Shining a light on the shadows: Identifying robust determinants of the shadow economy

Abstract

Despite the substantial body of research studying the determinants of the shadow economy in the past few decades, consensus on a set of consistent drivers of the underground sector has failed to emerge. This paper aims to synthesize the literature by identifying robust determinants of the shadow economy and addressing related modeling uncertainty. Using three different cross-national shadow measures and employing numerous determinants over hundreds of model combinations, we find that bureaucratic complexity is more significant than monetary severity in driving the shadow economy. Further, the incentives of new shadow entrepreneurs are somewhat different from established shadow operators. A one standard deviation increase in tax complexity increases the overall shadow economy by over ten percent of the mean. In contrast, a similar increase in business startup costs increases the prevalence of new informal entrepreneurs by almost more than double. Further, shadow determinants in developed and developing nations are dissimilar.