Paul Solman: In Greece, Underground Economy Fuels Financial Crisis

BY Paul Solman  July 6, 2010 at 1:49 PM EST

Paul Solman is reporting from Europe this week about economic woes abroad and tough choices those problems pose. This entry is cross posted on his Business Desk page.

My travels have taken me to France to talk with the Finance Minister Christine Lagarde — champion synchronized swimmer back when, hotshot Chicago antitrust lawyer for years, now one of President Sarkozy’s top operatives.

Yes, I’ll ask about the debate between austerity and stimulus that’s preoccupying economic policy makers in both Europe and the U.S. I’ll even ask about her controversial message to her fellow French that they stop favoring philosophy over work: “Enough thinking! Roll up your shirtsleeves.” And about her blaming Alan Greenspan’s low interest rates and the “smart crazies” on Wall Street for causing the economic crisis.

But this is a report on our week in Greece, ahead of the stories we’re producing that should run soon. Loyalists might consider it a personal preview.

At first glance, the Greek crisis is simply a matter of spending beyond one’s means — WAY beyond. And the proximate cause is easy enough to pinpoint: the rest of Europe loaned Greece the money to do it. Why not? If American banks can lend billions for implausible mortgages with no money down, just to get a slightly higher return, why should anyone be surprised that European banks would do the same with Greek government bonds?

You can take the line of rhetorical questioning a step further. If American banks are too big to fail — meaning the U.S. government will bail them out should they take on too much risk — why wouldn’t EUROPEAN banks enjoy similar implicit protection? In the U.S., homeowners couldn’t plausibly honor their debts; in Europe, a country couldn’t either. But in both cases, governments are forced to come to the rescue, lest their financial systems collapse.

But a slightly closer look at Greece doesn’t suggest people on a borrowing-and-spending spree quite so much as people who simply don’t PAY for what they spend.

The public sector accounts for about half of Greek GDP: roughly the average for a European country and lower than economic success stories like Sweden or Denmark. No, the overriding difference is tax collection. If you think there’s been a tax revolt in the U.S. — or even California — consider Greece.

The estimates we’ve heard, from the sources that seem the most reliable: 40-50 percent of the Greek economy is underground. i.e., untaxed. When we were in Spain, people there were embarrassed that the estimate was as high as 25 percent. In the U.S., the usual estimates are less than 10 percent.

In Greece, by contrast, the stories are jaw-dropping: surgery held up in mid-operation until a cash payoff was made; a university professor forced to pay off a COLLEAGUE in order to get a grant approved. We heard complaints about corruption, petty to high-level, from literally everyone we interviewed, big or small, rich or poor, in English or Greek.

The bottom line is as simple as it is daunting. The key to fixing the Greek economy is getting Greeks to finally stop paying cash and start paying their taxes. It would be a revolution. It would be a transformation.

The push is on. In April, the top income tax rate was raised to 45 percent for those making more than 100,00 Euros and the country raised taxes on dividends, large real estate holdings and offshore companies.

“The new tax bill is a revolution for Greece,” said Prime Minister George Papandreou at the time. “No government in the past has dared such reforms.”

In May, Los Angeles Times reporter Megan Stack wrote a really nice piece on the new government campaign against corruption.

But the message we heard — high and low — was loud and clear: If the government doesn’t catch and severely punish the big fish — the political and business elites who park money offshore, pay low marginal rates, literally pay off tax collectors to look the other way — it will never get the support it needs for the IMF-ordered austerity program it has pushed through Parliament. Without support, the Socialist government won’t stand, austerity won’t hold, and Greece, as our friend Ken Rogoff told us before we left, will “restructure their debt.” Default, that is.

Default may not be a bad idea for Greece, given its dire circumstances. But what would it mean for the European banks — German and French — that are holding Greek debt?

Ultimately, that’s why the world markets are so rattled by this small country of 11 million. (More TOURISTS populate the country every year.) Will Greece become another Lehman Brothers? And if it does, can the global financial system handle the shock?