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Fiscal Policy with an Informal Sector

Author

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  • Dellas, Harris
  • Malliaropoulos, Dimitris
  • Papageorgiou, Dimitris
  • Vourvachaki, Evangelia

Abstract

Macroeconomic models that omit the shadow economy systematically mis-forecast and mis-measure the effect of fiscal - in particular tax- policy on economic activity and tax revenue. We add an informal sector to the Bank of Greece DSGE model and use the actual package of fiscal consolidation implemented in Greece over the period 2010-2015 to evaluate the role of the black economy. In the data, official Greek GDP declined by about 26%, budget deficits proved larger and more persistent and tax rates increased by much more and tax revenue by much less than predicted. The model replicates the official output decline but implies a true output decline that is less than two thirds of that in recorded output. The discrepancy is even more pronounced for employment. The model also implies that the size of fiscal adjustment and the drop in economic activity could have been considerably milder had the informal sector been curtailed (it instead increased by about 50%). The underground economy seems to have been a key factor in Greece's failure to achieve orderly debt consolidation while avoiding economic depression.

Suggested Citation

  • Dellas, Harris & Malliaropoulos, Dimitris & Papageorgiou, Dimitris & Vourvachaki, Evangelia, 2017. "Fiscal Policy with an Informal Sector," CEPR Discussion Papers 12494, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:12494
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    References listed on IDEAS

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    1. Dimitris Papageorgiou, 2014. "BoGGEM: a dynamic stochastic general equilibrium model for policy simulations," Working Papers 182, Bank of Greece.
    2. Mendoza, Enrique G. & Razin, Assaf & Tesar, Linda L., 1994. "Effective tax rates in macroeconomics: Cross-country estimates of tax rates on factor incomes and consumption," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 297-323, December.
    3. Mertens, Karel & Ravn, Morten O., 2014. "A reconciliation of SVAR and narrative estimates of tax multipliers," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 1-19.
    4. Pappa, Evi & Sajedi, Rana & Vella, Eugenia, 2015. "Fiscal consolidation with tax evasion and corruption," Journal of International Economics, Elsevier, vol. 96(S1), pages 56-75.
    5. de Walque, Gregory & Lundvall, Henrik & Papageorgiou, Dimitris & Rysanek, Jakub & Kulikov, Dmitry & Júlio, Paulo & Lozej, Matija & Sideris, Dimitris & Maria, José R. & Micallef, Brian & Schmidt, Sebas, 2015. "Comparing fiscal multipliers across models and countries in Europe," Working Paper Series 1760, European Central Bank.
    6. repec:eee:ecolet:v:157:y:2017:i:c:p:17-20 is not listed on IDEAS
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    Cited by:

    1. Masuch, Klaus & Anderton, Robert & Setzer, Ralph & Benalal, Nicholai, 2018. "Structural policies in the euro area," Occasional Paper Series 210, European Central Bank.

    More about this item

    Keywords

    scal consolidation; multipliers; Shadow economy; tax revenue; true output;

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H68 - Public Economics - - National Budget, Deficit, and Debt - - - Forecasts of Budgets, Deficits, and Debt

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