Tax Reforms and the Underground Economy: A Simulation-Based Analysis

46 Pages Posted: 11 Feb 2016

See all articles by Barbara Annicchiarico

Barbara Annicchiarico

University of Rome, Tor Vergata - Department of Economics and Finance; University of Rome Tor Vergata - Centre for International Studies on Economic Growth (CEIS)

Claudio Cesaroni

University of Rome Tor Vergata - Department of Economics and Finance

Date Written: February 9, 2016

Abstract

This paper studies the effects of several tax reforms in an economy in which taxes are partially evaded by means of undeclared work. To this purpose, we consider a two-sector dynamic general equilibrium model calibrated to Italy which explicitly accounts for underground production. We construct various tax reform scenarios, such as deductibility of labor costs from business tax, ex-ante budget-neutral tax shifts from direct to indirect taxes, and various tax cuts financed by decreases of government spending. We find the following results. First, neglecting the existence of the underground sector may lead to severely miscalculate the macroeconomic impact effects of tax reforms, especially in the short run, where policy interventions produce direct and indirect effects on the markup. Second, partial deductibility of labor costs from the business tax base proves to be highly expansionary and highly detrimental to the size of the underground sector. Third, the dimension of the underground sector is permanently and considerably reduced by changes in the tax mix that diminish the labor tax wedge. Finally, all the considered tax reforms take the public-debt-to-output ratio toward a prolonged downward path.

Keywords: Dynamic General Equilibrium Model, Underground Economy, Tax Reforms, Italy

JEL Classification: E62, O41, O52

Suggested Citation

Annicchiarico, Barbara and Cesaroni, Claudio, Tax Reforms and the Underground Economy: A Simulation-Based Analysis (February 9, 2016). CEIS Working Paper No. 366. Available at SSRN: https://ssrn.com/abstract=2729963 or http://dx.doi.org/10.2139/ssrn.2729963

Barbara Annicchiarico (Contact Author)

University of Rome, Tor Vergata - Department of Economics and Finance ( email )

Rome, I-00133
Italy

University of Rome Tor Vergata - Centre for International Studies on Economic Growth (CEIS) ( email )

Via Columbia, 2
Rome, I-00133
Italy

Claudio Cesaroni

University of Rome Tor Vergata - Department of Economics and Finance ( email )

Rome
Italy

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