A Model to Estimate Spacial Distribution of Informal Economy

by Albu, Lucian Liviu
Published in Romanian Journal of Economic Forecasting
, 2008, volume 9 issue 4, 111-124


Among economists it is widely believed that high tax rates and ineffective tax collection by the government are the main causes contributing to the rise of the informal economy. Economists have already established two relationships, at least empirically demonstrated, between tax rates and tax evasion (or size of informal economy) and, between poverty and informal economy, respectively: the higher the level of taxation or/and poverty degree, the greater incentive to participate in informal sector and avoid paying taxes. At macroeconomic level, there are a number of indirect methods to estimate the size and dynamics of informal economy, such as Monetary Approach, Implicit Labour Supply Method, National Accounting Method, Energy Consumption Method, etc. Unfortunately, there are often huge differences among the estimated shares of informal or underground economy obtained by various methods. In this article, coming from generally accepted findings of the theory in matter of modelling underground economy, we concentrate on evaluating analytically the limit-values of certain parameters involved in the models used to estimate the size of underground economy and to explain the forming mechanism and its dynamics. We are combining in the same model the level of income and tax rate as main determinants of informal economy growth. Then, on the basis of the model, we simulate some exercises on available data. The second goal of our study is to extend investigation at regional level and, finally, to obtain a map reflecting the spatial distribution of informal economy in Romania.

Keywords: informal economy, spatial distribution, probability of detection, risk-aversion
JEL Classification:
C16, H21, H26, I32, R12