Call it economic stimulus, European style. The introduction of euro coins and notes next Jan. 1 will be a huge logistical headache, no question. The euro zone's 12 finance ministers, however, have a peculiar perspective on it. Many of them consider it a gift, a chance to give their flagging national economies a jolt at no extra budgetary cost.
The dream is to turn the two-month window, when the euro replaces francs, marks, lira, and other national currencies as legal tender, into a sort of dragnet to lure back the huge pile of cash that Europeans have stashed in offshore accounts out of the taxman's reach. Another goal: to give people in Europe's underground economy incentives to go legit.
The amounts of money involved are substantial. Analysts estimate that a total of $850 billion in annual earnings in the euro zone goes untaxed. While some of the tax-evaders are criminals, most are ordinary Europeans trying to duck the continent's onerous taxes--the counterpart of a generous social safety net. Scofflaws range from parents who pay nannies off the books to contractors who declare only part of workers' income. And they're found across the Continent. With Europe's biggest economy, the Germans hide $268 billion from the tax collector every year. Italians hide $250 billion. In addition, some $759 billion is salted away in foreign bank accounts, much of it for tax reasons.
The governments' great hope is to lure back offshore money, which is mostly denominated in euro-zone currencies, for deposit in local banks or investment in local capital markets where it can work productively, be tracked by the authorities, and get taxed. The politicians also want those who work mainly for cash and save it in large-denomination banknotes to be drawn into the official economy where their earnings can be regulated and taxed.
To be sure, the stimulus gained from luring this money in would be a one-time thing. But given the apparent depth of the global economic downturn, it could not come at a better time. "It could add as much as 0.9% to euro-zone GDP," says Emmanuel Ferry, analyst at the Paris brokerage Exane.
The main snag is coming up with a mix of incentives that will bring money out of the shadows without letting lawbreakers off scot-free. Here, European authorities seem already to be swimming against the tide. There's evidence that people are hustling cash out of their respective countries in advance of the conversion deadline. The idea is to avoid attracting tax authorities' attention next January by bringing sacks of cash to the bank. German police say they regularly apprehend people headed for Luxembourg and Switzerland--Germans' favorite tax havens--with as much as 40,000 Deutsche marks stuffed in their car trunks. Spanish police are encountering more people taking large amounts of pesetas into Andorra and Gibraltar. "One old man we stopped on his way into Gibraltar had 33 million pesetas [$182,000] stuffed in his jacket," says a spokesman for Spanish customs.
The primary reasons Europeans evade taxes are high marginal tax rates and the choking bureaucracies that monitor tax compliance which make it hard for small businesses to operate, let alone make a profit. Many immigrants have little choice but to join the underground economy because it's so hard to legitimize their status.
Exane estimates euro-zone residents have as much as $161 billion in cash, equivalent to 2.9% of euro-zone gross domestic product. France and Spain are trying to lure illicit money into legitimate accounts by ruling that between Dec., 2001, and June, 2002, banks only have to report cash deposits of over $9,000. The normal reporting threshold is $7,000. Theoretically, this should make small-time offenders feel better about dragging in their wads of dough.
Italy has become ground zero for the clean-money effort. There, Italian Treasury Minister Giulio Tremonti is making Europe's most aggressive effort to make the euro conversion a boon to the economy. Nearly a third of Italy's $900 billion GDP is, by private-sector estimates, undocumented. The government says its citizens have some $500 billion in savings abroad.
Tremonti is hard at work on proposals for a partial tax amnesty on money earned legally and hidden abroad from tax authorities. The key feature of his plan will probably be a one-time tax of 1% to 3% on legal capital repatriated during the euro conversion period. He may also raise the threshold for criminal penalties for tax evasion from $91,000 to double or triple that amount, meaning fewer tax evaders who fess up will be subject to criminal charges. He's also working on a scheme to persuade underground businesses to come in out of the cold by offering them a partial tax amnesty and an initial reduction in employee social charges.
There's plenty of skepticism. Many Italians fear that even if the government lets them off lightly now, they'll find themselves on a list of confessed tax dodgers who will get special scrutiny in the future. Moreover, many doubt the government will offer a good enough deal to make it worth the risk.
In Italy and elsewhere, however, the practical truth is that most tax evaders with offshore accounts won't be inclined to do their governments a favor by cooperating with the euro conversion programs. They risk nothing by leaving money abroad, since banks will automatically convert deposits in euro-zone currencies into the new money when the clocks strike midnight on New Year's Eve. That will happen in Lugano, Switzerland, a favorite Italian tax haven, exactly as it will in Milan or Rome.
BUILDING BOOM. But Europe's economy may get a boost anyway. There's already evidence that Europeans with lots of cash at home have decided not to risk smuggling it across borders or bringing their nest eggs into the bank. Instead, they're investing the money in washing machines, refrigerators, cars, and houses. In fact, says UBS Warburg economist Alison Cottrell, that's what's behind the construction sector boom in such places as the Spanish island of Majorca, a popular vacation spot for German tourists, where sea-view property prices have doubled over the past two years. Spain's Grupo Dragados, Italy's Buzzi Unicem, and other European building-material suppliers say that demand for their products has risen in recent months despite the slowing economy.
That's good news for Europe. Consumer confidence and spending in the euro zone have stagnated since July. Long-term, though, it will take more to legitimize Europe's underground economy. Once the blip of the conversion passes, Europeans will continue stashing away money abroad or hiding it beneath the floorboards until they can count on better returns and lower taxes in the formal economy.
By David Fairlamb in Frankfurt, with Gail Edmondson in Rome
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