Shadow Economy of a Nation in Shadows: The Case of TRNC

This chapter provides an overview of the size and correlates of the shadow economy in Turkish Republic of Northern Cyprus (TRNC). TRNC is a de-facto nation that is not recognized internationally which makes it an ideal setting for shadow economy to prosper. After we provide a brief review of the economy of TRNC, we present historical findings on the size of shadow economy and income underreporting in TRNC. Previous studies find that, during 2001–2011 period, the lost income for the fiscal authorities as a result of legally earned but unreported income in TRNC ranged between 50 and 60% of official GNP. Furthermore, ratio of income generated by informal employment to GNP for 2011 was 13.6% which was equivalent to 22.2% lost social security revenues for the TRNC government in the same year. In this chapter, we have updated the estimates for 2011–2023 using MIMIC method and find that the average size of the ratio of shadow economy to GDP was around 31%. We also update the calculation of income underreporting by private sector employees using a more recent household level data from 2015 and find a very high degree of income underreporting at 64% and 46% using, respectively, labour income and total income. One of the key behavioural reasons of income underreporting in TRNC, or justifiability of activities that are likely to contribute to shadow economy, is lack of trust towards policy makers and lack of risk of being held accountable. These psychological contributors of shadow economy for TRNC have not been analyzed before and should provide tools to those who are willing to combat informal economic activities in TRNC.