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The Underground Economy: Minimizing the Size of Government

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Abstract

In this paper we outline the results of some extensive econometric modelling that has been undertaken to establish a time-series of the size of the New Zealand Hidden Economy from 1968 to 1994. The derivation of these data has facilitated a good deal of associated research, and here we draw on those findings to comment, in particular, on the relationship between taxation policy and the effects taxes - in terms of both the overall tax burden and also the nature of the "tax mix", as between direct and indirect taxes, etc.. Our research in this area has revealed a clear and statistically significant link between high taxes and the size of the underground economy. Moreover, we have been able to establish the extent to which reductions in the tax burden, and changes to its "mix", can lower illicit activity in the economy. Interestingly, and very importantly, this in turn enables us to establish an "optimal" aggregate tax rate, if the objective is maximize the impact on the Hidden Economy. Many of the broad lessons that emerge from this research have applicability in the Canadian context, and more specific work of this type with Canadian data is currently being undertaken by the author and colleagues.

Suggested Citation

  • David E.A. Giles, 1998. "The Underground Economy: Minimizing the Size of Government," Econometrics Working Papers 9801, Department of Economics, University of Victoria.
    • Handle: RePEc:vic:vicewp:9801
    Note: ISSN 1485-6441. This is a revised version of a presentation to the Fraser Institute Conference on "How to Spend the Fiscal Dividend", Ottawa, Ontario, December 1997
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    1. Zellner, Arnold, 1970. "Estimation of Regression Relationships Containing Unobservable Independent Variables," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 11(3), pages 441-454, October.
    2. David Giles, 1997. "Causality between the measured and underground economies in New Zealand," Applied Economics Letters, Taylor & Francis Journals, vol. 4(1), pages 63-67.
    3. Giles, David E A, 1997. "Testing for Asymmetry in the Measured and Underground Business Cycles in New Zealand," The Economic Record, The Economic Society of Australia, vol. 73(222), pages 225-232, September.
    4. David Giles, 1997. "The hidden economy and tax-evasion prosecutions in New Zealand," Applied Economics Letters, Taylor & Francis Journals, vol. 4(5), pages 281-285.
    5. David E. A. Giles, & Patrick J. Caragata, 1998. "The Learning Path of the Hidden Economy:Tax and Growth Effects in New Zealand," Econometrics Working Papers 9805, Department of Economics, University of Victoria.
    6. Philip Cagan, 1958. "The Demand for Currency Relative to Total Money Supply," NBER Chapters, in: The Demand for Currency Relative to Total Money Supply, pages 1-37, National Bureau of Economic Research, Inc.
    7. Rolf Mirus & Roger S. Smith & Vladimir Karoleff, 1994. "Canada's Underground Economy Revisited: Update and Critique," Canadian Public Policy, University of Toronto Press, vol. 20(3), pages 235-252, September.
    8. Patrick J. Caragata, & David E. A. Giles, 1998. "Simulating the Relationship Between the Hidden Economy and the Tax Level and Tax Mix in New Zealand," Econometrics Working Papers 9804, Department of Economics, University of Victoria.
    9. Bruno S. Frey & Werner W. Pommerehne, 1984. "The Hidden Economy: State And Prospects For Measurement1," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 30(1), pages 1-23, March.
    10. David Giles, 1999. "The rise and fall of the New Zealand underground economy: are the responses symmetric?," Applied Economics Letters, Taylor & Francis Journals, vol. 6(3), pages 185-189.
    11. Edgar L. Feige, 1979. "How Big Is the Irregular Economy?," Challenge, Taylor & Francis Journals, vol. 22(5), pages 5-13, November.
    12. Frey, Bruno S. & Weck-Hanneman, Hannelore, 1984. "The hidden economy as an 'unobserved' variable," European Economic Review, Elsevier, vol. 26(1-2), pages 33-53.
    13. David E. A. Giles, 1998. "The Hidden Economy and the Tax-Gap in New Zealand: A Latent Variable Analysis," Econometrics Working Papers 9807, Department of Economics, University of Victoria.
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    Cited by:

    1. Roberto Dell’Anno & Miguel Gómez-Antonio & Angel Alañon-Pardo, 2007. "The shadow economy in three Mediterranean countries: France, Spain and Greece. A MIMIC approach," Empirical Economics, Springer, vol. 33(1), pages 197-197, July.
    2. Dell’Anno, Roberto & Davidescu, Adriana AnaMaria, 2019. "Estimating shadow economy and tax evasion in Romania. A comparison by different estimation approaches," Economic Analysis and Policy, Elsevier, vol. 63(C), pages 130-149.
    3. Paraskevi Koufopoulou & Colin C. Williams & Athanassios Vozikis & Kyriakos Souliotis & Antonios Samprakos, 2021. "Estimating Shadow Economy Size in Greece 2000 - 2018: A Flexible MIMIC Approach," SPOUDAI Journal of Economics and Business, SPOUDAI Journal of Economics and Business, University of Piraeus, vol. 71(3-4), pages 23-47, July-Dece.
    4. Andreas Buehn & Friedrich Schneider, 2012. "Corruption and the shadow economy: like oil and vinegar, like water and fire?," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 19(1), pages 172-194, February.
    5. Buehn, Andreas & Schneider, Friedrich, 2009. "Corruption and the Shadow Economy: A Structural Equation Model Approach," IZA Discussion Papers 4182, Institute of Labor Economics (IZA).
    6. Bame-Aldred, Charles W. & Cullen, John B. & Martin, Kelly D. & Parboteeah, K. Praveen, 2013. "National culture and firm-level tax evasion," Journal of Business Research, Elsevier, vol. 66(3), pages 390-396.
    7. Mahieddine Adnan Ghecham, 2017. "The Impact of Informal Sector on Income Distribution: Could Concentration of Income be Explained by the Size of Informal Sector?," International Journal of Economics and Financial Issues, Econjournals, vol. 7(1), pages 594-600.
    8. Soheila Kaghazian & Isa Zaghi Jojadeh & Yazdan Naghdi, 2015. "Underground Economy Estimation in Iran by Mimic Method," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 1, pages 90-109.

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    More about this item

    Keywords

    Hidden Economy; Underground Economy; Tax Evasion; Tax Gap;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • H1 - Public Economics - - Structure and Scope of Government
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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