State Aid Policies and Underground Activities
Aarhus University Economics Working Paper No. 10-2005
35 Pages Posted: 17 May 2007
Date Written: 2006
The main goal of this paper is to examine the implications of firm-oriented fiscal policies, such as capital subsidies and tax allowances, in an economy with an underground sector. In addition, we investigate whether the technology structure of "hidden" production may facilitate or counteract the effects of fiscal policies on firm behavior. Among our results we stress the following: first, capital subsidies promote tax evasion; these subsidies induce firms to increase actual capital accumulation (a level effect), but also produce a reduction in the regular share of aggregate capital stock (a composition effect).
Second, tax relief reduces underground activities and fosters capital accumulation, as well as aggregate production. Third, the technology structure matters for determining how to allocate resources between formal and informal production, hence the amount of reported revenues.
Keywords: State aid, capital subsidies, tax evasion, underground production, physical capital accumulation
JEL Classification: E26, E22, H25, H26
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