Abstract
The main goal of this paper is to examine the implications of firm-oriented fiscal policies, such as capital subsidies and tax allowances, in an economy with an underground sector. In addition, we investigate whether the technology structure of hidden production may facilitate or counteract the effects of fiscal policies on firm behavior. Among our results we stress the following: first, capital subsidies promote tax evasion; these subsidies induce firms to increase actual capital accumulation (a level effect), but also produce a reduction in the regular share of aggregate capital stock (a composition effect). Second, tax relief reduces underground activities and fosters capital accumulation, as well as aggregate production. Third, the technology structure matters for determining how to allocate resources between formal and informal production, hence the amount of reported revenues.
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