An Analysis of the Underground Economy and its Macroeconomic Consequences
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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.
Series:
Working Paper No. 2003/023
Subject:
Banking Budget planning and preparation Economic sectors Government debt management Informal economy Labor Public financial management (PFM) Revenue administration Tax evasion
English
Publication Date:
January 1, 2003
ISBN/ISSN:
9781451844061/1018-5941
Stock No:
WPIEA0232003
Pages:
26
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