeking to promote a quality of
tourism in which worker rights are embedded and to involve a maximum number of hotels.
Evaluation: No evaluation has yet been conducted
. Such an initiative is transferable to
Latvia where trade unions responsible for the tourism sector could adopt such an initiative in
collaboration with hotels.
Source: http://www.justtourism.org/
What can be done in Latvia?
• Make it a statutory responsibility for restaurant menus to include on their front page a
statement that it is compulsory for the restaurant to issue a till receipt for the price of
the meal. If this is not produced, then the purchaser has the right not to pay for the
meal.
• Introduce a receipt lottery is to reduce the use of envelope wages by limiting
unreported exchanges through the greater issue of receipts in business-to-consumer
transactions. This limits cash available to businesses that they can use to pay envelope
wages. To enable purchasers to electronically check whether the invoice has been
verified, a “Check the invoice” app can be introduced where the customer scans the
code on the invoice.
• Better data mining and risk assessment is needed. One simple initiative might be to
use a proxy indicator such as the minimum staff required for different types of
HORECA business (e.g., a restaurant). Dynamic benchmarking is then used to identify
risky businesses. This allows the data to dynamically determine what the norm is, and
this changing norm is used to identify outliers.
• In HORECA businesses, including both hotels, restaurants and bars, “turnover to
credit card transaction ratios” can be used to identify outlier businesses where turnover
to total credit card transactions deviate from the norm.
• Notification letters are postal or email communications from enforcement agencies to
companies or workers, giving information on applicable legal obligations and systems
of control in place. In the HORECA sector, one urgent need is to target notification
letters to encourage the full declaration of tips received by hospitality workers
• An initiative to reward compliant HORECA businesses, especially hotels, on
“compliance lists” is to improve their customer-base by introducing the “Just
Tourism” social labelling initiative of EFFAT. This introduces social labelling in the
hotel sector to help tourists make appropriate choices when selecting a hotel that they
respect workers’ rights
Taxi operators and drivers
57
Wage under-reporting in Latvia is identified as potentially high among taxi drivers and non-
declaration of transactions at up to 80%. Indeed, there have been numerous policy initiatives
to tackle this industry. The regulations of the Cabinet of Ministers were adopted on March 6,
2018: - No.148 “Requirements for the receipt of a special permit (license) of the planning
region and the city of the Republic and the procedure for the carriage of passengers by taxi”; -
No.149 "Regulations for the registration of drivers for the carriage of passengers by taxi and
passenger car". The aim of the regulations is to improve the licensing rules for taxis and other
carriers. Overall, this measure sets the rules with regards to how the carriage of passengers in
a taxi can be operated, including safety requirements. This measure also regulates how
payments (including cash payments) can be made, information to be included in the receipts
as well as how and what taxi drivers should report, in which areas they can operate
(depending on the license). There is also the amendments to the Law on State Social
Insurance and the Cabinet of Ministers Regulation No. 6 of March 6, 2018 to the Cabinet of
Ministers on the bill accompanying the budget of the Cabinet of Ministers. 147 “Procedures
for Carriage of Passengers by Passenger Car” . This policy determines the advance payment
of state social security contribution: payment of EUR 130 per vehicle per month. This
payment is for all carriers engaged in the carriage of passengers by car. The key reason why
such payment has been introduced is low tax revenues received from the taxi industry in the
state budget.
Box 27 describes the UK approach to the taxi industry which is based on conditionality.
Box 27: Conditionality in the taxi industry, United Kingdom
The draft Finance Bill in the UK requires a person
applying to renew a licence to drive a
private hire vehicle (taxi or minicab), or operate a private hire business, to undergo a tax
check. Unless this check is successfully completed, the licensing authority will not consider
the application for renewal. The purpose of the tax check is to establish that the person is
appropriately registered for tax and has been reporting income from the licensed activity to
the tax authority (HMRC). The measure also applie
s to initial applications, but here the
licensing authority only has to signpost applicants to guidance about their tax obligations and
obtain confirmation that the applicant is aware of them. The difference in treatment is because
first-time applicants may not begin trading until after the licence is obtained. The new rules
will come into effect in April 2022.
