Economic, social and legal side effects of quasi-formal employment

Regardless of the possible short-term financial gain for some participants, the practice of quasi-formal employment, involving a mix of declared and undeclared or ‘envelope’ wages, is in fact highly detrimental for all stakeholders involved. The detriment is particularly severe in the case of workers, given that underreporting of wages entails lower retirement income, reduces the amount of social benefits received in the case of unemployment and leads to problems with access to loans and mortgages (Reference Round, Williams and RodgersRound et al., 2008; Reference Sedlenieks, Arnstberg and BorenSedlenieks, 2003). However, the precarious nature of quasi-formal employment from the perspective of workers is above all evident in the aforementioned lack of protection in situations when the business owner fails to fulfil their part of the deal. Since the whole arrangement resides strictly on a verbal agreement between two parties, employers can easily manipulate the size of cash-in-hand payment or even decide not to pay it without any legal consequences. It is therefore not hard to realise that this form of employment introduces additional uncertainty for workers and makes them ‘fully subject to the manager or owner’ (Reference WoolfsonWoolfson, 2007: 555).

Yet, quasi-formal employment has an adverse long-term effect for business owners as well. For companies adopting it, this illicit strategy to reduce labour costs provides additional room to decrease the price of delivered goods and/or services, thus giving them an advantage on the market. Such an unfair competition can in turn force other companies to rely on this identical scheme or to seek other illegitimate means of cost reduction, which can result in a vicious circle of deteriorating business ethics (Reference GërxhaniGërxhani, 2004; Reference Sepulveda and SyrettSepulveda and Syrett, 2007).

When it comes to wider economic and societal issues related to this practice, the list goes far beyond lower levels of taxes and social security contributions collected. For instance, deliberate wage misreporting also distorts official macroeconomic and microeconomic figures (e.g. estimates of the gross domestic product and labour market statistics), thus undermining long-term economic and social policies of the government (OECD, 2003). What is more, it distorts the trust of compliant taxpayers in their fellow citizens, as well as the overall confidence in the capability of the state to secure fair business and social environments (Reference Frey and TorglerFrey and Torgler, 2007; Reference TorglerTorgler, 2004).

However, the fight against this deleterious economic and social phenomenon represents a substantial challenge for the authorities (OECD, 2008). Not only are both the employer and their quasi-formal employee officially declared, but also the former (seemingly) fulfils all obligations towards the state and the worker.^{Footnote 3} What is more, no written trace of agreement between the two stakeholders exists, which makes it extremely hard for surveillance bodies to identify violators and to prove that the worker receives a higher wage than reported (Reference Meriküll and StaehrMeriküll and Staehr, 2010). Prevention thus seems to be a more viable policy solution for tackling quasi-formal employment than repression. Yet, such an approach requires profound understanding of the key reasons for economic agents to engage in this ‘envelope wage’ practice. These reasons are still not sufficiently understood.

Drivers of quasi-formal employment: A literature review

While evasion of taxes and social security contributions is acknowledged as the most important reason for employers to underreport the wages of their workers, it is certainly not the only one (Reference Hazans and Vaughan-WhiteheadHazans, 2005; Reference Sedlenieks, Arnstberg and BorenSedlenieks, 2003; Reference WoolfsonWoolfson, 2007). For instance, this practice represents quite an efficient tool to get rid of workers who are not needed anymore. Since non-payment of the undeclared part of the wage inevitably ignites dissatisfaction on the part of the worker, this commonly results in their quitting the job and thereby rescues the employer from severance pay and administrative hassle (Reference Williams and PadmoreWilliams and Padmore, 2013b). Knowing this, one can anticipate that quasi-formal employment can also be used to oppress and exploit workers (Reference Hazans and Vaughan-WhiteheadHazans, 2005; Reference WoolfsonWoolfson, 2007). By threatening not to pay the cash-in-hand part of the wage or by decreasing it for every mistake, employers can easily create a situation of uncertainty for their workers, which makes the latter more prone to manipulation (Reference WoolfsonWoolfson, 2007).^{Footnote 4} This goes in line with the argument of Reference Shields and GrantShields and Grant (2010), that for employers ‘the primary agenda is not one of [labour] commodification but of objectification’ (p. 62).

