Shady Transactions: Three Essays on the Underground Economy

Abstract

<p> The term "underground economy" refers to output that is produced, and income that is generated, by agents who hide this fact from authorities. There has been a recent resurgence in interest in the underground economy and this interest has predominantly been stimulated by the perception that the underground economy is sizeable and growing. This dissertation is comprised of three essays, the goals of which are to provide empirical measures of underground activity.</p> <p> The first paper in this dissertation applies a modeling technique that treats the underground economy as an unobservable or latent variable and incorporates multiple indicator and multiple causal (MIMIC) variables to estimate a time-path of the size of broadly defined underground economy. Using macroeconomic Canadian data, the results indicate that the underground economy grew steadily over the sample period: from 7.5% of Gross Domestic Product (GDP) in 1976 to about 15.3% in 2001.</p> <p> The second paper uses microeconomic data and proposes a nonparametric expenditure-based approach to obtain estimates of income under-reporting by self- employed households. The approach is illustrated by estimating the effect of the Canadian Goods and Services Tax (GST) on income under-reporting. It is found that the difference between true and reported self-employment income is larger for households at the lower end of the self-employment income distribution and that there was no statistically significant change in under-reporting behaviour following the implementation of the GST.</p> <p>The third paper investigates the characteristics of businesses that engage in tax non-compliance using a survey of firms from around the world. Overall, small firms tend to be less compliant than larger firms. In addition, foreign owned firms, exporters, and firms that have audited financial statements are found to be more compliant but quite surprisingly, government ownership does not result in increased tax compliance. Finally, the existence of organized crime, high taxes, and government corruption all result in lower compliance.</p>