Rethinking the Informal Economy and the Hugo Effect

Abstract

This paper offers a new approach to measuring the size of the informal economy based on VAT data for the European Union. Although data intensive, our EVADE measure is simpler and more transparent than existing measures. EVADE also shows more variation across coun- tries of Europe than earlier measures, including significantly higher informality in Greece, Italy and Spain, for example. Moreover, we find considerably higher variation within coun- tries across time; in a cross-country time series regression, controlling for tax rates, we con- firm that the informal economy grows significantly in recessions and decreases in booms, which we term the “Hugo effect”.

Keywords: Informal Economy, Business Cycles, Growth, VAT compliance.

JEL Classification: E26, E32, H26, O17