It is thus not surprising that employers paying under-declared wages were, until recently, widely depicted as abusers (Reference Hazans and Vaughan-WhiteheadHazans, 2005; Reference Round, Williams and RodgersRound et al., 2008), while quasi-formal workers were assumed to be hapless victims. Such reasoning is completely legitimate since there are no obvious positive long-term benefits of this practice for workers, while the list of negative aspects is quite long (as explained). The lack of formal employment had thus been recognised as the main factor behind the decision of workers to accept such arrangements (Reference Hazans and Vaughan-WhiteheadHazans, 2005; Reference Kriz, Meriküll and PaulusKriz et al., 2007; Reference WoolfsonWoolfson, 2007). Indeed, since under-declared jobs provide at least minimum social protection, they certainly represent a more appealing option than fully undeclared work. In line with this, there has been a prevalent belief that workers mostly perceive under-declaration only as a temporary survival option, which they may escape from as soon as they find a completely regular job (Reference WoolfsonWoolfson, 2007).

Nevertheless, some recent studies based on large-scale representative surveys have challenged the generalisability of this depiction.^{Footnote 5} An insight into the causes and nature of informal activities in South-East Europe, for instance, revealed that 3 out of 10 quasi-formal workers in those countries either personally initiated under-declaration or this was a mutual idea of theirs and their employer’s (Reference Bezeredi and WilliamsBezeredi and Williams, 2017; Reference Franic and WilliamsFranic and Williams, 2017). In fact, almost one-half of quasi-formal workers surveyed were more or less satisfied with receiving their take-home pay in two different parts. While not refuting the existing theories on the exploitative character of quasi-formal employment, these findings indicate that there are probably some other important drivers of this practice from the perspective of workers which are not necessarily associated with their employment prospects.

In their search for an explanation of such a state of affairs, Reference Williams and FranicWilliams and Franic (2017) identified the quality of the ‘psychological contract’ with the state and the ‘social contract’ with other taxpayers as the key features underlying behaviour of a great many workers in this respect.^{Footnote 6} A similar conclusion was also reached by studies in Baltic and other post-Soviet countries (see Reference Round, Williams and RodgersRound et al., 2008; Reference Sedlenieks, Arnstberg and BorenSedlenieks, 2003; Reference Williams and HorodnicWilliams and Horodnic, 2015b). As a matter of fact, the close link between the lack of trust in the state and the decision of workers to hide one part of their wage was further illuminated by some recent cross-national studies (see, for instance, Reference Williams and HorodnicWilliams and Horodnic, 2015a; Reference Williams, Horodnic and WindebankWilliams et al., 2015). Vast and expensive state apparatuses, unsustainable pension systems, pervasive corruption, low cultures of tax compliance and inefficient judiciaries have been therefore getting increased attention in discussions about the main reasons why EU workers enter such illegitimate wage arrangements (Reference Round, Williams and RodgersRound et al., 2008; Reference TorglerTorgler, 2004; Reference Williams and MartínezWilliams and Martínez, 2014). However, one should also not neglect possible financial motivation for workers. Namely, given that wage underreporting results in savings from personal income taxes and social security benefit contributions, some employers can offer to share them with workers so as to ensure their cooperation. If true, this would certainly explain why that many workers personally initiate quasi-formal employment.

To add to this ongoing debate on the main drivers of the phenomenon from the perspective of workers, this article evaluates what lies behind their readiness to keep obeying the unwritten agreement once they have entered this realm. This issue is quite important as most workers discover inherent disadvantages of the scheme only upon commencing the job. For instance, a certain proportion of them face problems with employers failing to meet their part of the verbal agreement, which not only reduces the worker’s willingness to persevere in that particular job but also to accept similar employment offers in future. As well, some workers presumably become aware of their personal wrongdoings only after they start receiving cash-in-hand-payments, which could potentially alter the moral dimension of their reasoning and bring out the fear of being detected and prosecuted by the authorities. In line with this, in the rest of this article we design and estimate a cumulative logit model of determinants of workers’ satisfaction with their quasi-formal job.

Data and variables

Being the first EU-wide study on the demand and supply of undeclared goods and services, the Special Eurobarometer 284/Wave 67.3 survey provided an extensive insight into the prevalence and nature of quasi-formal employment.^{Footnote 7} Every respondent who identified themselves as an officially registered dependent employee was asked if their take-home pay was being split into two parts. A total of 616 individuals who admitted their involvement in this practice were then further questioned so as to grasp more details about that particular job. One of these supplementary questions was structured as follows:

Every interviewee could express their level of satisfaction choosing one of the three options: ‘I would rather have preferred full declaration’; ‘It depends’; and ‘I am happy with this’. The resultant variable can thus be perceived as an ordered categorical, given that every subsequent answer represents a higher level of contentment. To evaluate the factors shaping one’s satisfaction, we thus use a random intercept cumulative logit model defined as

(1a) $ln\left(\frac{P(y_i\le m)}{P(y_i>m)}\right)={\alpha }_{mj}+\sum _{k=1}^K{\beta }_k{X}_{ijk},m=1,2,3$

(1b) ${\alpha }_{mj}={\alpha }_m+u_j$

where y_i represents the level of satisfaction expressed by the individual i, m denote the three possible answers, X₁−X_k are explanatory variables and u_j ∼ N(0, σ_u²) are the level 2 random effects.

