Measuring the size of underground economy in Iran with emphasis on the incentives for evasion of insurance premium payment (1961 – 2001)

This paper attempts to estimate the size of underground economy in Iran and to identify the elements having taken a role in the creation of the same for the period 1961-2001 by using modified currency ratio method as a monetary approach to the estimation of the size of underground economy. Regression model has been stipulated with the consideration of special economic circumstances prevailing in Iran. Currency ratio (circulating currency to total private sector bank deposits ratio) has been considered as a function of economic development (per capita income), inflation rate, the degree of urbanization (a measure of the development of financial institutions) and private consumption expenditures. Government expenditures to GDP ratio (a measure of government economic interventions), import tax burden, direct tax burden, social security tax burden and black market foreign exchange rate have been also considered as the indicators and variables reflecting underground economy. The model has been estimated by using an auto-regressive distributed lag (ARDL) method and the results are indicative of a high volume of such activities within the frameworks of the economy of Iran. The mean size of underground economy has been 27.76 percent of GDP during the period of study. Out of all the factors creating the underground economy, the size of government fraction of economy has had the greatest effect and social insurance burden has had the smallest one. Although the increase in insurance burden is in itself a factor in the creation of underground economy, in its turn has a striking negative impact on the performance and stability of social insurance funds.