Taxing the unobservable: The impact of the shadow economy on inflation and taxation

Abstract

We test the notion that a government may rely less on taxes and more on inflation to finance its expenditures the larger the size of the shadow economy. In a sample of developed and developing countries over the 1999-2007 period, we indeed report a negative relation between the tax burden and the size of the shadow economy, and a positive relation between inflation and the size of the shadow economy. We provide evidence that both are conditional on central bank independence and the exchange rate regime. Both survive a series of robustness checks, controlling for reverse causality, simultaneity, level of development, and estimates of the shadow economy. Abstract:We test the notion that a government may rely less on taxes and more on inflation to finance its expenditures the larger the size of the shadow economy. In a sample of developed and developing countries over the 1999-2007 period, we indeed report a negative relation between the tax burden and the size of the shadow economy, and a positive relation between inflation and the size of the shadow economy. We provide evidence that both are conditional on central bank independence and the exchange rate regime. Both survive a series of robustness checks, controlling for reverse causality, simultaneity, level of development, and estimates of the shadow economy.

An Anti-Austerity Policy Recipe Against Debt Accumulation in the Presence of Hidden Economy

“…And, in what follows, this paper agrees with Mazhar and Pierre-Guillaume (2012) and disagrees with Ihrig and Karine (2004) or Dabla-Norris et al (2008) about the "tax-size" relationship, and disagrees with Mazhar and Pierre-Guillaume (2012) about the "inflation-size" relationship in so far as political stability rather than instability a la Cukierman et al (1992) and Huang and Shang-Jin (2006) is the case.…”

“…But, equally easier become official economy transactions, total output increases, and there is an optimal official-unofficial economy mix such that the relative size of the unofficial one declines though the absolute size may very well be increasing. This optimality of the mix refers to structural, technical-cum-allocative efficiency, which is ignored by Mazhar and Pierre-Guillaume (2012) and which once disturbed by increased taxation hurting official-economy production, it is restored through a decline in the hidden economy due to the diminishing returns of the resources redirected from the official to the hidden economy. The two relationships, tax-hidden economy size and inflation-hidden economy size, have to be inverse because it is the relative, not the absolute hidden economy size that matters, and it is this that should be the yardstick for empirical work on the subject.…”

Sustainability Of Regional Economic System

“…A substantial number of researchers have been studying various aspects of the non-observed (shadow) economy over a long period of time. These include authors such as: Katsios (2006), Medina and Schneider (2017), Schneider (2012), Schneider and Buehn (2017), Alexandru (2013), Solis-Garcia and Xie (2018), Feige (2008), Mazhar and Meon (2016).…”

The Impact of the Shadow Economy on Indirect Tax Revenues

“…Surprisingly, the literature regarding the role of informality in total tax revenues is sparse in empirical frameworks, with the unique exception of the recent work of Mazhar and Méon (), who provide evidence that tax revenues are decreasing in the size of hidden activities. The paper further tests the impact of informality on inflation, given that a government may increase the price index in an effort to raise revenues indirectly.…”

“…Will a government turn to indirect taxation, given its inability to tax the hidden economy, if this government has already increased its (domestic) indirect revenues, due to trade liberalization and the losses from international trade taxes? Surprisingly, the literature regarding the role of informality in total tax revenues is sparse in empirical frameworks, with the unique exception of the recent work of Mazhar and M eon (2012), who provide evidence that tax revenues are decreasing in the size of hidden activities. The paper further tests the impact of informality on inflation, given that a government may increase the price index in an effort to raise revenues indirectly.…”