German shadow economy booms amid high taxes and state aid

The German economy has been shrinking for more than two years, and 2025 offers only a slight glimmer of hope for an economic recovery.

Surprisingly, the so-called shadow economy — encompassing all economic activity happening off the books — is surging. So what's behind the fact that the share of undeclared work has jumped to more than 11% of Germany's overall economic output in just one year?

According to labor market expert Friedrich Schneider, who calculated this figure, the volume of undeclared work in 2024 was worth a total of €482 billion ($562 billion) — more than the entire government budget, and marking the highest level in nearly a decade.

For 2025, the economist from Johannes Kepler University in Linz, Austria, projects a further rise to €511 billion, an increase of 6.1%.

Schneider has been studying the phenomenon for over 40 years, and prefers to call it "shadow economy" rather than illegal work, he told DW.

"[Undeclared] economic activities, like repairing a car or cleaning, are legal but they're carried out without paying taxes or social contributions," he said, adding that legal requirements such as minimum wage laws or working time limits are often ignored in the shadow economy.

The construction sector is especially prone to undeclared work, as well as hospitality and cleaning servicesImage: picture-alliance/dpa/Winfried Rothermel

With a shadow economy share between 11% and 12% of gross domestic product (GDP), Germany ranks in the middle compared to other industrialized countries, according to Schneider, with  Romania topping the list with around 30%, and Greece coming in second at about 22%.

When calculating shadow economy output, Schneider compares the amount of cash in circulation with official economic output figures.

Tax morale declines amid poor state services

But what's driving the increase in undeclared work in Germany, which is Europe's biggest economy?

First of all, Schneider sees a growing perception in the population at large of paying too much in taxes and contributions to the social security system, while receiving poor public services in return.

"In Germany, people increasingly notice that trains are unreliable, highways are full of crumbling bridges needing repair, leading to traffic jams and delays. When citizens feel they're getting poor public services in return for high taxes, their willingness to pay — their tax morale — goes down."

So it's no surprise to him that many people resort to undeclared work, representing a kind "tax rebellion of the common man."

Social security contributions and taxes eat up about 40% of Germans' monthly wagesImage: Thomas Imo/photothek/picture alliance

The practice in Germany, however, cannot be described as large-scale tax evasion, he added, citing the example of a "teacher who gives private tutoring", or that of a tiler who renovates a bathroom "off the books."

If the tax burden is high but the state offers excellent services in return, people do accept that, Schneider noted, "but in Germany, we face a situation where the tax burden is very high, yet the services provided by the state are often deeply unsatisfactory."

Tax rebellion and the role of support for the poor

Generally, the shadow economy is rising when unemployment rises, when there are fewer orders for companies, no more overtime for workers, and reduced shifts.

"Then people think: 'I'm making less money from my official job, but I still want a vacation or a few extras.' And the simplest way to make up for the loss is through more under-the-table work," said Schneider — a pattern he saw emerging "again and again" during his 40 years of research. "When the economy struggles, the shadow economy thrives."

Germany is currently in the midst of a heated debate over government support for the poor and long-term unemployed, known as "Bürgergeld" or citizen's income.

Currently, the citizen's income for single adults who cannot work for various reasons amounts to €563 per month for living expenses, plus accommodation and health insurance that are paid by the state.

Critics argue that the citizen's income encourages undeclared work — even more so as it was raised by more than 12% on January 1, 2024, which was above wage increases and the inflation level.

Schneider has estimated that the increase prompted "between 88,000 to 100,000 people" to give up low-paid so-called mini-jobs, with workers there now "urgently needed."

And while the shortage of skilled and unskilled labor in Germany is growing, the government spends more and more on social benefits, including the citizen's income.

The German customs service in charge of figthing illegal work has increased its raids on construction sites recentlyImage: picture-alliance/dpa/B. Roessler

Expenditure for labor and social affairs already makes up more than a third of the total German national budget. Labor Minister Bärbel Bas expecting funding for citizen's income to reach nearly €52 billion in 2025 — about €5 billion more than the previous year.

In broken down figures, some €29.6 billion go directly into income support for the roughly 5.64 million recipients, while another €13 billion are earmarked for rent and heating subsidies. The remaining €10 billion are planned for job integration measures and administrative costs.

As the government is debating how to keep social costs in check, Labor Minister Bas has acknowledge that the scheme can attract criminal exploitation.

In a recent interview for the German weekly Stern magazine, she spoke of "mafia-like structures" in welfare fraud as exploitative networks would lure people from abroad, employ them illegally, and have them apply for income support at the same time.

A system prone to fraud

This blend of undeclared work and welfare fraud is something Markus Karbaum has often encountered. A job coach who has conducted numerous training sessions for citizen's income recipients in Berlin, Karbaum calls the combination of legal work, undeclared work, and welfare payments a "private supplemental income model."

According to Karbaum, some employers offer workers too few hours to make ends meet. For example, in industries like hospitality, which are prone to under-the-table pay, "some of the income is earned in cash," he told DW.

If that still doesn't cover basic living costs, employers would tell workers to "go get the rest from the job center," as citizen's income.

These three elements — part-time or mini-job earnings, cash income, and welfare — are commonly combined, Karbaum noted.

There's also an entitlement mentality among recipients, Karbaum says, as people would think "I have a right to citizen's income and social services, you can't take that away from me."

Karbaum told DW that he's got to know recipients who would show up to job training in new cars, carrying the latest smartphones, and tell him that they "fly abroad for three-week family vacations once a year" — something technically allowed under German unemployment rules, but clearly outside the spirit of the system.

Calling them "isolated cases," they would nevertheless be "a clear indicator of structural fraud," he added, and demands more cross-checking of personal data and better coordination between job centers and customs authorities, who are responsible for investigating undeclared work.

Labor market expert Friedrich Schneider agrees, saying however that his 40 years of research had shown that a thriving German economy is the "most effective solution" to curb shadow economy activity.

"When we're in a real [economic] boom, undeclared work declines."

This article was originally written in German.