The State Audit Office of Latvia has concluded a performance audit of the government approach to curbing the shadow economy. It has concluded that despite the long-term increased government’s attention paid to the shadow economy, the current approach with a separate plan at the centre is not sufficiently effective because the planned and implemented measures are more focused on consequences than causes. Research results are not used sufficiently. The data used for decision-making and communication with the public is not versatile. The State Audit Office of Latvia calls on the Ministry of Finance to review the current approach, thus reducing bureaucracy and administrative burden and improving the environment for economic activity.
The shadow economy is an economic activity that is not reported in official statistics and for which taxes are not paid in accordance with laws and regulations. It exists in all democratic countries and affects both state tax revenues, social guarantees of those involved, and fair competition negatively. A correlation can be observed: the higher the gross domestic product per capita and the higher the welfare of society, the lower the level of the shadow economy.
“In Latvia, the government has been paying increased attention to the shadow economy by developing and implementing a separate shadow economy restriction plan periodically since 2010,” indicated Ms Inga Vilka, Council Member of the State Audit Office of Latvia.
From 2014 to the end of 2022, the Shadow Economy Combating Council operated under the leadership of the Prime Minister. In 2023, the Shadow Economy Combating Subcommittee of the Budget and Finance (Tax) Committee was established in the Saeima (Latvian Parliament). The leading role in shadow economy issues and coordination of restriction has been taken by the Ministry of Finance, where a separate department was established in 2017.
Estimating the size of the shadow economy is complicated and one does it by applying different methods. The latest available assessments of the shadow economy in Latvia vary significantly, and they indicate that the size of the shadow economy in the country can be estimated in the range from 7 to slightly over 20% of the gross domestic product. The audit has established that the Ministry of Finance uses the shadow economy indicator calculated by Austrian professor F. Schneider as a performance indicator (19.9% in 2022) whereas they use the shadow economy index of Latvian professors A.Sauka and T.Putniņš mainly in communication with decision-makers and the public (21.4% in 2024) while the data of the Central Statistical Bureau of Latvia on the economy not reported in the reports (6.7% in 2023) are not used. It prevents identifying and assessing the situation impartially and reduces trust in state data. In addition, dependence on the availability of individual studies makes it difficult to assess the results of policy in the long term impartially.
The central instrument for curbing the shadow economy in Latvia is the Shadow Economy Restriction Plan. In 2024, the fourth Plan for 2024–2027 was launched, with the aim of reducing the share of the shadow economy from 19.9% to 18.9% of the gross domestic product by 2027. The audit concluded that no significant improvement is expected.
In addition to horizontal measures, the Plan has set two priority sectors, that is, construction and healthcare sector. When assessing the validity of the choice of these sectors during the audit, the auditors concluded that the prevalence of the shadow economy in healthcare sector was relatively low while sectors with a significantly higher shadow economy remained outside the Plan. In the construction sector, measures to reduce the shadow economy have been implemented for a long time, and the size of the shadow economy in the sector has decreased, but it is still assessed as high. In the auditors’ opinion, the measures provided for in the Plan will not reduce the causes of the shadow economy in construction.
The audit assessed the 56 measures provided for in the Plan, their impact on reducing the shadow economy, bureaucracy and administrative burden. One concluded that the majority of measures strengthened control mechanisms, rather than eliminated the causes of the shadow economy. The auditors conclude that the content of the Plan has not used research findings enough to select the most effective measures to reduce the shadow economy. The findings of researchers show that taxes are the most effective driving force of the shadow economy. Although the Ministry of Finance has been working on tax policy guidelines, a clear long-term vision for the development of tax policy has still not been approved in Latvia. The State Audit Office of Latvia considers that a predictable tax policy is a prerequisite for both economic development and the reduction of the shadow economy.
“At a time when the country is making great efforts to identify and, it is expected, also implement the possibilities of reducing bureaucracy and administrative burden, some of the measures in the Plan for curbing the shadow economy are aimed in the opposite direction, namely, to strengthen the requirements and control mechanism. This is already fighting the consequences, not the causes. Studies show that as prosperity and the level of trust grow, the shadow economy usually decreases,” stated Ms Inga Vilka, Council Member of the State Audit Office of Latvia.
Restricting the shadow economy is a horizontal policy, and many state institutions are involved in its implementation. The audit has concluded that the institutional system is complicated, responsibility is fragmented, and the emphasis is on processes rather than clearly achievable results. The Ministry of Finance has the leading role, which has established a special unit to coordinate the curbing of the shadow economy. The auditors consider that expanding the structure of the Ministry of Finance eight years ago with a new Deputy State Secretary and a department for restricting the shadow economy was disproportionate and irrational. The structural changes implemented in the Ministry during the audit (April 2025), returning to a single responsibility for tax policy and curbing shadow economy are a step towards rationalization that should be continued.
Recommendations of the State Audit Office of Latvia #PēcRevīzijas
The State Audit Office of Latvia has made one recommendation to the Ministry of Finance, namely, to review the government approach to limiting the shadow economy, base decisions and communication on comprehensive and long-term available data, reduce bureaucracy, and focus on eliminating the causes of the shadow economy.
Additional reading: audit report summary, infographics.
About the State Audit Office of Latvia
The State Audit Office of the Republic of Latvia is an independent, collegial supreme audit institution. The purpose of its activity is to find out whether the actions with the financial means and property of a public entity are legal, correct, useful and in line with public interests, as well as to provide recommendations for the elimination of discovered irregularities. The State Audit Office conducts audits in accordance with International Standards of Supreme Audit Institutions of the International Organization of Supreme Audit Institutions INTOSAI (ISSAI), whose recognition in Latvia is determined by the Auditor General. Upon discovering deficiencies, the State Audit Office of Latvia provides recommendations for their elimination, but it informs law enforcement authorities about potential infringements of the law.