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Tax Reforms and the Underground Economy: A Simulation-Based Analysis

Barbara Annicchiarico and Claudio Cesaroni ()
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Claudio Cesaroni: DEF, Università di Roma "Tor Vergata"

No 366, CEIS Research Paper from Tor Vergata University, CEIS

Abstract: This paper studies the effects of several tax reforms in an economy in which taxes are partially evaded by means of undeclared work. To this purpose, we consider a two-sector dynamic general equilibrium model calibrated to Italy which explicitly accounts for underground production. We construct various tax reform scenarios, such as deductibility of labor costs from business tax, ex-ante budget-neutral tax shifts from direct to indirect taxes, and various tax cuts financed by decreases of government spending. We find the following results. First, neglecting the existence of the underground sector may lead to severely miscalculate the macroeconomic impact effects of tax reforms, especially in the short run, where policy interventions produce direct and indirect effects on the markup. Second, partial deductibility of labor costs from the business tax base proves to be highly expansionary and highly detrimental to the size of the underground sector. Third, the dimension of the underground sector is permanently and considerably reduced by changes in the tax mix that diminish the labor tax wedge. Finally, all the considered tax reforms take the public-debt-to-output ratio toward a prolonged downward path.

Keywords: Dynamic General Equilibrium Model; Underground Economy; Tax Reforms; Italy (search for similar items in EconPapers)
JEL-codes: E62 O41 O52 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2016-02-10, Revised 2016-02-10
New Economics Papers: this item is included in nep-dge, nep-eec, nep-iue, nep-mac and nep-pbe
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Journal Article: Tax reforms and the underground economy: a simulation-based analysis (2018) Downloads
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