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Capital Subsidies and the Underground Economy

  • Francesco Busato
  • Bruno Chiarini
  • Pasquale de Angelis
  • Elisabetta Marzano

    ()

    (Department of Economics, University of Aarhus, Denmark)

In this paper we investigate the effects of different fiscal policies on the firm choice to produce underground. We consider a tax evading firm operating simultaneously both in the regular and in the underground economy. We suggest that such a kind of firm, referred to as moonlighting firm, is able to offset the specific costs usually stressed by literature on underground production, such as those suggested by Loayza (1994) and Anderberg et al. (2003). Investigating the effects of different fiscal policy interventions, we find that taxation is a critical parameter to define the size of capital allocation in the underground production. In fact, a strong and inverse relationship is found, and tax reduction is the best policy to reduce the convenience to produce underground. We also confirm the depressing effect on investment of taxation (see, for instance, Summers, 1981), so that tax reduction has no cost in terms of investment. By contrast, the model states that while enforcement is an effective tool to reduce capital allocation in the underground production, it also reduce the total capital stock. Moreover, we also suggest that the allowance of incentives to capital accumulation may generate, in this specific typology of firm, some unexpected effects, causing, together with a positive investment process, also an increase in the share of irregularity. This finding could explain, in a microeconomic framework, the evidence of Italian southern regions, where high incentives are combined with high irregularity ratios.

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Paper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 2005-10.

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Length: 24
Date of creation: 10 Jul 2005
Date of revision:
Handle: RePEc:aah:aarhec:2005-10
Contact details of provider: Web page: http://www.econ.au.dk/afn/

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  1. Dan Anderberg & Alessandro Balestrino & Umberto Galmarini, 2003. "Search and Taxation in a Model of Underground Economic Activities," Economic Inquiry, Western Economic Association International, vol. 41(4), pages 647-659, October.
  2. Maria Rosaria Carillo & Maurizio Pugno, 2002. "The underground economy and the underdevelopment trap," Department of Economics Working Papers 0201, Department of Economics, University of Trento, Italia.
  3. Bontempi Maria Elena & Giannini Silvia & Guerra Maria Cecilia & Tiraferri Angela, 2001. "Incentivi agli investimenti e tassazione dei profitti: l'impatto delle recenti riforme fiscali sul "cash flow" delle società di capitali," Politica economica - Journal of Economic Policy (PEJEP), Società editrice il Mulino, issue 3, pages 249-284.
  4. Loayza, Norman A., 1997. "The economics of the informal sector : a simple model and some empirical evidence from Latin America," Policy Research Working Paper Series 1727, The World Bank.
  5. Boeri, Tito & Garibaldi, Pietro, 2002. "Shadow Activity and Unemployment in a Depressed Labour Market," CEPR Discussion Papers 3433, C.E.P.R. Discussion Papers.
  6. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
  7. Yitzhaki, Shlomo, 1974. "Income tax evasion: A theoretical analysis," Journal of Public Economics, Elsevier, vol. 3(2), pages 201-202, May.
  8. Loayza, Norman V., 1994. "Labor regulations and the informal economy," Policy Research Working Paper Series 1335, The World Bank.
  9. Francesco Busato & Bruno Chiarini, 2004. "Market and underground activities in a two-sector dynamic equilibrium model," Economic Theory, Springer, vol. 23(4), pages 831-861, May.
  10. Bruno Chiarini & Elisabetta Marzano, 2004. "Dimensione E Dinamica Dell'Economia Sommersa: Un Approfondimento Del Currency Demand Approach," Working Papers 4_2004, D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy.
  11. Alm, James, 1985. "The Welfare Cost of the Underground Economy," Economic Inquiry, Western Economic Association International, vol. 23(2), pages 243-63, April.
  12. Busato, Francesco & Chiarini, Bruno & Rey, Guido M., 2012. "Equilibrium implications of fiscal policy with tax evasion: A long run perspective," International Review of Law and Economics, Elsevier, vol. 32(2), pages 197-214.
  13. Elisabetta Marzano, 2004. "Dual Labour Market Theories And Irregular Jobs: Is There a Dualism Even in The Irregular Sector?," CELPE Discussion Papers 81, CELPE - Centre of Labour Economics and Economic Policy, University of Salerno, Italy.
  14. Trandel, Greg & Snow, Arthur, 1999. "Progressive income taxation and the underground economy," Economics Letters, Elsevier, vol. 62(2), pages 217-222, 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.
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