This introduces a new concept of “conditionality” into the UK tax system, essentially in this
case making a licence which a trader needs to run their business legally conditional on
compliance with their tax obligations. The idea is that if you have access to a government
authorization, there are prices to be paid for that, including being compliant and showing you
are compliant.
HMRC estimates that this measure will result in £155million additional
revenue between 2022/23 and 2025/26.
Making the licensing of taxi drivers conditional on being registered for tax (or tax compliant)
requires the taxi licensing authority and tax authority to cooperate and share data. A risk is
“phoenixism”, whereby traders change the name or status of their business when a renewal
was due, so that each application appeared to be a first on
e and thus escapes the check.
Witnesses noted that while the tax check established whether a trader was registered for tax
and returning income from the trading activity, it would not in itself tackle the problem of
traders underreporting income.
The UK
government has ambitious plans to extend the principle of conditionality to other
sectors over time to integrate the tax system with wider government regulation. Before doing
so, evaluation will be required of its impacts on the taxi industry. This evaluation need to
58
evaluate separately the educational and information element relating to applicants for
new licences, and at the impact of the tax checks, in
particular whether it has led to
unintended consequences, such as an increase in unlicensed operations.
Before introducing tax checks, it is also important to work with stakeholders to communicate
clearly to applicants for licences what the tax check is for and what it consists of.
Source : https://publications.parliament.uk/pa/ld5801/ldselect/ldeconaf/198/19809.htm
What can be done in Latvia?
• Introduce black box taxi meters in all taxis
• To encourage customers to ask for receipts, introduce a “taxi receipts lottery” specific
to taxi receipts, using the date of the taxi ride and the price as the lottery number. This
provides the taxi customer with a reason to request a receipt (“I want to win the taxi
lottery”). The display of a “taxi lottery” poster in all taxis could be made compulsory
informing customers to request a receipt. A pilot experiment could be conducted in
Riga to test the feasibility of such a scheme and to evaluate the return-to-cost ratios of
additional tax revenue to the costs of operating the taxi lottery scheme.
• Make taxi licences conditional upon (i) registration with SRS and (ii) the driver having
no tax, social security or labour law violations (i.e., their naming on “compliance lists”
or not being named on “non-compliance lists”).
6.6. Start-ups
Business start-ups tend to have a lower level of legitimacy than more established businesses.
To reduce wage under-reporting in start-up businesses, the key intervention required is advice
and support, especially at the stage when they take on their first employee if wage under-
reporting is to be prevented. This support can be provided by enforcement authorities,
employer federations and non-governmental organisations (NGOs).
Often the intention when pursuing simplification is to reduce the costs of formality to increase
the formalisation of enterprises. Devas and Kelly (2001) examine a simplified “single
business permit” for small firms in Kenya and report how it led to some degree of
formalisation and improved conditions overall for small firms. Sander (2003) reporting a
similar pilot project in Entebbe, Uganda, asserts that the reforms reducing the costs of
formalisation led to a 43% increase in the registration of enterprises. However, in both Kenya
and Uganda, there is little understanding of the long-term impact of these reforms due to a
lack of follow-up research. Garcia-Bolivar (2006) report that reducing the costs of
formalisation in Bolivia led to a 20% increase in the number of firm registrations, and similar
increases in Vietnam. Two experimental studies have examined the impacts of reducing
registration costs on formalisation. Jaramillo (2009) reports a field experiment in Lima, Peru.
A randomly selected group of entrepreneurs were offered free business licences and support
with registration. Only one in four formalised. This was perhaps due to the recurrent costs of
formality, low perceived benefits of formalisation, their limited growth ambitions, and the low
trust in government. De Mel et al. (2012) undertook a similar experiment. A group of
entrepreneurs were offered positive financial inducements to formalise. They find that even
making a financial offer equivalent to one-half to one month’s median profits only resulted in
the registration of 20% of the enterprises, and a financial offer equivalent to two months’
profits led to 50% registering. Reducing the costs of registration therefore improves
formalisation but even offering large cost reductions fails to attract the majority to register.
