Taxes and the Underground Economy

May 16, 2005

From the latest issue of Region Focus—a quarterly publication from the Federal Reserve Bank of Richmond—the estimated sizes of the underground economies in various countries:

What explains the wide variation? One factor is burdensome taxes and regulations that push otherwise legal activities underground:

Friedrich Schneider, an economist at the Johannes Kepler University in Linz, Austria, defines the informal economy as: “All market-based legal production of goods and services that are deliberately concealed from public authorities … to avoid payment of income, value added, or other taxes[,] … to avoid payment of social security contributions … [or] to avoid having to meet certain legal labor market standards, such as minimum wages, maximum working hours, safety standards, etc. …”

[E]conomists generally agree that the shadow economy is worse in developing nations, whose webs of bureaucratic red tape and corruption are notorious.

Read the full article here. For more on how excessive tax burdens can expand underground economic activity—particularly cigarette smuggling—see our Background Paper No. 26, “How Excise Tax Differentials Affect Interstate Smuggling and Cross-Border Sales of Cigarettes in the United States.”

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