The Ease of Doing Hidden Business in Canada and B.C.

Also see this accompanying article: B.C.’s shadow economy has surged since the reversion to PST

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30-Second Summary

British Columbia’s shadow economy grew by a whopping 8.1% in 2016 – nearly twice that of B.C.’s official GDP, and four times the rate of Canada’s. But what is the “shadow economy” - and how does its expansion chip away at opportunities to increase prosperity for law-abiding citizens and businesses? In this issue of Policy Perspectives, David Williams looks at unreported economic activity in Canada, the reasons behind B.C.’s disproportionately large shadow economy, and how untaxed economic activity harms households and businesses through heavier tax burdens to cover the cost of non-compliance.

2-Minute Brief

Hidden economic activity is thriving in British Columbia and Canada. According to the latest available Statistics Canada data, B.C.’s “shadow” economy is the third largest in Canada—and it’s growing fast. In 2016, B.C.’s unreported economic activity grew nearly twice that of B.C.’s official GDP, and four times faster than national GDP. To make matters worse, these figures are likely severely underestimated because Statistics Canada is not measuring much of the hidden and illegal activities going on, such as those related to money laundering and the production and distribution of illegal goods and services. This has become evident with the recent legalization of cannabis and its impact on official GDP measurement.

The evidence therefore raises questions as to whether Canada and B.C.’s official GDP – and thereby public policy decisions – are being distorted by the lack of measurement of illegal economic activities that should be estimated and counted as part of GDP. Canada has also lacked a complete estimate of the missing revenue from hidden economic activity and tax non-compliance.

There are good reasons to believe that the shadow economy is larger in B.C. than in other parts of Canada. A contributing factor may be the province’s tax regime. The reversion back to the PST in 2013 has likely facilitated hidden activities, reduced tax compliance and weakened the resiliency of B.C.’s tax system. By contrast, intelligently designed value-added taxes tend to discourage hidden activities.

Another contributing factor is that B.C.’s economy is heavily skewed towards small unincorporated businesses. The current tax structure disincentivizes companies from scaling up. But there are serious benefits to growing B.C.’s businesses. Larger companies:

  • Are responsible for the lion’s share of (official) private sector GDP;
  • Have higher productivity;
  • Pay higher wages;
  • Participate more in export markets;
  • Spend more on research and development; and
  • Tend to be subject to greater reporting and scrutiny than small firms, including by independent auditors, tax authorities, regulators, the media, financial markets and legislators.

The missing tax revenue from hidden economic activity and non-compliant individuals and firms means that law-abiding households and businesses must shoulder a greater tax burden to pay for public services used by all. How much, exactly? About $540 per taxpayer in Canada. We're all paying an extra $1.50 per day - the price of a small cup of coffee.

Looking ahead, it is imperative that our regulatory systems, and taxation in particular, be intelligently designed to discourage and detect hidden economic activity, and remove disincentives to growing more B.C. businesses to the scale at which they can reap the benefits of higher productivity, participate in export markets and pay higher wages.