New study: Limited impact of the tax credit for household expenses on the shadow economy among businessesTax Administration Bulletin, 5/24/2023
There is a lesser risk for shadow-economy activity in companies that sell services consisting of a large amount of work that qualifies for the tax credit. However, the average risks of shadow-economy activity are no different when business sectors eligible for the tax credit are compared with other business sectors. Various mistakes on the submitted claims for the tax credit for household expenses and fraudulent schemes for getting the credit cause tax-revenue losses for the State of Finland that may reach 20 or even 30 million euros.
In general, if service production that allows the company’s customers receive the tax credit is an important part of the company’s annual turnover, the company runs a lower risk of participating in shadow-economy activities.
However, the risk does not seem to decrease as much in the case of business enterprises providing such services only occasionally or in a small scale. Another finding is that the probability of non-reporting and non-payment of taxes is just as likely among companies selling services that qualify for the credit, and companies that do not sell them.
The Tax Administration’s Grey Economy Information Unit researched the impact of the tax credit for household expenses on shadow economy, based on tax-assessment data from tax years 2018 to 2021. Typically, proponents of this tax credit refer to its favourable effects in creating jobs and in combating the shadow economy, to justify the credit’s continued existence.
“Our analysis indicates that while the tax credit can deter shadow economy among business enterprises to some extent, the useful impact only seems to concern relatively few business enterprises in different sectors instead of improving the state of affairs in entire sectors. As it turns out, the combat against shadow economy cannot be referred to as a justification for making the credit higher, or as a justification for extending the credit’s scope to new sectors of business”, says Director Janne Marttinen from the Finnish Tax Administration's Grey Economy Information Unit.
A question that had to be left outside of the analysis was the following: if no tax credit were available to households buying services, how many unreported household-service performances there would be and how much households would pay for them.
The credit’s deterrent effect only concerns a certain part of every business sector
Consumers who have had services performed in their household can claim the credit for household expenses, if the service provider is a company with a tax-prepayment registration. This means that an extra incentive is in place for companies selling these services to ensure that they comply with all the tax rules and keep their registration intact.
The information derived from the individuals’ claims is also used for a control purpose. This increases the probability of any non-compliant entrepreneurs to be detected if they leave their sales unreported.
The Grey Economy Information Unit’s report analyses companies in sectors where the tax credit for household expenses is available, by comparing them with companies in other sectors where the business models are basically similar but no work qualifying for tax credits can be offered to customers.
According to Antti Tokola, senior adviser at the Grey Economy Information Unit, the overall risk of encountering shadow-economy practices is, surprisingly, at the same level in both types of business sectors.
Many fraudulent claims for tax credits
Some of the individual taxpayers who claim the credit have referred to expenses and other grounds that are false. According to the report, the State of Finland loses 20 to 30 million euros in annual tax revenue because of taxpayers’ claims for the credit that contain mistakes or are intentionally prepared with false information. This means that the problem is probably present in 5% to 7% of all submitted claims for the credit for household expenses.
“An example of a questionable claim is to refer to a cost spreading, where the renovation costs in a household are made to extend across several tax years although the renovation was completed in a short time. Another example is to exaggerate the part of the cost related to labour, which artificially increases the customer’s tax credit to a higher amount”, says Antti Tokola.
The Grey Economy Information Unit’s report was the first one regarding abuse of the tax credit.
One way to reduce shadow-economy practices among companies providing services to households might be to introduce a few changes to the tax rules, such as a prohibition against claiming the credit if a cash payment was made to the company, and a similar prohibition if an employee of the company did not actually perform the main part of the service.
“Furthermore, concerning other ways of addressing the problem, our report indicates that to lower the credit threshold to zero would not be a cost-effective way to seek remedy, at least not from the viewpoint of combating the shadow economy”, says Antti Tokola.
According to yearly statistics, some 490,000 individual taxpayers submit a claim for the credit for household expenses. The granted credits diminish total tax revenues derived from individual income taxes by more than 400 million euros a year.
The Grey Economy Information Unit’s publication:
Impact of the tax credit for household expenses. Does the existing credit system deter shadow economy? (pdf in Finnish)
Tax credit for household expenses to curb the shadow economy — impact is weaker than expected
Grey Economy Information Unit's report for quantifying the shadow economy: A deficit of hundreds of millions in state funds from undeclared work