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UNCLAS SECTION 01 OF 03 ISTANBUL 000180 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN TU
SUBJECT: SHADOW BOXING: TURKEY'S UNREGISTERED ECONOMY 
 
 
This message is sensitive but unclassified-- not for internet 
distribution.  This message was coordinated with Embassy 
Ankara. 
 
¶1. (SBU) Summary: Turkey's economic success over the last 
four years has prompted renewed discussion about the need to 
move on to tackle other deep-rooted structural problems in 
the Turkish economy.  Chief among these issues is Turkey's 
shadow (or unregistered) economy, which experts estimate 
represents anywhere from a third to a half of the country's 
economic activity.  The problem crops up in the context of 
virtually every other economic issue-- from the difficulty 
banks will have implementing Basel II standards because of 
the lack of reliable balance sheets in most Turkish companies 
to the lack of a level playing field for foreign investors, 
when they confront competition from companies that do not pay 
tax or required benefits.  Economists here are divided on how 
Turkey can best address the issue, but most appear inclined 
to support the IMF's view that tax rates should be lowered 
only after the country has ratcheted up enforcement and done 
a better job of collecting payments.  In recent months, 
government leaders have stepped up the rhetoric and indicated 
that they intend to do just that, but the verdict is out on 
whether such oft-repeated promises will become reality.  End 
Summary. 
 
¶2. (SBU) In the Shadows: The true extent of the problem of 
Turkey's unregistered or "shadow" economy is a matter of hot 
debate.  Most of our Istanbul business contacts, while 
disclaiming any personal knowledge or involvement in evading 
taxes or employing workers off the books, estimate that up to 
half of the Turkish economy is unregistered.  Similarly, 
business srveys cite a majority of Turkish businessmen as 
aying that the problem of businesses "operating inthe 
shadows" exists in their sectors.  Governmen officials in 
Ankara have been reluctant to makea definitive estimate, but 
concede that a figure etween a third and a half of economic 
activity i not out of the question.  Academics who have 
stdied the issue in Turkey have produced estimates rnging 
from 13 to 60 percent, depending on the moel used.  Most 
cluster around a figure of 35 percent, which the World Banks 
lead economist Rodrigo Chavez cites as a reasoable working 
assumption. 
 
¶3. (U) While definitie figures are hard to come by, 
anecdotal evidenc abounds about the pervasiveness of the 
problem.  From disappointed tourists who lack a receipt for 
the product they purchased at the Grand Bazaar, and who face 
a higher price when they press for one, to diplomats who 
encounter bemusement when they attempt to take advantage of 
their tax exempt status, and find themselves receiving a 
"discount" rather than a tax credit.  More generally the 
issue is evident in the ability of tiny corner stores 
(bakkals) to sell products at prices that rival those of the 
largest supermarket chains.  Local tax collecting officials 
are also fond of relating stories about the jewelers and 
doctors who lead lavish life styles in Istanbul but at tax 
time claim without embarrassment that they make less than the 
country's minimum wage or (in many cases) nothing at all. 
For their part, foreign investors point to the presence of 
unregistered companies as a key disincentive, as the "unlevel 
playing field" they create leaves them at a serious economic 
disadvantage, while banks rue the difficulties informality 
creates in accurately assessing the creditworthiness of those 
seeking loans. 
 
¶4. (U) Nature of the problem: Economists argue that Turkey's 
shadow economy results from multiple factors: high tax and 
social security rates, weak inspection and enforcement, 
poverty, and a tradition of widespread tax evasion, 
exacerbated by low public confidence in how governments have 
managed public funds.  They add that the phenomenon in Turkey 
differs from that of other countries in that rarely do 
companies or individuals operate totally outside the system. 
Instead, they typically under-report their income, the number 
of their employees, and the wages they pay.  Indeed, while an 
estimated 53 percent of Turkish workers are unregistered, of 
those who are registered nearly half are reported as earning 
the minimum wage.  While believable for low-cost rural and 
Anatolian areas, such compensation is unlikely to be an 
accurate reflection of earnings in urban areas such as 
Istanbul, Izmir and Ankara.  Recent studies of tax compliance 
show similar patterns.  An anonymous survey of nearly 40,000 
taxpayers commissioned last year by Turkey's Tax 
Administration showed that for every 100 YTL in income that 
was reported, respondents were concealing another 269 YTL. 
Corporate taxpayers were slightly more honest, but still 
concealed 147 YTL of income for every 100 YTL they claimed. 
 
