Fiscal illusion and the shadow economy: Two sides of the same coin?

Buehn, Andreas and Dell'Anno, Roberto and Schneider, Friedrich (2012): Fiscal illusion and the shadow economy: Two sides of the same coin?

Abstract

This paper presents an empirical analysis of the relationship between fiscal illusion and the shadow economy for 104 countries over the period 1989–2009. We argue that both unobservable phenomena are closely linked to each other, as the creation of a fiscal illusion may be helpful if governments want to control shadow economic activities. Using a MIMIC model with two latent variables we confirm previous findings on the driving forces of the shadow economy and identify the main determinants and indicators of fiscal illusion. Most importantly, we find that fiscal illusion negatively affects the shadow economy: Concealing the real tax burden through fiscal illusion potentially contributes to the government’s efforts to repress shadow economic activities.

• Item Type: MPRA Paper
• Language: English
• Keywords: Fiscal illusion; shadow economy; MIMIC model; latent variables, tax burden, tax complexity
• Subjects: E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O17 - Formal and Informal Sectors ; Shadow Economy ; Institutional Arrangements; K - Law and Economics > K4 - Legal Procedure, the Legal System, and Illegal Behavior > K42 - Illegal Behavior and the Enforcement of Law

References

Anderson J.C., Gerbing D.W. (1984). The effect of sampling error on convergence, improper solutions, and goodness-of-fit indices for maximum likelihood confirmatory factor analysis. Psychometrika, 49: 155-173.

Barrett, P. (2007). Structural equation modelling: Adjudging model fit. Personality and Individual Differences, 42: 815-824.

Bollen, K.A., Long, J. S. (1993). Testing structural equation models. Beverly Hills, CA: Sage.

Boomsma, A. (1982). The robustness of LISREL against small sample sizes in factor analysis models. In K. J. Jöreskog and H. Wold (Eds.), Systems under indirect observation: Causality, structure, prediction (Part 1).Amsterdam: North-Holland.

Boomsma, A. (1985). Nonconvergence, improper solutioms, and starting values in LISREL maximum likelihood estimation. Psychometrika, 50: 229-242.

Brown, T.A. (2006). Confirmatory Factor Analysis for Applied Research. New York: Guilford Press.

Browne M., Cudeck R. (1993). Alternative ways of assessing model fit. In: Testing Structural Equation Models. Bollen KA, Long JS eds, 136–162. Beverly Hills, CA: Sage

Buchanan, J.M. (1967). Public finance in democratic process: fiscal institutions and individual choice, Chapel Hill (USA) University of North Carolina press.

Buehn, A., Schneider, F. (2012). Shadow economies around the world: Novel insights, accepted knowledge, and new estimates. International Tax and Public Finance, 19: 139-171.

Chong, A., Gradstein, M. (2007). Inequality and Informality. Journal of Public Economics, 9: 159-79.

Cullis, J., Jones, P. (1987). Fiscal Illusion and Excessive Budgets: Some Indirect Evidence. Public Finance Quarterly 15:219–28.

Dell’Anno, R. (2007). Shadow Economy in Portugal: an analysis with the MIMIC approach. Journal of Applied Economics 10(2): 253-277.

Dell’Anno R. (2008). What is the relationship between Unofficial and Official Economy? An analysis in Latin American Countries. European Journal of Economics, Finance and Administrative Sciences 12: 185-203.

Dell’Anno, R., Mourão, P. (2012). Fiscal Illusion around the World. An analysis using the Structural Equation Approach. Public Finance Review, 40(2), pp. 270-299.

Dollery, B.E., Worthington, A. (1996). The Empirical Analysis of Fiscal Illusion. Journal of Economic Surveys 10: 261–97.

Duncan, O.D. (1975). Introduction to Structural Equation Models. New York: Academic Press.

Fasiani, M. (1941). Principii di scienza felle finanze, vol. I. Torino: Giappichelli Editore.

Feld, L., Schneider F. (2010). Survey on the Shadow Economy and Undeclared Earnings in OIEC Countries, German Economic Rview 11 (2), 109-149.

Jöreskog, K.G., Goldberger, A. (1975). Estimation of a model with multiple indicators and multiple causes of a single latent variable, Journal of the American Statistical Association, 70: 631-639

Kaufmann, D., Kaliberda, A. (1996). Integrating the Unofficial Economy into the Dynamics of Post-Socialist Economies: A Framework of Analysis and Evidence, in: B. Kaminski (Ed) Economic Transition in the Newly Independent States (M.E. Sharpe Press. Armonk, New York).

McArdle, J.J. (1980). Causal Modeling Applied to Psychonomic Systems Simulation, Behavior Research Methods & Instrumentation, 12: 193 -209.

McArdle, J.J., McDonald, R.P. (1984). Some Algebraic Properties of the Reticular Action Model, British Journal of Mathematical and Statistical Psychology, 37: 234 -251.

Mill, J.S. (1848). Principles of Political Economy. Consulted Edition: Mill, J. Stuart 1994. Oxford: Oxford University Press.

Oates, W.E. (1988). On the Nature and Measurement of Fiscal Illusion: A Survey. In Taxation and Fiscal Federalism: Essays in Honour of Russell Mathews, G. Brennan et al., eds., 65-82, Sydney: Australian National University Press.

Schmölders, G. (1960). Das Irrationale in der öffentlichen Finanzwirtschaft. Reinbeck: Rowohlt.

Schneider, F. (2005). Shadow economies around the world: What do we really know. European Journal of Political Economy, 21: 598-642

Schneider, F., Enste, D.H. (2000). Shadow economies: size, causes and consequences, Journal of Economic Literature 38: 77-114.

Schneider, F., Buehn, A., Montenegro, C. (2010). New Estimates for the Shadow Economies all over the World, International Economic Journal, 24(4): 443-461.

Seater, J.J. (1993). Ricardian Equivalence, Journal of Economic Literature, 31, 142-190.

Stapleton, D. (1978). Analyzing political participation data with a MIMIC Model. Sociological Methodology, 15: 52-74

Steiger, J.H., Lind J.C. (1980) Statistically-based tests for the number of common factors. Paper presented at the annual Spring Meeting of the Psychometric Society in Iowa City. May 30, 1980.

Tanzi, V. (1999). Uses and abuses of estimates of the underground economy, Economic Journal 109: 338–347.

Wagner, R. (1976). Revenue structure, fiscal illusion and budgetary choice. Public Choice 25: 45-61