An Estimate of Tax Evasion in Croatia

The definition of the underground economy in this work is a legal economic activity that is not reported for the purpose of avoiding the payment of taxation; the tax defaulter thus increasing his own personal benefit. Tax evasion is an unlawful manner of reducing the tax liability: for example, underreporting the income made or by stating inflated business deductions. In the case of tax avoidance, however, the taxpayer simply makes use of the opportunities provided in the law for the reduction of his or her tax liability. The consequence of an increase in evasion is the erosion of the tax base. A shortfall in revenue collected will result in a deficit that can be financed either by a further increase in taxation, which ultimately deepens the size of the underground economy and the inclination to evasion, or by borrowing, placing an extra burden on future taxpayers. The stability of the tax system is an important factor in the reduction of tax evasion. The transitional environment, however, with its dynamics and a number of changes in the tax and economic systems has a negative effect on a reduction in the extent of tax evasion. In the environment of the adjustment of taxation systems to the market economy, the broadening of the tax base, the introduction of new and the abolition of old taxes and of changes in the tax rates, it is hard to make reliable conclusions about the extent of tax evasion. Through a separate analysis of the evasion of some direct and indirect taxes for the 1994-2000 period, two estimates have been obtained: the lower estimate of tax evasion, which approximately follows the trend in the underground economy (UE) as a percentage of GDP, and ranges about 5.5% of GDP; and the upper estimate, which partially follows the trend in the overall tax burden of the economy, and was considerably reduced after 1998 with a reduction of the payroll taxes, that ranges from about 11 to about 7.5% of GDP in 2000. A decision to resort to evasion is very easily taken in an unstable environment, while for an irreversible process, though promising, tax defaulters need a critical mass of positive reforms and a relatively long period of time.