 
ISTANBUL 00000180  002 OF 003 
 
 
¶5. (SBU) Coping with Crisis: Both business and government 
contacts note that the size of Turkey's unregistered economy, 
after stabilizing and beginning to decline before the 2001 
crisis, has since expanded as businesses have sought to 
survive the crisis years.  Indeed, they argue that in a sense 
the shadow economy functioned as a safety net, permitting 
small inefficient companies to survive the economic 
turbulence.  Experts at the State Planning Office (SPO) 
estimate that 90 percent of Turkey's informal employment is 
in firms employing less than 9 people.  Informality thrives, 
they add, because of Turkey's poverty and unequal income 
distribution. 
 
¶6. (SBU) Enforcement Deficiencies: Government officials 
concede that bureaucratic lapses have contributed to the 
prevalence of the problem.  The World Bank's Chavez points 
out that with a work force of 24 million people and a working 
age population of nearly 50 million, the Turkish government 
has only 250 labor inspectors to ensure that Turkish 
companies are meeting legal requirements.  In addition, lack 
of cooperation between agencies, especially those 
administering taxes and those administering social security, 
facilitated informality, in that reported employment levels 
at the two agencies differed widely.  To address the problem, 
the GOT has moved to merge social security numbers with 
taxpayer identification numbers, so there will be a single 
identifying number for registrants. 
 
¶7. (SBU) It is hoped that the single taxpayer number, 
together with stepped up enforcement and a streamlining of 
the revenue administration, will improve efficiency.  A key 
IFI-sponsored structural reform, the legislation for which 
passed parliament in the spring of 2005, was a reorganization 
of the Tax Administration, making it a semi-autonomous agency 
with a functional organizational structure and a large 
taxpayer unit.  That unit is designed to do a better job both 
servicing large taxpayers and enforcing their compliance. 
Under the reform, Turkey's multiple government bodies 
responsible for tax audits are supposed to coordinate their 
targeting, and regional tax offices now report directly to 
the Tax Administration rather than to the Ministry of Finance 
as a whole.  Finally, the Tax Administration has invested in 
a new IT system, to ease its data collection process.  U.S. 
Treasury advisors have provided technical assistance 
throughout the reorganization process. 
 
¶8. (SBU) Lower rates?:  Experts are divided on whether Turkey 
could improve collections by lowering tax rates, as has been 
attempted in other countries in the region.  Chavez concedes 
that the jury is out on whether this approach would work, but 
said the Bank is in the process of examining Turkish Central 
Bank data which should provide insight into the price 
elasticity of formal labor.  He noted that earlier studies 
had reached the "counterintuitive" conclusion that such 
demand was somewhat inelastic, but that the new study should 
provide a more definitive indication.  If the results show 
some elasticity, he said, the Bank would consider supporting 
some lowering of labor taxes, provided it was part of an 
overall package.  The countervailing measures would likely 
not be politically popular, he conceded, and he stressed that 
the idea would undoubtedly run into strong opposition from 
the IMF.  Indeed, Deputy Representative Christian Keller told 
us the supply side approach would be a serious risk for 
Turkey, and he doubts lower rates would lead those who have 
not registered their workers or paid their taxes to reform. 
Instead, he said, the Fund believes the proper sequence is 
for Turkey to improve its tax administration, show more 
enforcement teeth, and only then think of lowering tax rates. 
 The Fund has cleared lower corporate tax rates, he admitted, 
but he noted that this was accompanied by abolishment of 
investment incentives that had encouraged capital-- rather 
than labor-- intensive production.  The overall effect, he 
claimed, would thus be revenue neutral. 
 
