The Influence of Tax Compliance Burden Upon the Size of the Informal Economy: Europe and Latin American Countries

Abstract

The existence of shadow economy has serious implications for social and economic development. The reasons for informality are numerous and vary from one region to another. Whereas in Europe priority is usually given to the own economical benefit by means of tax evasion, in Latin America the situation is more complex; sometimes it is a personal option based on economical reasons but also on the lack of confidence in public institutions, other times it is a matter of need because of the inflexibility of labour market that cannot absorb the labour surplus into its industrialization process. This paper examines how much of the difference in the size of the informal sector and across European and Latin American countries can be accounted for by tax compliance costs (i.e., the cost of establishment and of paying taxes), and explores the odds of decreasing the expansion of the informal economy by acting on this parameter. The results confirm the advisability of having into account, in the fight against informality, the compliance tax cost as an important tool to enhance voluntary compliance, which has in turn chiefly to do with the efficiency of tax administration.