Determinants of the Shadow Economy—Implications for Fiscal Sustainability and Sustainable Development in the EU

The shadow economy weakens fiscal sustainability, hampers the financing of public goods, and impedes the achievement of sustainable development goals. The informal sector remains a persistent challenge for policymakers, as it distorts competition, reduces transparency, and undermines the effectiveness of economic and fiscal policies. The aim of this article is to identify the key factors determining the size of the shadow economy in European Union countries and to provide policy-relevant insights. The analysis covers data on the share of the informal economy in GDP and macroeconomic variables such as GDP per capita, consumer price index, average wages, household consumption, government expenditure, and unemployment, as well as indicators of digital development in society and the economy (DESI, IDT), the share of cashless transactions in GDP, and information on the implementation of digital tax administration tools and restrictions on cash payments. Five hypotheses (H1–H5) are formulated concerning the effects of income growth, labour market conditions, digitalisation, cashless payments, and tax administration tools on the shadow economy. The research question addresses which factors—macroeconomic conditions, economic and social digitalisation, payment structures, and fiscal innovations in tax administration—play the most significant role in determining the size of the shadow economy in EU countries and whether these mechanisms have broader implications for fiscal sustainability and sustainable development. The empirical strategy is based on multilevel models with countries as clusters, complemented by correlation and comparative analyses. The results indicate that the most significant factor in limiting the size of the shadow economy is the level of GDP per capita and its growth, whereas the impact of card payments appears to be superficial, reflecting overall increases in wealth. Higher wages, household consumption, and digital development as measured by the DESI also play an important role. The implementation of digital solutions in tax administration, such as SAF-T or e-PIT/pre-filled forms, along with restrictions on cash transactions, can serve as complementary measures. The findings suggest that sustainable strategies to reduce the shadow economy should combine long-term economic growth with digitalisation and improved tax administration, which may additionally foster the harmonisation of economic systems and support sustainable development.