An Analysis of the Underground Economy and its Macroeconomic Consequences

Author/Editor:

Era Dabla-Norris ; Andrew Feltenstein

Publication Date:

January 1, 2003

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

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.

Series:

Working Paper No. 03/23

Subject:

English

Publication Date:

January 1, 2003

ISBN/ISSN:

9781451844061/1018-5941

Stock No:

WPIEA0232003

Format:

Paper

Pages:

26

Please address any questions about this title to publications@imf.org