Elevator pitch
The shadow (underground) economy has a major impact on society and economy in many countries. People evade taxes and regulations by working in the shadow economy or by employing people illegally. On the one hand, this unregulated economic activity can result in reduced tax revenue and fewer public goods and services, lower tax morale and less tax compliance, higher control costs, and lower economic growth rates. But on the other hand, the shadow economy can be a powerful force fostering institutional change and boosting the overall production of goods and services in an economy. The shadow economy has implications on the political order and institutional change.
Key findings
Pros
High taxes and social security contributions and heavy regulation are the key drivers of the shadow economy.
Resources and labor force not needed in the official economy can be used in the shadow economy to increase overall supply of goods and services.
Opinions on how to deal with the labor force in the shadow economy differ widely.
Governments try to encourage firms to move out of the shadow economy by improving public institutions.
Fostering stronger popular participation in government decision-making, expanding elements of direct democracy, and eliminating corruption can also reduce the shadow economy.
Cons
The shadow economy is hard to measure, and different methods yield different results.
Some measurement difficulties occur because the term shadow economy is not clearly defined.
By worsening fiscal deficits and reducing infrastructure investment, the shadow economy reduces welfare and economic growth.
The shadow economy can undermine state institutions, leading to more crime and less support for institutions, ultimately threatening economic and political development.
Trying to reduce the shadow economy through punitive fines and tighter controls is costly and not very effective.
