Shadow economy accounts for 15.3% of GDP

Malta’s shadow economy declined to 15.3% of GDP in 2024, marking the lowest level recorded in two decades, research by the Central Bank of Malta shows.

The study, authored by economist Glenn Abela, notes that the underground economy has followed a steady downward trajectory from a peak of 22.8% in 2005. Despite this improvement, the report warns that a substantial portion of economic activity continues to operate outside official oversight.

The shadow economy encompasses legal economic activities that are deliberately concealed from authorities to avoid taxes, social security contributions, labour regulations or administrative requirements.

While these activities contribute to economic output, they remain largely absent from official records. The shadow economy does not include criminal activities like smuggling or drug trafficking.

According to the report, the persistence of undeclared economic activity reduces government revenues, undermines the accuracy of national accounts and places compliant businesses at a disadvantage when competing with operators who evade fiscal and regulatory obligations.

Self-employed and cash-based sectors remain vulnerable

The report identifies tax evasion as being particularly prevalent in sectors characterised by high levels of self-employment and micro-enterprises, where opportunities to under-report income are more readily available.

Cash-intensive industries are also considered especially vulnerable because cash transactions are more difficult for authorities to trace and monitor. The study notes that the use of cash remains one of the strongest indicators associated with hidden economic activity.

Researchers argue that high tax burdens can encourage participation in the shadow economy by widening the gap between gross earnings and take-home pay, creating incentives for undeclared work and off-the-books transactions.

New methodology

Given the inherently concealed nature of the shadow economy, researchers relied on a Multiple Indicators and Multiple Causes (MIMIC) model to estimate its size.

The econometric model treats the shadow economy as a latent variable that cannot be observed directly. Instead, it identifies relationships between factors that encourage informal activity—such as tax burdens and unemployment—and indicators associated with hidden economic transactions, including cash usage and labour market participation.

The resulting index was then calibrated against an external estimate that placed Malta’s shadow economy at 21% of GDP in 2013, allowing researchers to derive annual estimates expressed as a percentage of GDP.

Curbing hidden activity

The report attributes much of the decline in Malta’s shadow economy to a combination of economic growth and stronger institutional capacity.

A key feature of this shift has been the growing use of technology in tax enforcement. The government has introduced artificial intelligence systems capable of identifying anomalies and potential non-compliance in VAT declarations, with plans to extend similar tools to other areas of taxation. The report suggests that such technologies are increasing the likelihood of detecting undeclared activity, making tax evasion a riskier proposition.

These efforts have been reinforced by legislative changes, which expanded the investigative powers available to tax authorities and introduced substantially higher penalties for non-compliance. Together, these measures have increased the financial and legal costs associated with operating outside the formal economy.

However, the study argues that reducing informality requires more than stronger enforcement. Improving the efficiency and transparency of public services is seen as equally important in strengthening trust in institutions and encouraging voluntary compliance.

The report refers to the proposed National Business Portal, which would simplify registration and reporting procedures for self-employed workers and micro-enterprises. By reducing administrative burdens, policymakers hope to make participation in the formal economy easier and more attractive.

The report also stresses the importance of maintaining a strong labour market, noting that low unemployment and reduced barriers to finding work lessen the incentives for workers to seek undeclared employment. Together, these developments are contributing to a gradual narrowing of the space in which informal economic activity can operate.

For high-risk sectors, particularly cash-intensive activities, the report proposes targeted reporting requirements, coupled with streamlined administrative processes.

The EU shadow economy averages 15% to 25% of GDP, though it varies greatly by region. Western and northern countries like Finland maintain low rates, typically below 10%. Conversely, southern and eastern nations experience much higher informal activity, with Bulgaria peaking at 30%.