Decentralization and the shadow economy: Oates meets Allingham–Sandmo

Abstract

This paper studies the impact of decentralization on the shadow economy. We argue that decentralization may decrease the size of the shadow economy mainly through two transmission channels: (1) Decentralization enhancing public sector efficiency (efficiency effect), and (2) decentralization reducing the distance between bureaucrats and economic agents, which increases the probability of detection of shadow economic activities (deterrence effect). Using various measures of fiscal, political and government employment decentralization in a cross-section of countries, we find the deterrence effect to be of more importance. The deterrence effect is stronger, the lower the degree of institutional quality. Remarkably, we find no robust evidence of the efficiency effect.

Virtual Versus Physical Government Decentralization: Effects on Corruption and the Shadow Economy

“…While the government is a direct participant in corruption with a rent‐seeking bureaucrat, it indirectly affects incentives of firms and individuals to operate underground by altering taxes or regulations. Within this context, the effects of decentralization, especially fiscal decentralization, on corruption have been widely studied (see, for example, Fan, Lin, and Treisman ; Fisman and Gatti ; Goel and Nelson ), but the literature on the linkage between decentralization and the shadow economy is somewhat more modest (see Buehn, Lessmann, and Markwardt ; Teobaldelli ). Yet, corruption and the shadow economy are widely prevalent across the world (see Tanzi ; http://www.transparency.org) and may be viewed more generally as capturing the institutional quality of nations (Knack and Keefer ).…”

Forms of government decentralization and institutional quality: evidence from a large sample of nations

“…See Goel and Saunoris (2015) for an alternate treatment. Buehn, Lessmann, and Markwardt (2013). In terms of relative magnitudes, a 10% increase in DECENT-VITRUAL would decrease the shadow economy by about 9%, while a similar increase in DECENT-PHYSICAL would have about one-third of that impact based on respective elasticities evaluated at corresponding means.…”

“…Others have also considered fiscal decentralization in its effects on the size of the shadow economy (e.g., Buehn, Lessmann, Markwardt 2013) and corruption (e.g., Arikan 2004). To this end, a measure of fiscal decentralization in models 2.2 and 2.3 from Table A3 are included, and these results are in models 3.3 and 3.4 in Table A4.…”

“…5 See, for example, Buehn, Lessmann, and Markwardt (2013), Goel and Saunoris (Forthcoming), and Teobaldelli (2011). 6 See Schneider and Enste (2000), Tanzi (1982), and Transparency International.…”

Reflections on the Meaning and Measurement of Unobserved Economies: What Do We Really Know About the 'Shadow Economy'?

“…voice, accountability and corruption (Torgler , Schneider & Macintyre, 2011); work in the shadows (Schneider, 2014); energy prices (Suslov & Ageeva, 2009); decentralization (Buehn, Lessmann & Markwardt, 2013;Dell' Anno & Teobaldelli, 2015); trust (D'Hernoncourt & Méon, 2012); education (Buehn & Farzanegan, 2013); pollution (Elgin & Oztunali, 2014);…”