Denmark vs. Croatia: Tax Evasion and the Concept of the Shadow Economy

The concept of the shadow economy is associated with all economic activities that occur outside the legal frameworks of a given economy, and tax evasion as part of shadow economy activities poses a serious threat to the financial stability of the state and the quality of public goods and services. The issue of tax evasion represents a significant challenge for numerous countries, including members of the European Union, as a threat to social equality and fairness.

For instance, on one hand, Denmark is known for its low level of shadow economy and high fiscal discipline among economic entities, while on the other hand, Croatia faces serious challenges in combating tax evasion due to a high level of informal sector activity. The differences in approaches to combating tax evasion in Denmark and Croatia reflect on economic development and stability.

The depth of the impact that tax evasion, as well as the entire shadow economy, will have on the economy will depend on the effectiveness of the measures that state authorities and policymakers undertake to combat them. Therefore, it is important to understand the scope and causes of shadow economy activities in order to effectively reduce their impact on the economy and to develop more effective strategies and policies.

Shadow Economy and Tax Evasion

The shadow economy and tax evasion are closely linked because economic entities that evade tax obligations usually conduct their activities outside legal frameworks. By practicing tax evasion, economic entities (both businesses and individuals) reduce their tax burden, but through these activities, they adversely affect not only the balance of the state budget but also the broader society. This leads to unfair competition that ultimately impacts those who strive to operate within legal frameworks.

When discussing tax evasion in the context of the European Union as a common economic area of member states, it is important to understand what impact it can have on the union as a whole. EU member states face varying levels of shadow economy and tax evasion activities, which do not equally affect fiscal policy and competitiveness. Likewise, member states apply different measures to combat these issues alongside existing universal measures from the European Commission. Estimates of losses from tax evasion reach several hundred billion euros annually, significantly affecting state budgets and the ability to address issues within individual countries of the union. Considering that tax evasion often crosses national borders due to the EU’s free market, it is crucial that there is continuous strategic and informational cooperation in the fight against these activities.

The Scope of the Shadow Economy in Denmark and Croatia

Denmark is one of the European countries with the lowest share of the shadow economy in GDP, estimated at 11.7 percent, primarily due to the effective regulation of the tax payment system and the trust of citizens in state authorities. The use of digitized tools for monitoring fiscal data and detecting irregularities further ensures transparency and a high level of control. Additionally, one of the factors is the extremely high share of card and digital payments, around 90 percent of all payments, making it significantly harder to underreport profits or income for tax evasion purposes.

In comparison to Denmark, the share of the shadow economy in Croatia is estimated to reach significantly higher levels, around 30.3 percent of GDP. One of the main reasons for the prevalence of shadow economy activities and low fiscal discipline is the low trust of economic entities in public institutions, leading to an extremely low level of “guilt conscience.” One of the main reasons for low trust in institutions is the high perception of corruption in the country. While in Denmark the corruption perception index is 90, in Croatia it is significantly lower, at 43. Furthermore, the lack of effective control and transparency mechanisms allows for easier expansion of activities within the shadow zone. The prevalence of work within the shadow economy is also facilitated by the high level of cash transactions, which, according to the Tax Administration, account for 66.2 percent of all fiscalized transactions in 2023, making Croatia fourth in the EU. Given that cash transactions often evade official records, their share potentially reaches even higher levels when considering shadow economy activities.

Unregistered economic activities, and thus tax evasion, appear in both countries in sectors with specific characteristics. The highest penetration of the shadow economy (the proportion of activities in the sector that is in the shadow zone) is recorded in the sectors of agriculture, recreation and entertainment, and accommodation and food. The sectors with the highest recorded share within the shadow economy are: manufacturing, wholesale and retail trade, accommodation, and beverage preparation and serving, as well as construction. It is clear that these sectors can be divided into two groups: tourism-dependent sectors and labor-intensive sectors. The main driver of the shadow economy in tourism-dependent sectors is the underreporting of labor to reduce seasonal labor costs, while in labor-intensive sectors, it is the concealment of sales in the form of unreported revenue or failure to issue invoices for completed work. To successfully implement tailored tax policies, it is important to understand the different patterns of taxpayer behavior across sectors.

Combating the Shadow Economy and Tax Evasion in Denmark

The key to low levels of the shadow economy in Denmark is modern measures that the state combines with legal reforms, digitalization of the tax system, and educating citizens on tax literacy. A significant increase in the number of tax inspectors in Skat (the Danish tax authority) in recent years has been focused on controlling traditionally risky sectors (construction, hospitality…). Inspections in these activities are primarily conducted within the framework of income reporting, tax obligations, VAT, and registration of legal entities.

Faster detection of irregularities is made possible by the high level of digitalization of the tax system. Taxpayers file their tax returns almost exclusively electronically using simple user interfaces, and a large amount of data, such as information on received salaries, is automatically provided to the tax authority by third parties. Digitalization is one of the most important tools in the fight against tax evasion, precisely because it enables faster control and efficient information exchange between public institutions, banks, and the tax authority.

