AmCham arrow Publications arrow Topics Archive arrow Topics Archive 2006 arrow Vol.36- No.2 arrow Analysis: The Underground Economy Poses a Perennial Challenge
Analysis: The Underground Economy Poses a Perennial Challenge PDF Print E-mail

Criminal activity aside, unlicensed street vending is the largest component of the hidden economy, but the authorities find it difficult to crack down.

BY PHILIP LIU

 

Along with Taiwan's economic development over the past few decades, the "underground" portion of the economy has also continued to grow as various people have sought to position their businesses beyond the reach of tax collectors.

In any country, the exact size of the underground economy is uncertain, since there is no way to accurately measure what are illegal - or at least extra-legal - activities. In Taiwan, the Directorate General of Budget, Accounting, and Statistics (DGBAS) under the Executive Yuan estimates the scale at some 10% to 20% of the gross domestic product, an amount that comes to NT$1 trillion to $2 trillion (US$31 billion to $62 billion at current exchange rates) a year. The variance of more than US$30 billion indicates the extent to which the authorities are in the dark even as to the dimensions of the phenomenon.

World Bank estimates of the size of the underground economies in numerous developed countries are within the range cited for Taiwan: 10.9% of GDP for the United Kingdom, 11.8% for Canada, 12.2% for the United States, 12.8% for Germany, 13% for Denmark, Singapore, and Hong Kong, and 18.7% for Belgium. In many other countries, though, the level is significantly higher: 22% in Italy, 38% in South Korea, 50% in the Philippines, and as much as 70% in Thailand.

The DGBAS notes that the underground economy consists of both criminal activities (such as smuggling, piracy, and pornography) and the "hidden economy" composed of unlicensed street vendors and unregistered companies. The sex industry, including pornographic publications, videos, and CD-ROMS, as well as outright prostitution, is perhaps the largest element of the underground economy, but the criminal nature of these activities means that the size of the market is unknown.

Street vending, the next biggest underground economic sector, has become a major means of livelihood for many local people, especially during times of economic slowdown. The number of street stalls has been steadily rising. According to a survey commissioned by the DGBAS, there were 291,164 street stands in Taiwan in 2003, up from 256,133 in 1993 and 234,335 in 1988. Taipei County, with 44,582 street stalls, had the largest concentration, followed by Taipei City with 26,981, Kaohsiung City with 23,221, and Kaohsiung County with 18,893. Snack sellers were the most numerous with 74,773 stalls, followed by those offering light meals with 37,842, fruit hawkers with 29,675, and vegetable vendors with 22,576.

In terms of employment, street vending involves an estimated workforce of 443,797 people, including 291,064 stall owners, 132,257 of their family members, and 132,257 employees. With each hawker household having an average of 4.6 members, a total of well over a million people are believed to depend on street vending for their livelihood. In the survey, some 153,000 of the vendors said they took in revenue of over NT$1 million (US$31,250) in 2003, including 60,436 with more than NT$2 million. The total estimated annual revenue from street vending topped NT$433 billion (US$13.5 billion).

Profits tend to be rather high, averaging 28.53% according to the survey responses, which mostly likely were understated. Sellers of ornaments and personal goods reported the highest profit levels, at 34.8%, followed by vendors of beverages with 33.4%, and footwear and food items at around 32%. A main reason for the attractive profits is of course the low overhead due to the absence of rental and cleaning costs. In addition, only some 7% of street vendors (those who actually hold government licenses) pay business tax, which for them is set at a low level of 7.1%. The extent of tax evasion by street vendors is estimated at billions of NT dollars per year.

Established retailers protest

For tax-paying retailers operating with four walls and a roof and required to meet a host of government regulations, the street vendors represent what they regard as an unfair competitive threat. Liu Tang-wei, manager of the Shin Shin department store on Taipei's LinSen North Road, says that the many street vendors in the neighborhood selling food items draw a substantial amount of business away from the store's supermarket. He estimates the lost income at around 20% to 30% of the supermarket's revenue. "But when it comes to clothing, daily necessities, and cosmetics, the impact is limited," says Liu, "due to the difference in quality between the street vendors' goods and what we can offer."

The police are under constant pressure from legitimate retailers to crack down on the operations of unlicensed hawkers in their neighborhoods. Street vendors doing business in areas of the cities not set aside for night markets are subject to fines ranging from NT$1,200 to NT$2,400 for hindering traffic or disturbing the peace. In a daily cat-and-mouse game with law enforcement officers, hawkers whose stands are easily portable are always ready to flee or hide their wares whenever police are detected down the block - but when necessary are also prepared to write off fines as a cost of doing business.

