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Income Tax Flattening: Does It Help to Reduce the Shadow Economy?

  • Peter, Klara Sabirianova

    ()

    (University of North Carolina, Chapel Hill)

This paper examines the effect of global transition to simpler, flatter income tax systems on the size of the shadow economy. By offering a new estimation framework, the paper revives the traditional electricity consumption approach to measuring the shadow economy. It overcomes the limitations of previous literature by using a new functional form, better quality data, a larger sample of 170 countries, a longer time span of 25 years, a panel framework, and instrumental variables. Our analysis provides strong evidence of a positive relationship between income tax rates and the size of the shadow economy. The effects of structural progressivity and complexity of national tax schedules are also found to be positive and statistically significant. These positive effects are reinforced when tax changes are accompanied by improving government services and strengthening the legal system. The flat tax is estimated to reduce the shadow economy in the short run, but this effect diminishes and disappears in the long run.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4223.

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Length: 50 pages
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:iza:izadps:dp4223
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  1. Michael Alexeev & William Pyle, 2002. "A Note on Measuring the Unofficial Economy in the Former Soviet Republics," Middlebury College Working Paper Series 0230, Middlebury College, Department of Economics.
  2. Yuriy Gorodnichenko & Jorge Martinez-Vazquez & Klara Sabirianova Peter, 2007. "Myth and Reality of Flat Tax Reform: Micro Estimates of Tax Evasion Response and Welfare Effects in Russia," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper0720, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
  3. Devereux, Michael P & Lockwood, Ben & Redoano, Michela, 2002. "Do Countries Compete Over Corporate Tax Rates?," The Warwick Economics Research Paper Series (TWERPS) 642, University of Warwick, Department of Economics.
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  5. Anna Ivanova & Michael Keen & Alexander Klemm, 2005. "The Russian ‘flat tax’ reform," Economic Policy, CEPR;CES;MSH, vol. 20(43), pages 397-444, 07.
  6. Dreher, Axel & Schneider, Friedrich, 2006. "Corruption and the Shadow Economy: An Empirical Analysis," IZA Discussion Papers 1936, Institute for the Study of Labor (IZA).
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  13. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
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  16. Rork, Jonathan C., 2003. "Coveting Thy Neighbors' Taxation," National Tax Journal, National Tax Association, vol. 56(4), pages 775-87, December.
  17. Peter, Klara Sabirianova & Buttrick, Steve & Duncan, Denvil, 2010. "Global Reform Of Personal Income Taxation, 1981–2005: Evidence From 189 Countries," National Tax Journal, National Tax Association, vol. 63(3), pages 447-78, September.
  18. 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.
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  22. Schneider, Friedrich, 1986. " Estimating the Size of the Danish Shadow Economy Using the Currency Demand Approach: An Attempt," Scandinavian Journal of Economics, Wiley Blackwell, vol. 88(4), pages 643-68.
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