It is important to note that the data are essentially given on two levels (i.e. individuals nested within countries), and therefore multi-level analysis is required so as to obtain unbiased estimates (Reference Hosmer, Lemeshow and SturdivantHosmer et al., 2013; Reference HoxHox, 2010; Reference Snijders and BoskerSnijders and Bosker, 1999). As can be seen from equation (1b), this is done by adding a random intercept (note the presence of a country indicator j =1,2,…,27 in both the equations).^{Footnote 8}

The thresholds α_m in equation (1b) represent the log-odds of the individual with X₁ = X₂ =⋯=X_K and u = 0 having a response in category m or lower. These intercepts vary from country to country, which is enabled by including the group-level residuals u_j. Every parameter β_k quantifies the effect of a unit change in determinant X_k on the log-odds that a response is m or lower, when the country effect u is held constant. Owing to the multi-level character of the analysis, each β_k is essentially the effect of the accompanying predictor for individuals in the same country.

Given this definition of the model, one can realise that the interpretation of coefficients in cumulative logit modelling is counterintuitive. That is to say, a negative value of β_k would suggest that a one-unit increase in the corresponding explanatory variable entails a decrease in the propensity of being dissatisfied with receiving cash-in-hand supplements (i.e. an increase in the likelihood of expressing higher level of contentment).

Turning to the variables that could explain why some individuals are happy with their position while others completely oppose this form of employment, we start with the afore-elaborated issues of horizontal and vertical trust. These are assessed by checking whether there is any link between the tax morale of a worker and their satisfaction with their own quasi-formal job. The tax morale index was constructed by applying factor analysis on variables conceptualising the respondents’ tolerance towards the following four types of non-compliant behaviour: receiving welfare payments without entitlement; partial or complete non-declaration of income by a self-employed individual; undeclared work by a firm for a household; and tax evasion in company-to-company transactions. For each of the four situations the respondents were asked to express their views on a 10-point Likert-type scale, with larger values indicating greater level of tolerance. Owing to the properties of factor analysis, the resultant predictor is therefore an interval variable with values ranging from 1 to 10. It is important to note that the tax morale index is essentially given on an opposite scale, since larger values signify more permissive attitudes towards tax evasion (i.e. lower tax morale).

To further elucidate the direction in which the fight against this phenomenon should go, it is also important to evaluate the role of deterrence in this respect. The effectiveness of repression is hence examined by including individuals’ assessment of the detection risk, as well as the sanction they expect in the case of this happening. Explicitly, every survey respondent was asked to evaluate the risk of being caught by the authorities, with the following answers being possible: very small, fairly small, fairly high and very high. Likewise, three options were offered for expected penalties: only tax and social security contributions due; tax and social security contributions, plus a fine; and prison.

Another thing which ought to be scrutinised is how the exact function of cash-in-hand payments within the arrangement affects the viewpoints of workers. Every quasi-formal worker was asked whether the undeclared part of wage served to remunerate strictly overtime/extra work, whether it was part of the payment for regular work or whether it covered both. This variable is quite important as its effects on one’s satisfaction could signal possible financial drivers of this practice on the part of workers.

To control for socio-economic and demographic peculiarities of one’s happiness with receiving partitioned wages, we also include age, gender, marital status and occupation as explanatory variables in the model. In total, eight potential determinants are scrutinised, with their detailed description given in Table 1. Before proceeding to the results, it should be mentioned that the issue of missing data was addressed by applying the multiple imputation procedure (Reference NewmanNewman, 2014; Reference RubinRubin, 1987). For every non-existent value in the dataset 10 simulations were produced using the REALCOM impute software. The coefficients of the two-level random intercept cumulative logit model were then estimated following the Markov Chain Monte Carlo method in MLwiN.

Table 1. Summary of individual-level covariates used in a two-level random intercept cumulative logit model on satisfaction with quasi-formal employment.

