An Analysis of the Underground Economy and its Macroeconomic Consequences

January 1, 2003

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Era Dabla-Norris, and Andrew Feltenstein. An Analysis of the Underground Economy and its Macroeconomic Consequences, (USA: International Monetary Fund, 2003) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper develops a dynamic computable general equilibrium model in which optimizing agents evade taxes by operating in the underground economy. The cost to firms of evading taxes is that they find themselves subject to credit rationing from banks. Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base. Aggregate investment in the economy is lowered because of credit rationing. Taxes that are too low eliminate the underground economy, but result in unsustainable budget and trade deficits. Thus, the optimal rate of taxation, from a macroeconomic point of view, may lead to some underground activity.

Subject: Banking, Budget planning and preparation, Economic sectors, Government debt management, Informal economy, Labor, Public financial management (PFM), Revenue administration, Tax evasion

Keywords: Budget planning and preparation, Capital tax, Credit rationing, Firm capital, Firm's capital, Government debt management, Implied ownership, Informal economy, Macro economy, Savings rate, Tax evasion, Tax rate, Underground economy, WP

Publication Details

Pages:

26
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2003/023
Stock No:

WPIEA0232003
ISBN:

9781451844061
ISSN:

1018-5941

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