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Taxing the unobservable: The impact of the shadow economy on inflation and taxation

  • Ummad Mazhar
  • Pierre-Guillaume Méon

We test the notion that a government may rely less on taxes and more on inflation to finance its expenditures the larger the size of the shadow economy. In a sample of developed and developing countries over the 1999-2007 period, we indeed report a negative relation between the tax burden and the size of the shadow economy, and a positive relation between inflation and the size of the shadow economy. We provide evidence that both are conditional on central bank independence and the exchange rate regime. Both survive a series of robustness checks, controlling for reverse causality, simultaneity, level of development, and estimates of the shadow economy.

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Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers CEB with number 12-023.

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Length: 35 p.
Date of creation: Aug 2012
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Handle: RePEc:sol:wpaper:2013/125005
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