Source: Author’s own work based on the Special Eurobarometer 284/Wave 67.3.

Findings

The results of the Special Eurobarometer survey show that 4 out of 10 quasi-formal workers in the EU27 were happy with receiving additional cash payments alongside their official wage (Figure 1). On the other hand, less than 30% would prefer full declaration, while 16% were indecisive. As can be seen from Figure 1, workers in Poland, Lithuania and Greece were the least positive about underreporting of their wages, followed by their fellows in Slovakia, Hungary, Sweden, Italy, Spain and Romania.

Figure 1. Spatial distribution of attitudes towards receiving envelope wages, percentage of quasi-formal employees in 2007.

Source: Author’s own work based on the Special Eurobarometer 284/Wave 67.3.

On the other hand, this practice seems to have been highly approved by quasi-formal workers in Malta, the United Kingdom, Luxembourg and Denmark. In a few countries, undecided individuals actually represent a substantial share of quasi-formal workers. Such examples are Cyprus (with 43% of recipients being neither happy nor unhappy with this arrangement), Bulgaria (32%) and Portugal (31%).

The results of the two-level random intercept cumulative logit model on the factors shaping attitudes towards this employment scheme, which are presented in Table 2, reveal that tax morale and the function of cash-in-hand payments were the only important determinants in this respect. Given that previous studies identified tax morale as the central element behind the decision of a great many workers to enter this realm in the first place (Reference Franic and WilliamsFranic and Williams, 2017; Reference Williams, Horodnic and WindebankWilliams et al., 2015; Reference Williams and HorodnicWilliams and Horodnic, 2015b), these findings further reinforce the key role of intrinsic willingness (or unwillingness) to pay taxes in the development and continuation of quasi-formal employment.

Table 2. Two-level random intercept cumulative logit model on satisfaction with quasi-formal employment, in 2007.

Source: Author’s own work based on the Special Eurobarometer 284/Wave 67.3.

Estimates based on multiple imputation technique with 10 imputations.

RC: reference category.

* p < 0.05.

** p < 0.01.

*** p < 0.001.

When it comes to the exact function of the cash-in-hand part of take-home pay, the cumulative logit model reveals that individuals who received cash strictly for overtime and/or extra work were most likely to express unconditional support for wage underreporting. This is actually not surprising given that such workers find it much easier to draw a clear line between invested efforts and received remuneration. Since an additional labour input results in higher cash supplements, those individuals undoubtedly have a strong motivation to work harder.

This reasoning can also help in explaining why individuals receiving cash for both regular and overtime work were most likely to express dissatisfaction with their position (Table 2). However, besides the inability to draw a line between invested efforts and income, this could also be due to cash-in-hand payments representing a much larger portion of the total earnings. If true, this would mean that such individuals have lower formally declared wage in comparison to other quasi-formal workers, which then entails lower expected pension, more emphasised problems with obtaining loans and mortgages, much lower welfare benefits in case of losing their job and so on.

On the other hand, perceived detection risk and expected sanctions seem not to have played an important role. Although the obtained coefficients mostly had expected signs, none of them was found to be statistically significant (Table 2). These findings are also in line with the above-mentioned studies on the key reasons for workers to enter such employment arrangements, thus offering further evidence against the use of repression in the fight against this phenomenon.

Finally, it should be mentioned that none of the demographic and socio-economic variables seemed to exert influence on the satisfaction of quasi-formal workers. Despite substantial dissimilarities with respect to the propensity to enter such labour relations in the first place (see Reference Kedir, Fethi and WilliamsKedir et al., 2011; Reference Williams, Horodnic and WindebankWilliams et al., 2015; Reference Williams and PadmoreWilliams and Padmore, 2013a), there appeared to be no difference between genders when it came to the levels of satisfaction expressed. The same also held true for an individual’s age and marital status, as well as for their occupation.

Yet, these rather unusual findings regarding the role of demographic and socio-economic characteristics can be easily explained by their interconnection with tax morale. Numerous studies have revealed that women commonly express higher moral values than men, while older people find it harder to justify tax evasion in comparison to young individuals (e.g. Reference Frey and TorglerFrey and Torgler, 2007; Reference Lago-Peñas and Lago-PeñasLago-Peñas and Lago-Peñas, 2010). Similarly, high-income earners are found to have more permissive attitudes towards non-compliant behaviour than those with average and below average income (Reference Alm and TorglerAlm and Torgler, 2006).