Tax Evasion, the Underground Economy and Financial Development

Keith Blackburn, Niloy Bosey and Salvatore Capasso

Centre for Growth and Business Cycle Research Discussion Paper Series from Economics, The University of Manchester

Abstract: We study the relationship between the underground economy and financial development in a model of tax evasion and bank intermediation. Agents with heterogenous skills seek loans in order to undertake risky investment projects. Asymmetric information between borrowers and lenders implies a menu of loan contracts that induce self-selection in a separating equilibrium. Faced with these contracts, agents choose how much of their income to declare by trading off their incentives to offer collateral against their disincentives to comply with tax obligations. The key implication of the analysis is that the marginal net bene?t of income disclosure increases with the level of ?financial development. Thus, in accordance with empirical observation, we establish the result that the lower is the stage of such development, the higher is the incidence of tax evasion and the greater is the size of the underground economy.

Pages: 25 pages
Date: 2010
New Economics Papers: this item is included in nep-acc, nep-cta and nep-pbe
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Citations: View citations in EconPapers (6)

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Journal Article: Tax evasion, the underground economy and financial development (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:man:cgbcrp:138

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