Hidden, Informal, and Illegal Economic Activties
Final Report Abstract
During the first part of my research visit I had the opportunity to work at the Office of Tax Policy Research at University of Michigan under the supervision of Professor Joel Slemrod. In many fruitful discussion we elaborated that the literature on informal economic activities has not yet paid sufficient attention to enforcement as an important determinant. For that reason, I started two studies - among the typical determinants such as taxes, regulations, and the labor market - the impact of enforcement on the shadow economy. The first presents empirical results more generally, while the second is a case study for Germany. Both studies show that that a stronger enforcement of tax rules and regulations can help to moderate shadow economic activities. These results for Germany confirm the more general findings. In the light of the empirical results politicians have thus several options. Standard instruments to moderate the shadow economy are to improve the labour market, to enhance the formation of human capital, and to reduce the burden of taxation. An alternative option is enforcement as it increases the probability of detection making shadow economic activities less attractive. It is thus an appropriate instrument to control the shadow economy. During the research visit to the Andrew Young School of Policy Studies at Georgia State University, I investigated an alternative way to deplete the shadow economy, which is reforming the tax system to improve the dynamics of the official economy. The output of the many fruitful and stimulating discussions with colleagues at the school is research on the impact of the tax system composition on the size of the shadow economy, in particular how tax and expenditures policies lead to a variety of behavioral responses. One of the central aspects of these responses is that the taxpayers positively value the provision of public goods but are unwilling to finance it. This leads to legal and illegal means to escape the burden of taxation and to move economic activity to the informal sector. A simple, empirically testable mode that uses the "effective budget constraint" of the government summarizing the behavioral responses that are relevant for the choice of a social optimum might help to analyze the effect of taxation on GDP, the share of government expenditures in the economy and the size of the informal sector. The research contributes to our understanding of the impact of the tax system composition on the size of the shadow economy and thus fills an important gap in the literature.
