Assessment of underground economy and tax evasion: Empirical evidence from Pakistan

Abstract

Underground economy has serious implications for economic performance and public policy of a country. The purpose of this paper is to estimate the size of underground economy and tax evasion in Pakistan for the period 1973-2016. This study uses monetary approach for estimation of size of the underground economy and tax evasion in Pakistan. The results indicated that increase in taxes, intensity of regulation, and inflation were the driving force of underground economy. The estimates show that the size of underground economy in Pakistan showed an increasing trend from 1974 onward and attained its maximum value in 1998. Thereafter, its size exhibited decreasing trend with small fluctuations. Interestingly, the impact of taxation reforms introduced in 1997 was not considerable. Results indicated that the tax burden is the driving force for the existence of underground economy which need to be appropriately set and enforced. This may discourage people from indulging in underground economies. The results from this study can be used for effective policy formulations with respect to underground economy.