This is doubtless due to the low benefits of formalisation, limited ambitions of the
59
entrepreneurs, mistrust of governments, and the fear of the high recurrent costs of
formalisation in the medium- to long-term. Such experiments therefore clearly reveal that
decreasing registration costs alone is insufficient to produce formalisation.
Another simplification option is to reduce administrative complexity, such as by simplifying
tax and labour administration for small businesses (e.g., the number of forms and returns,
pursuing joint rather than separate inspections) and enhance the provision of support and
education to help firms comply. To aid this, compliance cost studies provide a means of
evaluating the extent to which the regulatory burden prevents formalisation for different
sectors and types of enterprise. However, as Hart et al. (2005) reveal, current compliance cost
studies have three major weaknesses: they focus upon only the costs easily quantified but
exclude other costs (e.g., psychological stress); they often exclude the benefits of regulation to
entrepreneurs, and they focus on direct compliance costs rather than indirect costs (e.g., when
enterprises decide not to grow or formalise due to the perceived formal regulations).
Simplifying the formal regulations can also involve more fundamental regulatory changes.
One option in this regard is to simplify the self-assessment tax returns for the self-employed.
In many countries, the self-employed complete detailed (often self-assessed) tax returns.
These require a significant time commitment and often involve psychological stress. Income
must be recorded, receipts kept of all expenditure, and calculations made for all tax deductible
items, so that net profit can be calculated. Elffers and Hessing (1997) propose the introduction
of a single standard deduction for expenses (see also Slemrod and Yitzhaki, 1994). This might
be a fixed amount or a percentage of gross income. If introduced, this would get rid of the
idea of tax deductible items, the need to keep and log receipts from expenditures, and
significantly simplify the tax system.
The advantage for entrepreneurs of applying this overall deduction, which has operated in the
US federal income tax system for many years, is that: it is a safe and certain figure known in
advance; it saves time and trouble; there is no need for a tax advisor; and it reduces
uncertainty. The higher the standard deduction, the greater is the chance that they will use this
rather than operate in the informal sector. Indeed, Gross (1990) reports its popularity,
revealing that in the US in 1990, 71% of taxpayers opted for the standard deduction, in the
form of a fixed amount. From a revenue-to-costs viewpoint, meanwhile, it is wholly
ineffective and inefficient for tax administrations to check every deductible item on a self-
assessment form. This involves small amounts of money and takes officials much time to
check, discuss and correct. In consequence, this measure could considerably reduce the
workload of tax administrations, allowing resources to be shifted towards other initiatives to
facilitate formalisation. It could also be revenue neutral. By auditing existing tax returns
across various industries and occupations for the mean or median deductions claimed, this
standard deduction could be either universally applied (which would be simplest) or applied
in the first instance only to those sectors and/or occupations where informal entrepreneurship
is rife.
Many of those starting-up businesses secure their venture capital from informal sources such
as family, friends and acquaintances. These loans are frequently relatively informal and this
can result in an attitude being adopted from the outset that informal practices are part of the
culture of the business venture being established. To address this, the Netherlands introduced
a scheme, Tante Agaath-Regeling (“Rich Aunt Agatha Arrangement”), later renamed the
Venture and Start-up Capital tax rules scheme. This provides the lenders with a tax incentive
to declare the loan. By exempting lenders from certain taxes, these loans become known to
the tax administration, making it less likely that businesses will view themselves as engaged
in informal funding arrangements, which might well spill over into their trading practices
60
(Renooy et al., 2004; Williams, 2004b). The loan had to be for a minimum of €2,269 and a
maximum of €50,000. No formal evaluations were conducted.
