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Measuring the Shadow Economy: Endogenous Switching Regression with Unobserved Separation

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  • Tomas Lichard
  • Jan Hanousek
  • Randall K. Filer

Abstract

We develop a novel estimator of unreported income, perhaps due to tax evasion, that does not depend on as strict identifying assumptions as previous estimators based on microeconomic data. The standard identifying assumption that the self- employed underreport income whereas wage and salary workers do not is likely to fail in countries where employees are often paid under the table or have a secondary source of self-employed income. Assuming that evading individuals have a higher consumption-income gap than non-evading ones due underreporting both to tax authorities and in surveys, an endogenous switching model with unknown sample separation enables the estimation of consumption-income gaps for both underre- porting and truthful households. This avoids the need to identify non-evading and evading groups ex ante. This methodology is applied to data from Czech and Slovak household budget surveys and shows that estimated evasion is substantially higher than found using previous methodologies.

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Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp494.

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Date of creation: Oct 2013
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Handle: RePEc:cer:papers:wp494

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Keywords: endogenous switching regression; shadow economy; tax evasion; undereporting;

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