¶9. (SBU) Keller also challenged the argument that Turkey's 
labor regime is much more onerous than that of other OECD 
countries.  Both Keller and SPO official said that reports 
indicated that Turkey has the highest tax and social security 
rates on labor (the "tax wedge") are misleading, as they are 
based on a unique profile: that of a sole wage-earner 
supporting a family of four.  Results for other 
classifications place Turkey further down the list, and 
indeed, the overall results are skewed as Turkey's deduction 
system does not track with OECD models.  (Wage-earners do not 
receive credits for dependents but for some of their 
consumption; most studies do not incorporate these unique 
Turkish deductions, however.) 
 
¶10. (SBU) Think Tank View: Harvard-educated economists at 
 
ISTANBUL 00000180  003 OF 003 
 
 
Ankara's Economic Policy Research Institute share Keller's 
doubts.  Noting their ongoing work to evaluate Turkey's 
unregistered economy, they concur that tax rates are not the 
key determinant of informality; rather cultural mores and 
economic difficulties explain the phenomenon.  Amplifying on 
the point that Turks do not totally skirt the system, but 
rather underpay, they noted this leads to the 
counterintuitive result that a rise in the minimum wage can 
actually reduce informality, since most "minimum wage" 
earners actually earn more than that.  Raising the minimum 
wage thus brings their reported earnings closer to the 
reality.  They also argued that their research shows that 
reducing the tax wedge on labor in Turkey will not reduce 
informality.  "Sticks are more important than carrots," they 
suggested, so that the key is to ratchet up enforcement, 
while at the same time simplifying the system and making it 
less of an (administrative) burden.  The key problem for 
Turkey, they suggested is not the tax and social security 
burden, but rather the high cost of labor, in comparison to 
China and India.  This point is seconded by Rustu Bozkurt of 
Sisecam, whose research shows that with the cost of a labor 
union member exceeding per capita income by 5 times, Turkey's 
ratio is nearly three times the world average.  Decreasing 
Turkey's labor costs, they argued, will create more flexible 
labor markets and help address the informality issue. 
 
¶11. (SBU) New Measures: Turkey's Tax Administration appears 
to be heeding the experts' counsel, as it has announced a 
range of measures in recent months to tighten tax 
enforcement.  In addition to the steps to unify tax and 
social security records, late last month the Revenue 
Administration's Director General Osman Arioglu announced a 
range of measures aimed at improving the government's ability 
to track economic activity.  They include placing memory 
chips in cash registers to follow cash flow, use of 
electronic tickets for transportation that will immediately 
be registered in tax offices, as well as on-line links to 
title offices, banks, interbank card centers, and other bulk 
trade offices.  While the utility of some of the planned 
measures is not immediately apparent (other tax officials 
have described to us in detail how henceforth all gasoline 
purchases will be linked to license plate numbers and 
electronically tracked), most should aid enforcement.  Major 
lacunae remain, however.  One senior tax official related to 
us that while he can examine taxpayers income records, he 
still is not able to question individuals about spending that 
is not consistent with their reported income levels. 
 
¶12. (SBU) Comment: Ministers from Economy Minister Ali 
Babacan to Finance Minister Kemal Unakitan have declared open 
season on the unregistered economy and warned that the days 
of lax enforcement are over.  They have also said that no 
further tax amnesties are on the horizon.  Turks have heard 
such warnings before, however, and until enforcement catches 
up, are unlikely to be impressed.  Still this will be a 
critical issue for Turkey's economic future, as the country 
seeks to broaden its tax base and ensure a revenue stream 
that enables it to meet its financial obligations without 
discouraging economic activity.  End Comment. 
JONES