Another example of a tax incentive is the start-up premium (Gründungszuschuss, GZ) in
Germany. In 2002, the Commission on “Modern services in the labour market” (known as the
Hartz Commission) proposed a new public subsidy for business start-ups
(Existenzgründungszuschuss). The subsidy, known as the “Ich-AG”, or “Me PLC” scheme,
was criticised for performing the same function as a second existing scheme, the “bridging
grant” (Überbrückungsgeld). In August 2006, therefore, the two were fused in the “start-up
premium” (Gründungszuschuss) scheme. Available to recipients of unemployment benefit
wanting to start up their own business, these entrepreneurs receive in addition to their
unemployment benefit a monthly grant of €300 in the first six months. If after six months the
recipient can prove intense business activity and initial success, an additional €300 is received
for another nine months. Bernhard and Wolff (2011) find that the scheme tends to attract
more women than men, whilst Caliendo et al. (2011) also show that GZ participants are older
and have higher educational qualifications. As Bernhard and Wolff (2011) note, between
119,000 and 147,000 recipients of unemployment benefit enrolled annually in the GZ scheme
between 2007 and 2010. Although there is no evidence regarding whether it reduced informal
entrepreneurship, Caliendo et al. (2011) reveal a high survival rate of GZ participants’
businesses. Some 19 months after start-up, 75-84% of former GZ recipients were still in
business. This scheme, therefore, appears to help smooth the transition from unemployment to
formal entrepreneurship, and to reduce participation in informal entrepreneurship by the
unemployed.
What does seem apparent is that bespoke support and advice services are required for
informal entrepreneurs seeking to formalise. This has been explored in Italy (e.g., Caianello
and Voltura, 2003; Meldolesi and Ruvolo, 2003), the UK (e.g., Barbour and Llanes, 2013;
Evans et al., 2006; Small Business Service, 2004; Williams, 2004a, 2005, 2006), and the USA
(e.g., Jurik, 2005). The rationale for a bespoke support and advice service is that the business
advice and support required by those formalising their business ventures differs from that
required by start-ups or formal businesses seeking to expand (Caianello and Voltura, 2003;
Copisarow, 2004; Copisarow and Barbour, 2004; ILO, 2002; Meldolesi and Ruvolo, 2003;
Williams, 2005). It is also widely acknowledged that support and advice is generally not
widely available about how to formalise (Barbour and Llanes, 2013; Copisarow and Barbour,
2004; Small Business Council, 2004; Williams, 2005). In many countries, simple advice
about how to formalise a business venture, for example in the form of flow charts of what
needs to be done, is not available. Neither is advice available on how to start-up a venture
legitimately available again in the form of simple flow charts. Instead, entrepreneurs are often
confronted with the citation of complex labour and tax codes when approaching labour and
tax administrations, which is not at all helpful to entrepreneurs seeking to establish legitimate
business ventures.
Educating entrepreneurs about the formal rules is important if their norms, values and beliefs
are to be in symmetry with the codified laws and regulations that constitute the formal
institutions. To do this, entrepreneurs require two types of education. Firstly, there is a need to
educate entrepreneurs about what the current formal rules require them to do by providing
easily consumable information regarding their responsibilities. A significant portion of tax
evasion, as well as social insurance and labour law violation, may be unintentional, resulting
from a lack of knowledge, misunderstandings and/or a false interpretation of their legal
responsibilities (Hasseldine and Li, 1999; Natrah, 2013). In consequence, one way forward is
to provide greater information to entrepreneurs in an easily consumable and understood
format about their responsibilities (Internal Revenue Service, 2007; Vossler et al., 2011).
61
Secondly, awareness raising campaigns are required on the benefits of full declaration and
costs and risks of wage under-reporting.
What can be done in Latvia?
• Introduce a “buddy system” for start-up entrepreneurs where they buddy with a more
experienced entrepreneur. This would use local “role models” organised by for
example chambers of commerce to act as mentors to nascent entrepreneurs starting-up.
These local role models/mentors who are legitimate entrepreneurs would buddy with
younger nascent entrepreneurs to help them legitimise and provide support and advice
on legitimate business development. Technical assistance could be sought from the
Ministry for the SLI or SRS to secure EU funds for this awareness raising initiative.
