Fiscal Sustainability and the Informal Economy: A Non-Linear Perspective

This study examines the issue of fiscal sustainability—measured through the response of the budgetary balance to public debt levels—for 36 OECD countries and candidate countries, and it shows that the relationship is non-linear and depends on the level of the informal economy as a threshold variable. Using the Panel Smooth Transition Regression model, the analysis uncovers regime-dependent fiscal behavior, indicating that the effect of public debt on the budget deficit varies significantly under different economic conditions. In regime 1—at a low level of the informal economy-, the impact of debt on the budgetary deficit is negative and significant, but in regime 2—when the informal economy exceeds the transition threshold-, this impact becomes positive and significant. These results indicate that, in an economic context with a larger informal economy, debt may have a different effect on the budgetary deficit, possibly due to factors such as reduced fiscal efficiency or loss of government revenue. Therefore, fiscal sustainability can be affected by the level of the informal economy.