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Parallel economy

Regina Mennig / gsw
February 5, 2014

Experts predict that Germany's parallel economy is set to bottom out and then quickly regain momentum. They warn that billions in tax revenues could evaporate if the government does not take action.


A worker who tiles bathrooms over the weekend for cash under the table, a cleaning lady who hasn't officially registered her work: cases like these are apparently set to emerge less often this year in Germany. The volume of revenue in the underground economy - where money is exchanged for services without anyone paying the required taxes or social security contributions - is projected this year to sink to its lowest level in more than two decades, but then, is likely to rise.

That forecast comes from researchers at Tübingen's Institute for Applied Economic Research (IAW) and Austria's Johannes Kepler University in Linz, who believe the parallel economy will amount to 12.2 percent of Germany's GDP this year. Compared to other OECD countries, that puts Germany somewhere in the middle.

The economic researchers also write that the United States has one of the smallest parallel economies relative to GDP - at a projected 6.2 percent for 2014. The reason for that is the lack of labor market regulations in the US as well as the generally low level of taxation, said Friedrich Schneider, a co-author of the IAW study, adding that "the incentive to work under the table there does exist in the agricultural sector and among immigrants."

Rounding out the bottom of the parallel economy rankings of more than 20 OECD countries is Greece in spite of the fact that business conducted outside state supervision has fallen there most in recent years. "The Greek economy has contracted so heavily, and income has fallen so sharply, that people cannot even afford illegal labor anymore," said Schneider.

France and Austria also particularly stood out during Schneider's research, he said, pointing out that in both cases, rising unemployment had led to an increase in activity in the underground economy.

An infographic compares various parallel economies around the world (c) DW

Famous fraudsters' bad influence

"When an economic crisis grips an economy, then the parallel economy initially serves as a buffer that lets people continue working without becoming dependent on social welfare," says Dominik Enste, listing one general cause that leads parallel economies to flourish. Enste is a professor of business ethics at the Cologne University of Applied Sciences. In his research, he takes factors into account that go beyond economic fluctuations, such as the qualitative relationship of citizens to their state.

For example, Enste says the comparatively high willingness to pay taxes in Scandinavian countries goes hand-in-hand with people there seeing themselves as part of a collective unit.

"In Italy, or Greece, by contrast, the state is viewed more as an opponent from which people should hold back as many taxes as possible," the professor said. Enste views people's sense of tax duty in Germany as being about average - and as currently facing negative influences due to recent, high-profile cases of tax evasion among the FC Bayern head Uli Hoeness and the well-known feminist Alice Schwarzer. Both have now turned themselves in for keeping money in Swiss bank accounts in order to avoid taxes in Germany.

Dominik H. Enste (c) Institut der deutschen Wirtschaft Köln
Tax evasion sends a bad signal, says Dominik Enste of the Cologne University of Applied SciencesImage: Institut der deutschen Wirtschaft Köln

Strictly speaking, tax evasion is part of the parallel economy, since the term refers only to those activities that create new value; for example, a garage that was built off the books.

Nonetheless, Enste sees the prominent cases of tax evasion as sending a bad signal: "Now regulars in a bar might have reason to say, 'If Mr. Hoeness or Ms. Schwarzer is doing it, then nobody can get too upset if I don't take care of my taxes honestly, or if I choose not to officially declare some household help.'"

Questioning the new government's agenda

High-profile cases of tax evasion are not the only factors giving a boost to Germany's underground economy, says the IAW researcher, who puts part of the blame with the new coalition government's plans. Those plans include a nationwide minimum wage of 8.50 euros ($11.50) and financing public pensions starting at age 63 - changes that make legal employment more expensive and the alternative more lucrative, the authors argue in their study.

A migrant worker at work in a field (C) nick barounis - Fotolia.com
The government's plans for a federal minimum wage may ramp up the parallel economyImage: nick barounis/Fotolia

The experts also see a key source of influence in so-called bracket creep, which occurs when salary hikes are devoured by rising inflation, but people still end up paying higher taxes because they've been bumped into a higher tax bracket due to their higher pay.

The parallel economy in Germany costs the state and the social security system around 50 to 60 million euros annually, the study's authors estimate, and they also believe this figure will rise in the medium term by around 8 million euros per year due to the new government's plans.

Economist Friedrich Schneider offers a few examples of how changing laws can help curb underground economic activity: "You could, for example, raise the earning limit for tax-free mini-jobs to 500 euros (Ed. note: currently at 400 euros), or you could expand tax exemptions for costs related to home improvement services."

Schneider also says an approach implemented in Denmark could be useful. There, the state no longer awards contracts to companies that can be proven to have employed illegal workers.

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