Institutional communication is not only conducted at the national and European levels, but Danish authorities also strive to establish international cooperation by entering into bilateral and multilateral agreements for information exchange. The OECD’s BEPS project is one of the key mechanisms of which Denmark is a part. The project focuses on combating strategies of multinational companies that seek to exploit “loopholes in the law” to shift profits to countries with little or no tax burden. Additionally, with the implementation of CRS, global standards for automatic exchange of financial information between tax authorities, financial institutions in Denmark are obliged to collect information on accounts of foreign residents and provide it to the tax authority.

Furthermore, in 2012, Danish authorities introduced a tax amnesty for foreign undeclared accounts to encourage voluntary reporting of income abroad. This allowed for the reporting of income deposited in foreign accounts on the condition of settling tax obligations, but without the enforcement of criminal prosecution measures.

Denmark is known for the high tax morale of its citizens, regardless of the high tax burden, which is one of the fundamental pillars of its success in combating tax evasion. This is achieved through continuous education of citizens about the importance of paying taxes for the quality of public health, education, and social systems. Already in primary schools, mandatory educational programs are conducted where students are taught about the importance of paying taxes, and in later stages of education, they learn through simulations how to file tax returns. State authorities justify the trust of their citizens in state institutions with the high quality of public services and goods.

Combating the Shadow Economy and Tax Evasion in Croatia

Since 2013, Croatia has begun implementing numerous modern measures to combat tax evasion and the shadow economy. The fiscalization introduced in 2013 enabled electronic tracking of invoices in real-time and also represents a turning point in the development of the tax system of the Republic of Croatia. Mandatory fiscalization of invoices aimed to curb the concealment of actual revenue in sectors where significant irregularities had previously been recorded, such as hospitality, construction, and retail.

Furthermore, by connecting databases of institutions such as the Ministry of the Interior, FINA, and the Ministry of Finance, discrepancies in reported income and expenses can be detected. Croatia, like Denmark, participates in the OECD’s BEPS project and implements the CRS system for automatic exchange of financial information.

Reducing the motivation to enter the shadow zone is sought by reducing the tax burden on entrepreneurs. Starting in 2024, a new tax reform will come into effect, allowing for significant tax relief for entrepreneurs within corporate income tax, raising the threshold for applying the lower rate of 10 percent to 1,000,000 euros. Additionally, starting in 2025, the threshold for mandatory entry into the VAT system will be raised to 60,000 euros. According to the Ministry of Finance, tax reforms from 2016 to 2024 resulted in a total relief of the economy, as well as individual entities, amounting to around 2 billion euros annually.

Transparency of the tax system is sought through the public disclosure of a list of debtors (individuals and legal entities) who owe significant amounts of unpaid taxes to the state. These measures aim to create pressure on debtors to settle their obligations and serve as a form of prevention against future tax non-payment. Currently, there are 31,609 taxpayers on the “shame list” who owe significant amounts of tax to the state.

State authorities aim to increase the perception of the risk of tax evasion among taxpayers by tightening the criminal legal framework. Over time, monetary fines for any activities related to tax evasion have increased, and stricter measures in criminal proceedings have been introduced, with severe cases ending in strict prison sentences of up to 10 years.

Public awareness of the importance of adhering to tax regulations is promoted through public campaigns such as the one from 2012, “Without a receipt, it doesn’t count.” During the campaign, citizens were encouraged to request receipts when making purchases to involve them in monitoring the operations of legal entities. Aside from occasional public campaigns, there are no mandatory educational programs, and tax topics are superficially and rarely covered only in later stages of secondary education. Additionally, taxes are portrayed in the media through the lens of ineffective public administration, and positive examples of the use of public money are rarely represented, negatively affecting citizens’ perception of the tax system.

Comparison of Effectiveness and Barriers

The differences in approaches to combating the shadow economy and tax evasion in Denmark and Croatia primarily arise from the economic, institutional, and cultural specificities of the countries.

Namely, Danish mechanisms are based on establishing trust between taxpayers and institutions, thereby encouraging prevention, self-reporting, and warnings, while repressive measures are applied only when serious irregularities are discovered or when there is no response to a warning. High investments in digitalization ensure efficient information exchange between the tax authority and financial institutions as well as taxpayers. The transparency of the public finance system and the high quality of public services and goods allow citizens to see the benefits of paying taxes in their local communities, thereby encouraging them to operate within legal frameworks.

On the other hand, the Croatian approach to combating tax evasion and the shadow economy is more reactive than preventive and is based on repressive measures, such as monetary fines. Despite investments in digitalization, the system remains highly bureaucratic and does not ensure sufficient transparency. Insufficient transparency results in low trust of citizens in state institutions, which acts as a demotivating factor for participation in combating tax evasion. What Croatia can learn from Denmark, as a country with an extremely low level of tax evasion and shadow economy, are methods for strengthening trust in institutions. Namely, by increasing trust and simplifying procedures through digitalization, a higher level of citizen satisfaction can be achieved, further motivating them to comply with the law. Likewise, tax discipline can be strengthened through a model of transparent governance that would allow citizens insight into how funds collected through taxation are spent.

From the examples of both countries, it can be concluded that an effective fight against tax evasion and the shadow economy requires a comprehensive approach that combines not only repression and control but also the application of preventive measures. Therefore, it is not just a technical challenge but also a process of changing social values based on the relationship between the state and its citizens. The solution, therefore, lies in building strong institutions and creating a society in which tax discipline brings real and visible benefits for all.