Tax evasion, the underground economy and financial development

Keith Blackburn, Niloy Bose and Salvatore Capasso

Journal of Economic Behavior & Organization, 2012, vol. 83, issue 2, 243-253

Abstract: We study the relationship between the underground economy and financial development in a model of tax evasion and bank intermediation. Agents with heterogeneous 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 benefit 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.

Keywords: Tax evasion; Shadow economy; Financial development (search for similar items in EconPapers)
JEL-codes: E26 G14 H26 O16 O17 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (82)

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Working Paper: Tax Evasion, the Underground Economy and Financial Development (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:83:y:2012:i:2:p:243-253

DOI: 10.1016/j.jebo.2012.05.019

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