Income Tax Flattening: Does It Help To Reduce The Shadow Economy?

Date Added: Jun 2009
Format: PDF

This paper examines the effect of global transition to simpler, flatter income tax systems on the size of the shadow economy. By offering a new estimation framework, the paper revives the traditional electricity consumption approach to measuring the shadow economy. It overcomes the limitations of previous literature by using a new functional form, better quality data, a larger sample of 170 countries, a longer time span of 25 years, a panel framework, and instrumental variables. The authors' analysis provides strong evidence of a positive relationship between income tax rates and the size of the shadow economy.