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Income Tax Flattening: Does It Help to Reduce the Shadow Economy?

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  • Peter, Klara Sabirianova

    ()
    (University of North Carolina, Chapel Hill)

Abstract

This paper examines the effect of global transition to simpler, flatter income tax systems on the size of the shadow economy. By offering a new estimation framework, the paper revives the traditional electricity consumption approach to measuring the shadow economy. It overcomes the limitations of previous literature by using a new functional form, better quality data, a larger sample of 170 countries, a longer time span of 25 years, a panel framework, and instrumental variables. Our analysis provides strong evidence of a positive relationship between income tax rates and the size of the shadow economy. The effects of structural progressivity and complexity of national tax schedules are also found to be positive and statistically significant. These positive effects are reinforced when tax changes are accompanied by improving government services and strengthening the legal system. The flat tax is estimated to reduce the shadow economy in the short run, but this effect diminishes and disappears in the long run.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4223.

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Length: 50 pages
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:iza:izadps:dp4223

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Related research

Keywords: shadow economy; tax evasion; personal income tax; corporate income tax; flat tax; structural progressivity; tax complexity; electricity approach; institutions;

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References

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  4. repec:dgr:uvatin:2006061 is not listed on IDEAS
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Cited by:
  1. Peter, Klara Sabirianova & Buttrick, Steve & Duncan, Denvil, 2009. "Global Reform of Personal Income Taxation, 1981-2005: Evidence from 189 Countries," IZA Discussion Papers 4228, Institute for the Study of Labor (IZA).

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