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Taxes, Risk-Aversion, and the Size of the Underground Economy: A Nonparametric Analysis With New Zealand Data

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Author Info
David E. A. Giles ()
Betty J. Johnson ()

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Abstract

We use nonparametric regression analysis to investigate the relationship between the effective tax rate and the relative size of the underground economy, using New Zealand data. The theoretical underpinnings of such a relationship are established by extending some of the predictions of the recent model of Trandel and Snow (1999) to allow for the form of the available aggregate data. Time-series evidence indicates that these data are non-stationary and cointegrated, and this is taken into account in our estimation. The theoretical framework produces an ambiguous prediction regarding the sign of the relationship we are studying. However, our nonparametric empirical analysis produces a positive and "S-shaped" relationship, and this supports earlier empirical studies that imposed such functional forms. The estimated model is used to simulate the effects of hypothetical tax changes on the size of the New Zealand underground economy, and to draw policy conclusions.

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Paper provided by Department of Economics, University of Victoria in its series Econometrics Working Papers with number 9910.

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Length: 23 pages
Date of creation: 11 Aug 1999
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Handle: RePEc:vic:vicewp:9910

Note: ISSN 1485-6441
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Related research
Keywords: Tax evasion; underground economy; risk aversion; tax rates; nonparametric regression.;

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Find related papers by JEL classification:
C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Semiparametric and Nonparametric Methods
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Watson, Harry, 1985. "Tax evasion and labor markets," Journal of Public Economics, Elsevier, vol. 27(2), pages 231-246, July. [Downloadable!] (restricted)
  2. David E. A. Giles & Gugsa T. Werkneh & Betty J. Johnson, 1999. "Asymmetric Responses of the Underground Economy to Tax Changes: Evidence From New Zealand Data," Econometrics Working Papers 9911, Department of Economics, University of Victoria. [Downloadable!]
    Other versions:
  3. Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 1998. "Regulatory Discretion and the Unofficial Economy," American Economic Review, American Economic Association, vol. 88(2), pages 387-92, May. [Downloadable!] (restricted)
  4. David E. A. Giles, 1999. "Modelling the Hidden Economy and the Tax-Gap in New Zealand," Econometrics Working Papers 9905, Department of Economics, University of Victoria. [Downloadable!]
    Other versions:
  5. Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
  6. Linda F. DeBenedictis, & David E. A. Giles, 1998. "Robust Specification Testing in Regression: The FRESET Test and Autocorrelated Disturbances," Econometrics Working Papers 9806, Department of Economics, University of Victoria. [Downloadable!]
  7. Patrick J. Caragata, & David E. A. Giles, 1998. "Simulating the Relationship Between the Hidden Economy and the Tax Level and Tax Mix in New Zealand," Econometrics Working Papers 9804, Department of Economics, University of Victoria. [Downloadable!]
  8. Trandel, Greg & Snow, Arthur, 1999. "Progressive income taxation and the underground economy," Economics Letters, Elsevier, vol. 62(2), pages 217-222, February. [Downloadable!] (restricted)
  9. Giles, David E A, 1997. "Causality between the Measured and Underground Economies in New Zealand," Applied Economics Letters, Taylor and Francis Journals, vol. 4(1), pages 63-67, January. [Downloadable!] (restricted)
  10. Davidson, Russell & MacKinnon, James G, 1981. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Econometrica, Econometric Society, vol. 49(3), pages 781-93, May. [Downloadable!] (restricted)
    Other versions:
  11. Crane, Steven E & Nourzad, Farrokh, 1987. "On the Treatment of Income Tax Rates in Empirical Analysis of Tax Evasion," Kyklos, Blackwell Publishing, vol. 40(3), pages 338-48.
  12. Cheung, Yin-Wong & Chinn, Menzie David & Tran, Tuan, 1995. "How Sensitive Are Trends to Data Definitions? Results for East Asian and G5 Countries," Applied Economics Letters, Taylor and Francis Journals, vol. 2(1), pages 1-6, January. [Downloadable!] (restricted)
  13. David E. A. Giles, 1998. "Modelling the Tax Compliance Profiles of New Zealand Firms: Evidence from Audit Records," Department Discussion Papers 9803, Department of Economics, University of Victoria. [Downloadable!]
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  14. Leybourne, S J & McCabe, B P M, 1994. "A Simple Test for Cointegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 56(1), pages 97-103, February.
  15. Allingham, Michael G. & Sandmo, Agnar, 1972. "Income tax evasion: a theoretical analysis," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 323-338, November. [Downloadable!] (restricted)
  16. Kwiatkowski, Denis & Phillips, Peter C. B. & Schmidt, Peter & Shin, Yongcheol, 1992. "Testing the null hypothesis of stationarity against the alternative of a unit root : How sure are we that economic time series have a unit root?," Journal of Econometrics, Elsevier, vol. 54(1-3), pages 159-178. [Downloadable!] (restricted)
    Other versions:
  17. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254. [Downloadable!] (restricted)
  18. Dolado, Juan J & Jenkinson, Tim & Sosvilla-Rivero, Simon, 1990. " Cointegration and Unit Roots," Journal of Economic Surveys, Blackwell Publishing, vol. 4(3), pages 249-73.
  19. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June. [Downloadable!] (restricted)
  20. Toda, Hiro Y. & Yamamoto, Taku, 1995. "Statistical inference in vector autoregressions with possibly integrated processes," Journal of Econometrics, Elsevier, vol. 66(1-2), pages 225-250. [Downloadable!] (restricted)
  21. Pencavel, John H., 1979. "A note on income tax evasion, labor supply, and nonlinear tax schedules," Journal of Public Economics, Elsevier, vol. 12(1), pages 115-124, August. [Downloadable!] (restricted)
  22. Kesselman, Jonathan R., 1989. "Income tax evasion : An intersectoral analysis," Journal of Public Economics, Elsevier, vol. 38(2), pages 137-182, March. [Downloadable!] (restricted)
  23. David E. A. Giles, & Patrick J. Caragata, 1999. "The Learning Path of the Hidden Economy: The Tax Burden and Tax Evasion in New Zealand," Econometrics Working Papers 9904, Department of Economics, University of Victoria. [Downloadable!]
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  24. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  25. Yitzhaki, Shlomo, 1974. "Income tax evasion: A theoretical analysis," Journal of Public Economics, Elsevier, vol. 3(2), pages 201-202, May. [Downloadable!] (restricted)
  26. Koskela, Erkki, 1983. "A note on progression, penalty schemes and tax evasion," Journal of Public Economics, Elsevier, vol. 22(1), pages 127-133, October. [Downloadable!] (restricted)
  27. Clotfelter, Charles T, 1983. "Tax Evasion and Tax Rates: An Analysis of Individual Returns," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 363-73, August. [Downloadable!] (restricted)
  28. Schneider, Friedrich, 1994. "Can the Shadow Economy Be Reduced through Major Tax Reforms? An Empirical Investigation for Austria," Public Finance = Finances publiques, , vol. 49(Supplemen), pages 137-52.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. David E. A. Giles & Gugsa T. Werkneh & Betty J. Johnson, 1999. "Asymmetric Responses of the Underground Economy to Tax Changes: Evidence From New Zealand Data," Econometrics Working Papers 9911, Department of Economics, University of Victoria. [Downloadable!]
    Other versions:
  2. Lindsay M. Tedds & David E. A. Giles, 2000. "Modelling the Underground Economies in Canada and New Zealand: A Comparative Analysis," Econometrics Working Papers 0003, Department of Economics, University of Victoria. [Downloadable!]
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