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Taxing the unobservable: The impact of the shadow economy on inflation and taxation

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  • Ummad Mazhar
  • Pierre-Guillaume Méon

Abstract

We test the notion that a government may rely less on taxes and more on inflation to finance its expenditures the larger the size of the shadow economy. In a sample of developed and developing countries over the 1999-2007 period, we indeed report a negative relation between the tax burden and the size of the shadow economy, and a positive relation between inflation and the size of the shadow economy. We provide evidence that both are conditional on central bank independence and the exchange rate regime. Both survive a series of robustness checks, controlling for reverse causality, simultaneity, level of development, and estimates of the shadow economy.

Suggested Citation

  • Ummad Mazhar & Pierre-Guillaume Méon, 2012. "Taxing the unobservable: The impact of the shadow economy on inflation and taxation," Working Papers CEB 12-023, ULB -- Universite Libre de Bruxelles.
    • Handle: RePEc:sol:wpaper:2013/125005
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    More about this item

    Keywords

    Shadow economy; Inflation; Taxes; Inflation tax;
    All these keywords.

    JEL classification:

    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H27 - Public Economics - - Taxation, Subsidies, and Revenue - - - Other Sources of Revenue

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