• Advice and support to start-up businesses on how to formalise by the state. This
should include simple flow diagrams of what needs to be done, especially on how to
register their first employee if wage under-reporting is to be reduced from the outset of
a business venture creation.
7. Communication of the government institutions with the tax payers
7.1. Whether and how communication takes place to have a positive impact on reducing
envelope wages?
Why it is important to focus upon this determinant and its impact on preventing envelope
wages
To improve trust in government and therefore prevent participation in wage under-reporting,
it is necessary to modernise enforcement authorities by making them more customer-friendly
and approachable. Citizens, workers and employers often do not adhere to the formal rules,
and there is thus a breakdown in the social contract between government and its citizens, due
to a low level of trust in government. A modernisation of governance is one way forward.
Best practices in fighting this determinant in other countries
At least three institutional reforms can be pursued:
• Procedural justice can be improved, which here refers to the authorities treating citizens
in a respectful, impartial and responsible manner and thus shifting away from a “cops and
robbers” approach and towards a service-oriented approach;
• Procedural fairness can be enhanced, which refers to citizens believing that they pay
their fair share compared with others; and
• Redistributive justice can be improved, which relates to whether citizens believe that
they receive the goods and services they deserve given the taxes they pay.
What can be done in Latvia?
• Measures are required to improve procedural justice, procedural fairness and
redistributive justice. These measures have been discussed above.
7.2. Consult first approach
The inspection authorities follow the principle “Consult first”. The purpose of the principle
“Consult first” is to achieve that “rules of the game” or applicable requirements are clearly
understandable to entrepreneurs. For example, in SRS, “Consult first” is based on the
following key courses of the activity:
62
• customer oriented activity - to preventively achieve mutual understanding and
cooperation between the SRS and customers of SRS, as well as to promote
performance of requirements stipulated by regulatory enactments, providing
explanation of legal norms, in order not to establish violations for customers of the
SRS and penal sanctions should not be applied;
• effective supervision - to implement the body of control measures, in order to ensure
compliance with requirements set by regulatory enactments, informing customers of
the SRS regarding the established violations/ non-compliances, at the same time
giving recommendations and giving a possibility for customers of the SRS to
eliminate the violation/non-compliance within the set term.
In order to assess the progress in the implementation of “Consult first” and to identify the
areas that need to be further improved by the institutions, the MoE has developed an
evaluation tool and assesses the compliance of the institutions with the “Consult first”
principle once a year. Every year, the institutions are assessed in four phases – by
interviewing customers of institutions, employees of institutions and by carrying out self-
assessments and expert assessments of institutions. After evaluation of the results, each
institution receives individual recommendations, which will allow to improve the work of the
institutions and to further improve processes in the coming year.
In 2019, the implementation of the “Consult first” principle was evaluated in 22 supervisory
authorities, analysing responses received from a total of 4,928 customers (entrepreneurs) and
1,721 employees, assessing the self-assessments provided by the institutions, as well as the
assessment of 6 experts and 8 council experts.
Reflecting this “Consult first” principle, the SLI working strategy from 2018-19 marks a shift
away from traditional KPIs, such as the number of inspections conducted and number of
instances of undeclared work identified, towards new preventative KPIs. These include:
• The number of advice/support consultations provided (currently piloted with
enterprises in two sections where undeclared work is prevalent). Success is measured
by the level of customer satisfaction.
A prerequisite for this KPI is the development of a communications strategy/media plan in the
SLI business plan which addresses who is to be targeted and why, the information/messages
to be conveyed to different audiences, the most effective delivery method, and plans for
working in partnership with other government departments and social partners for the
formalisation of support and advice. This activity, however, has not been fully enacted yet and
will be included in the next SLI strategy for the period (2020-22).
A key area in pursuing the Consult First approach is the extra training required for inspectors
to change their mindset from one based on control and punishment, to one where they consult
with employers and workers first in order to improve communication. This remains both a
challenge and a work in progress. In the SLI strategy there are also the KPIs:
•