The authorities have been reluctant to crack down harder on street vending because it offers a social cushion for many people who cannot find a job on the normal employment market. But at the same time the government has to consider the environmental problems that residents frequently complain about. These problems include the noise and garbage created by the stands, as well as the space taken up on already crowded roads and sidewalks.

In an effort to bring more order to the situation, the municipal authorities have sought to move street vendors to designated locations and have them register for tax payment. A noted example of this program is the ZaoHe Nightmarket near BaDe Road in the Songshan District. The 600-meter-long ZaoHe Street is sealed off daily from 5 p.m. to midnight to allow street vendors selling a wide variety of food and other goods to operate. A committee established by the hawkers is responsible for maintaining order and cleanliness. Using ZaoHe as a model, the city government is planning to create additional locations to concentrate street vending and bring the activity under greater control.

For vendors without fixed locations, the tax authorities appear to believe that the costs would be greater than the rewards if they were to try to bring them under the tax system. "It is very difficult to get a handle on the business situation of underground activities and to impose tax on them," says Hsih Chao-liang, deputy section chief in the finance ministry's department of taxation. "Currently, our efforts focus on those who have filed tax returns and to see whether they have evaded taxes by understating their income. Admittedly, it's kind of unfair."

Going on-line

A fast-emerging segment of the underground economy is on-line auctions, which has been booming with the increase in Internet usage. A few small local websites introduced the concept to Taiwan in the late 1990s, and the market began to develop in earnest in 2001, when Yahoo/Kimo inaugurated a well-designed on-line platform in Chinese language for consumer-to-consumer transactions of either new or used products. The extraordinary success of Yahoo - estimated total auction value of NT$10 billion (US$310 million) in 2005 - inevitably caught the attention of eBay, the world's largest auction website, which launched its Taiwan platform in early 2002.

On-line auctioning has become a sideline for many people, including office workers, students, and housewives. Growing numbers of young people are even dedicating themselves to on-line auctioning full-time with an eye to developing a long-term career. At Yahoo, for instance, of the 20% largest traders, more than half treat on-line auctioning as their full-time jobs. Many smaller businesses also take part in the activity in order to help clear inventories and expand markets.

Last year, Yahoo dropped a bomb on Taiwan's on-line auction market by charging auction sellers a fee, starting April 9. The move triggered a massive migration among auction traders. A month later, auction items listed on the Yahoo site had plunged from 4 million to 1.9 million, while those on e-Bay surged to 815,000 from 200,000-plus in early 2005. Despite the decline in the number of items for sale, Yahoo asserts that removal of the clutter of marginal goods has brought about an increase in the success rate for on-line transactions, leading to only a limited reduction in overall trading value.

In view of the growth in on-line auctioning and concern that it was losing tax revenue, the Ministry of Finance began implementing new regulations in November 2005. Sellers with monthly revenue exceeding NT$60,000 must now register with the authorities and pay business tax of 1% on revenue between NT$60,000 and $200,000 and 5% for revenue above NT$200,000. In addition, traders are liable for personal income tax for on-line trading income exceeding NT$50,000 a year. Hung Hsiao-ling, e-commerce supervisor of Yahoo, notes that only a very limited number of on-line traders have enough income to incur a tax liability under these rules.

Another major underground economic sector is private money lending. Although the popularity of cash cards issued by the banks has cut down on this activity in recent years, such lending is still common in Taiwan. Stories frequently appear in the media about people being gouged by loan sharks charging annual interest rates as high as 40%.

An expanding underground economic activity is the remittance of capital abroad by the wealthy for investment in overseas securities and real estate. Under current regulations, which impose taxes only on income generated within Taiwan, income from these overseas activities is tax-free. The tax reform program being pursued by the government has aimed to change that system, however. Before stepping down recently from his post as finance minister, Lin Chuan reported that Taiwan hopes to sign taxation agreements with a number of other governments in the next two to four years, facilitating the taxation of overseas income.

Chou Kuo-zui, chairman of the Insurance Business Development Center, cites yet another hidden economic activity - the sale of underground insurance policies, usually denominated in U.S. dollars. These are designed to help clients, often doctors and lawyers, to transfer their wealth abroad and evade tax. According to the Bureau of Insurance under the Financial Supervisory Commission, demand for these underground policies has declined sharply in the past several years, as a result of some disputes between buyers and sellers, as well as the emergence of attractive investment-type insurance products in the local market.

The insurance example offers hope that with the growing maturity of the overall economy, elements of the underground portion may be gradually assimilated into the legal, above-ground sector. But since the underground economy will never completely disappear, the authorities will be faced with the continuing challenge of striking a proper balance - how to be fair to legitimate tax-paying businesses while also maintaining an economic outlet for some less advantaged segments of the society?
 
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