THE UNDERGROUND ECONOMY AND AUSTRALIA'S GDP

Tony JohnsonABS

Introduction

"Measuring the Non-Observed Economy: A handbook" (2002) OECD, IMF,ILO, CIS

Key aim - to promote best practice to ensure estimates of GDP are as exhaustive as possible within the production boundary defined in SNA93

Some academic economists claim Australia's GDP understated by 15% because of missed underground production

ABS has recently reviewed its treatment of underground transactions in the national accounts

Economic activity typically missing from data sources used to compile the national accounts. Includes transactions that are either:

Underground

Illegal

Informal

Household production for own use

Australian practice - Illegal activity is excluded from GDP. The remaining components are included, but are often based on scant and fragmented information. The third and fourth components are relatively small for Australia

The "non-observed" economy

Definition -

"Those activities that are productive and legal but are deliberately concealed from the public authorities to avoid payment of taxes or complying with regulations" (Handbook 2002, p 13)

"Skimming" of cash receipts and overstating (or understating) of expenses by businesses

"Moonlighting" by householders

Underground activity

Underground economy in AustraliaEstimates are made using aggregate tax audit information available for a single period only

Percent adjustments by industry have been held constant over time

Supply and use balancing may add some further implicit adjustment

GROSS DOMESTIC PRODUCT ACCOUNT, INCOME ESTIMATES 2001

Explicit adjustment for underground activity $m

Adjustment to initial income estimate %

CoE 0 0GOS Non fin. corps. Private Public Total

32050

3205

3.30

2.8 Financial corporations 0 0

General government 0 0 Dwellings 0 0

TOTAL GOS 3205 1.6GMI 5277 9.7Total factor income 8482 1.5Taxes less subsidieson production and imports

- 0

GDP 8482 1.3

Upper limit to missing GDP

Review data sources and make judgements about potential for missed underground transactions

Assign hypothetical "upper limits" to missing transactions at most detailed level possible

Individual judgments subject to potentially large error, but in aggregate provides an indication of what could be plausible for missing GDP

Assumptions used

Underground activities are conducted only in cash

General government and government businesses are not involved

Large and medium businesses are unlikely to be involved

Imputed components of GDP are unaffected (by definition)

Small businesses and individuals are the major contributors

ƒ In Australia, at least 65% of GDP (as measured) is unlikely to be missing underground transactions

Upper bound estimates of potentially missing transactions $m

Upper bound estimates of potentially missing transactions

%CoE 6382 2.0GOS Non fin. corps. Private Public Total

53560

5356

5.50

4.6 Financial corporations

0 0

General government 0 0 Dwelling owned by persons

0 0

TOTAL GOS 5356 2.6GMI 20256 37.4Total factor income 31994 5.5Taxes less subsidieson prodn. and imports

0 0

GDP 31994 4.8

UPPER BOUND ESTIMATES OF UNDERGROUND ACTIVITY 2000-01

Upper bound estimate (cont.)

Taking into consideration:

adjustments already made

implicit adjustments in supply-use balancing

the generous upper bounds chosen

Australia's GDP highly unlikely to be understated by more than 2% on account of missing underground transactions, and most likely less

Additional plausibility checks

A high degree of accuracy can be attached to population data from periodic censuses

Make assumptions about upper bounds for involvement and average value of underground income according to labour force status and occupation

Divide derived upper bounds by number of households. This can be compared with after tax household income from household surveys

ƒ Results were consistent with that previously described

Could GDP be understated by 15%?estimates derived from currency demand models as high as 15% of GDP

Implications of 15% can be tested for plausibility

ƒ We concluded highly implausible when assessed at the detailed level

Large businesses would have to be widely involved in understating both income and wages and salaries paid and this is highly unlikely in the Australian context

Discussion points

Are countries making explicit adjustments for underground transactions?

If so, what order of magnitude?

What data sources and methods are used

Is it an important quality issue for national accountants?

Do countries have a view on the legitimacy of monetary model estimates of the cash economy?