Think Greece: Inflation, taxation, and the underground economy

Original source: SimoleonSense.com .

Fascinating paper…that may shed some light on the Greek Situation

Introduction (via Econobrowser)

If you carry out your business in the underground economy, you will benefit by avoiding taxation, but you lose the legal and contract protection that you would have had if you’d instead been working in the formal sector. If only the first effect mattered, you’d expect to see countries with higher tax rates have a greater role for the informal sector. But Aruoba finds just the opposite– the bigger the informal sector, the lower tax receipts as a percent of formal-sector GDP.

Aruoba’s interpretation is that the weaker a country’s institutions, the greater the attractiveness of the informal sector, and the more the government is likely to rely on inflation rather than standard taxes to raise revenue.

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