The Shadow Economy in Israel

It is estimated that halving the size of the shadow economy would increase state revenues by 3-4 percent of GDP, about NIS 30-40 billion. With this additional income, the government would be able to increase public spending, reduce the tax burden and lower the national debt. The primary factors encouraging the shadow economy include a high marginal tax rate, cumbersome bureaucracy, insufficient enforcement, and flawed reporting norms. In order to reduce the size of the phenomenon, it is necessary to focus on three main areas: (1) improving the enforcement process: it is recommended that goals be set for the Israel Tax Authority both in terms of enforcement and in terms of improved service and more streamlined reporting, and that norms of transparency be applied with regard to meeting these goals; (2) changing the collection method: to make it more difficult for citizens to evade taxes, it is recommended that tax filing be made mandatory, that the system move to taxation on the basis of households (rather than individuals) and that it recognize expenses, and that information technology is leveraged to facilitate automated reporting and regulation; and (3) reducing the tax burden: it is recommended that tax rates be lowered for small businesses that use electronic means of reporting income in order to reduce incentives to conceal income.

This paper appears as a chapter in the Center’s annual publication, State of the Nation Report 2014, Dan Ben-David (editor).