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Tackling undeclared work: developing an effective system for inspection and prevention

04/10/2012

The Peer Review investigated some of the common causes of undeclared work across European countries and the range of related measures, from prevention and deterrence, through to detection, negotiation and finally action. Particular emphasis was put on the role of labour inspectorates.

The Ministry of Labour and Social Affairs in the Czech Republic hosted a Peer Review in Prague that brought together ministry officials and independent experts from ten countries (Croatia, Estonia, Germany, Greece, Ireland, Latvia, Lithuania, Serbia, Slovakia and Turkey), as well as representatives from the host country and DG Employment, Social Affairs and Inclusion of the European Commission.

The host country presented its measures to tackle undeclared work, which have been underpinned by recent changes to Czech labour legislation and taken forward by a European Social Fund project "Effective System of Employment Development, Implementation of Comprehensive Inspections and Tackling Undeclared Work in the Czech Republic".[1] Since its launch in July 2011, the project has aimed to reduce illegal employment by setting up a new, unified system of inspection activities. This system has involved direct cooperation between the State Labour Inspection Office, Czech Social Security Administration, Czech Labour Office and other authorities in the recruitment and training of over 330 inspectors, as well as plans to procure fully equipped 'mobile offices' for inspections. The project has also used "CzechPoint", a network of contact points (located mainly in post offices as part of e-government) where target groups of jobseekers are regularly required to check-in at short notice in order to disrupt patterns of illegal work. The project is due to end in December 2013 and the lessons learnt so far include the critical importance of inter-institutional cooperation and the value of CzechPoint in hampering undeclared work.

A number of observations and conclusions arose from the Peer Review discussions, as summarised below.

Whilst the nature of undeclared work varies from one country to the other, depending on the economic, social and political context, some common causes can be identified.[2] Generally, undeclared work is driven by low economic growth, high unemployment coupled with low labour demand, as well as a prevalence of low basic skills. "Undeclared work pays" seems to be the defining term insofar as both employers and individuals tend to enter into the grey economy when tax, social security and legal systems make declared work less favourable. High non-labour costs for employers (covering administration, health provision, parental leave, training etc.), differential tax rates (between, for example, the status of employed and self-employed), low wages (and hence low retained earnings), high marginal tax rates (from benefits to work) and restrictive labour laws (for example, in relation to the high cost and inflexibility in issuing redundancies) have all been cited as acerbating factors.

Public perception and understanding also have a strong influence on the level of undeclared work to the extent that in some countries, particularly those hard hit by the economic crisis, illegal work is widely accepted as the only mean of financial survival. From a behavioural point of view, everyday employers and citizens are making a 'risk-reward calculation', assessing whether the immediate and short-term gains of undeclared work outweigh the likelihood of being caught and the size of the penalty.

There are various types of undeclared work, but the most common are the 'švarc' system[3] (or similar), 'envelope wages'[4], false or absent work agreements and undeclared overtime.[5] The sectors that commonly make use of these types are those with high labour demand, particularly for low-skilled workers, and marginal value-added activities. Construction, care services, agriculture, transport, wholesale/retail trade, personal services and seasonal work regularly fall into this category. At the company level, micro, small and family-run businesses seem particularly susceptible due to their tight financial margins. And at the individual level, young people, students, women and pensioners are at a greater risk of working illegally due to their more vulnerable position in the labour market, non-marketable skills and their need for a second income to make ends meet. Hence, the negative social impact of undeclared work is by no means negligible.

The range of measures to tackle undeclared work can be understood in terms of a process, from prevention and deterrence, through to detection, negotiation and finally action. Some countries, such as Estonia, are characterised by a more preventive approach, involving large-scale awareness-raising campaigns, the strong development of e-services (to access information and advice and reduce the 'burden' of honest tax administration), anonymous whistle-blowing and 'second chance letters' to correct employer/individual behaviour before it becomes too late. Other, more detective measures can be found in the Czech Republic and Germany where there is a strong (although not exclusive) focus on controls and inspections. Whatever the approach, there is a clear consensus on the need to have political will and backing to tackle undeclared work; without such support, the capacity and credibility of any measure can be severely undermined. Moreover, there is a need for a clear and robust legal framework - one that clearly defines undeclared work, gives authority to inspectorates and helps to enforce penalties.

The Peer Review generated significant discussion around the role of the inspectorate service, which is at the heart of controlling and ultimately penalising undeclared work. The effectiveness of the service can be improved if the inspectors are well remunerated and trained, with prospects of career progression and job security; bonus and payment-by-results systems are operated in a few countries, such as Latvia, but tend to be sensitive and are not endorsed by all. In some cases, there may be value in organising inspectors into specialist teams, which helps to give a professional cadre to the service, as well as deal with more dangerous or large-scale cases. The inspectorate also needs to have the 'power' to exercise its duties, which means an increased legal basis. In terms of tools and systems, inspectors need to be equipped with vehicles and the latest information technology in order to be mobile and 'connected'. Their effectiveness can be further enhanced by the strategic analysis and planning of inspections. Risk profiling, targeted controls and operating a 24/7 service have all been cited in this context.

Undeclared work is a complex issue and therefore requires strong cooperation between the different state authorities, as well as other labour market actors. In many countries, organisations covering labour inspection, revenue, social welfare, security, customs and social dialogue, to name but a few, work together to exchange information and coordinate preventive and control measures. Success factors in the cooperation include the existence of formal agreements (with clearly defined roles and responsibilities), joint inspections, access to or ideally integration of databases, and legal arrangements covering such matters as data protection.

With regards to the unemployed, a balanced combination of activation, monitoring and sanctions can be effective in dissuading or preventing individuals from engaging in undeclared work. Greater consideration can also be given to the tax and social security systems by introducing, for instance, progressive tax, in-work benefits (whereby being in declared work pays) or reductions in the marginal rate of tax.

This final point leads to the more general issue of reforming tax and social security regimes. National authorities need to make 'declared work pay' in order to engage employers and individuals who are on the financial margins. Aside from general reform, specific measures can include lower rates of taxes or social security for certain (in-difficulty) sectors, regulatory impact assessments in order to reduce the level of red tape overall and tests of specific inconsistencies, such as those between the employed and self-employed status. In the context of dual labour markets (as in Turkey or Serbia), payment packages can also be helpful based on the principle that some tax is better than no tax.[6]


[1] From the European Social Fund Operational Programme Human Resources and Employment (2007CZ05UPO01).

[2] There is no common EU definition of undeclared work.

[3] The 'švarc system' refers to a practice where an individual undertakes the 'normal' duties of an employee, whilst maintaining the legal and more financially advantageous status of a self-employed person.

[4] 'Envelope wages' refer to cash-in-hand payments to supplement often minimum wages.

[5] The švarc system was discussed during the Peer Review as a form of undeclared work. However, strictly speaking in the Czech context, it is 'misdeclared work'. The work is actually declared (and this has been the case according to law until recently) and the state only loses out on tax and social security payments. Given the varying interpretations of the švarc system, it is not surprising that some countries consider the system to be legal, as in the case of Latvia.

[6] Further reading on the subject of undeclared work was suggested by the Irish ministry official, namely the article "Enforcement problems in 'informal' labour markets: a view from Israel", Guy Davidov (2006), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=921275


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