Underground Economy
CHAPTER 1
INTRODUCTION
1.1
BACKGROUND
In every economy, there exist vast variety of activities some which undergo official recording and some other activities take place outside the officials. The later is the underground economy that refers to the economic activities that generate income but are hidden from official authorities in order to evade various taxes and remain unrecorded in official statistics (Yasmin and Rauf, 2004).
The most common causes of underground economy are heavy tax burdens where economic agents evade high tax charges and resort to stay untaxed, high business regulation whereby this regulations are difficult to obey and do tempers with the welfare of the society (intensity regulation) as well as public doubts where the public may believe that the state do not use their taxes efficiently. This phenomenon requires attention of economists, policy makers, public officials and politicians because income earned in underground economy is quickly absorbed in the formal economy hence stimulate economic growth as well as tax revenue if indirect taxes are employed. On the other hand, huge shadow economy reflect a direct loss of public revenue hence depress the growth of GDP. Again, it provides greater incentive for domestic and foreign workers to move away from the official economy (Ariyo and Bekoe).
According to Schneider (2012), increase of the shadow economy can cause state revenues to decline which will ultimately reduce the quality and quantity of publicly provided goods and services. This will ultimately results in deterioration of provision of public goods by government, increase unfair competition by forcing legal businesses out of the market and great harmonious environment for criminal activities including tax evasion. Further, these
1
activities alter the quality of statistics like unemployment, official labour force, income and consumption that policy makers depend on to formulate their policies. Consequently, suboptimal policies
INTRODUCTION
1.1
BACKGROUND
In every economy, there exist vast variety of activities some which undergo official recording and some other activities take place outside the officials. The later is the underground economy that refers to the economic activities that generate income but are hidden from official authorities in order to evade various taxes and remain unrecorded in official statistics (Yasmin and Rauf, 2004).
The most common causes of underground economy are heavy tax burdens where economic agents evade high tax charges and resort to stay untaxed, high business regulation whereby this regulations are difficult to obey and do tempers with the welfare of the society (intensity regulation) as well as public doubts where the public may believe that the state do not use their taxes efficiently. This phenomenon requires attention of economists, policy makers, public officials and politicians because income earned in underground economy is quickly absorbed in the formal economy hence stimulate economic growth as well as tax revenue if indirect taxes are employed. On the other hand, huge shadow economy reflect a direct loss of public revenue hence depress the growth of GDP. Again, it provides greater incentive for domestic and foreign workers to move away from the official economy (Ariyo and Bekoe).
According to Schneider (2012), increase of the shadow economy can cause state revenues to decline which will ultimately reduce the quality and quantity of publicly provided goods and services. This will ultimately results in deterioration of provision of public goods by government, increase unfair competition by forcing legal businesses out of the market and great harmonious environment for criminal activities including tax evasion. Further, these
1
activities alter the quality of statistics like unemployment, official labour force, income and consumption that policy makers depend on to formulate their policies. Consequently, suboptimal policies