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Tax Reforms and the Underground Economy: A Simulation-Based Analysis

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This paper studies the effects of several tax reforms in an economy in which taxes are partially evaded by means of undeclared work. To this purpose, we consider a two-sector dynamic general equilibrium model calibrated to Italy which explicitly accounts for underground production. We construct various tax reform scenarios, such as deductibility of labor costs from business tax, ex-ante budget-neutral tax shifts from direct to indirect taxes, and various tax cuts financed by decreases of government spending. We find the following results. First, neglecting the existence of the underground sector may lead to severely miscalculate the macroeconomic impact effects of tax reforms, especially in the short run, where policy interventions produce direct and indirect effects on the markup. Second, partial deductibility of labor costs from the business tax base proves to be highly expansionary and highly detrimental to the size of the underground sector. Third, the dimension of the underground sector is permanently and considerably reduced by changes in the tax mix that diminish the labor tax wedge. Finally, all the considered tax reforms take the public-debt-to-output ratio toward a prolonged downward path.

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  • Barbara Annicchiarico & Claudio Cesaroni, 2016. "Tax Reforms and the Underground Economy: A Simulation-Based Analysis," CEIS Research Paper 366, Tor Vergata University, CEIS, revised 10 Feb 2016.
  • Handle: RePEc:rtv:ceisrp:366
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    Cited by:

    1. Barbara Annichiarico & Fabio Di Dio & Francesco Felici, 2016. "IGEM II: a New Variant of the Italian General Equilibrium Model," Working Papers 4, Department of the Treasury, Ministry of the Economy and of Finance.
    2. Bruno Chiarini & Maria Ferrara & Elisabetta Marzano, 2016. "Investment Shocks, Tax Evasion and the Consumption Puzzle: A DSGE Analysis with Financial Frictions," CESifo Working Paper Series 6015, CESifo Group Munich.

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    Keywords

    Dynamic General Equilibrium Model; Underground Economy; Tax Reforms; Italy;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models
    • O52 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Europe

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