The Consequences of Progressive Income Taxation for the Shadow Economy: Some Theoretical Considerations

  • Reinhard Neck
  • Friedrich Schneider
  • Markus F. Hofreither


In recent years, both the public debate and the scientific literature have shown increased interest in the phenomenon of the shadow (underground, hidden) economy.1 As a working definition, we may say that the shadow economy consists of those economic activities which contribute to value-added and should be included in GDP or national income according to the conventions of national-income accounting, but are at present not registered by the national measurement agencies. Political concern about the size and the growth of the shadow economy arises for various reasons: apart from the general undesirability of illegal activities, there are also economic problems associated with the underground economy. For example, it may be a result or a cause of allocative and distributive distortions; the effects of stabilization policies may be different when there is a considerable amount of hidden activities; and, in general, spillovers between the shadow and the official economy must not be neglected when policy measures are being planned and implemented. Moreover, if rising tax rates lead to an increase in the extent of the shadow economy, higher tax rates may cause lower instead of higher tax revenues for the government. This possibility of a falling portion of the Laffer curve has to be taken into account when budgetary policies are under consideration.2


Labor Supply Shadow Economy Underground Economy Official Economy Progressive Income Taxation 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Allingham, M.G., and Sandmo, A. (1972): “Income Tax Evasion: A Theoretical Analysis.” Journal of Public Economics 1: 323–338.CrossRefGoogle Scholar
  2. Andersen, P. (1977): “Tax Evasion and Labor Supply.” Scandinavian Journal of Economics 79: 375–383.CrossRefGoogle Scholar
  3. Baldry, J.C. (1979): “Tax Evasion and Labour Supply.” Economics Letters 3: 53–56.CrossRefGoogle Scholar
  4. Büchner, H.-J. (1987): “Der Einfluß der Steuerhinterziehung auf direkte und indirekte Steuern.” Discussion Paper No. A-100, Sonderforsehungäbereich 303, University of Bonn.Google Scholar
  5. Christiansen, V. (1980): “Two Comments on Tax Evasion.” Journal of Public Economics 13: 389–393.CrossRefGoogle Scholar
  6. Clotfelter, Ch.T. (1983): “Tax Evasion and Tax Rates: An Analysis of Individual Returns.” Review of Economics and Statistics 65: 363–373.CrossRefGoogle Scholar
  7. Coweli, E.A. (1981): “Taxation and Labour Supply with Risk Activities.” Eco- nomica48: 365–379.Google Scholar
  8. Coweli, F.A. (1985): “Tax Evasion with Labour Income.” Journal of Public Economics 26: 19–34.CrossRefGoogle Scholar
  9. Coweli, F.A. (1987): “Honesty is Sometimes the Best Policy.” Discussion Paper No. TIDI/107, ESRC Programme, London School of Economics and Political Science.Google Scholar
  10. Coweli, F.A. (1988): “Tax Sheltering and the Cost of Evasion.” Discussion Paper No. TIDI/119, ESRC Programme, London School of Economics and Political Science.Google Scholar
  11. Coweli, F.A, (1989): Cheating the Government. The Economics of Evasion. Cambridge, Mass.: MIT Press.Google Scholar
  12. Coweli, F.A., and Gordon, J.P.F. (1988): “Unwillingness to Pay: Tax Evasion and Public Good Provision.” Journal of Public Economics 36: 305–321.CrossRefGoogle Scholar
  13. Crane, S.E., and Nourzad, F. (1985): “Time Value of Money and Income Tax Evasion under Risk-Averse Behavior: Theoretical Analysis and Empirical Evidence.” Public Finance 40: 381–394.Google Scholar
  14. Crane, S.E., and Nourzad, F. (1986): “Inflation and Tax Evasion: An Empirical Analysis.” Review of Economics and Statistics 68: 217–223.CrossRefGoogle Scholar
  15. Crane, S.E., and Nourzad, F. (1987): “On the Treatment of Income Tax Rates in Empirical Analysis of Tax Reform.” Kyklos 40: 338–348.CrossRefGoogle Scholar
  16. Cross, R., and Shaw, G.K. (1982): “On the Economics of Tax Aversion.” Public Finance 37: 36–47.Google Scholar
  17. Dubin, J.A., Graetz, M.J., and Wilde, L.L. (1987): “Are We a Nation of Tax Cheaters? New Econometric Evidence on Tax Compliance.” American Economic Review, Paper and Proceedings 77: 240–245.Google Scholar
  18. Frey, B.S., and Pommerehne, W.W. (1984): “The Hidden Economy: State and Prospects for Measurement.” Review of Income and Wealth 30: 1–23.CrossRefGoogle Scholar
  19. Friedland, N., Maital, S., and Rutenberg, A. (1978): “A Simulation Study of Income Tax Evasion.” Journal of Public Economics 10: 107–116.CrossRefGoogle Scholar
  20. Gaertner, W., and Wenig, A. (eds.) (1985): The Economics of the Shadow Economy, Heidelberg: Springer-Verlag.Google Scholar
  21. Geeroms, H, and Wilmots, H. (1985): “An Empirical Model of Tax Evasion and Tax Avoidance.” Public Finance 40: 190–209.Google Scholar
  22. Graetz, M.J., Reinganum, J.F., and Wilde, L.L. (1986): “The Tax Compliance Game: Toward an Interactive Theory of Law Enforcement.” Journal of Law, Economics and Organization 2: 1–32.Google Scholar
  23. Greenberg, J. (1984): “Avoiding Tax Avoidance: A (Repeated) Game-Theoretic Approach.” Journal of Economic Theory 32: 1–13.CrossRefGoogle Scholar
  24. Isachsen, A.J., and Strom, S. (1980): “The Hidden Economy: The Labor Market and Tax Evasion.” Scandinavian Journal of Economics 82: 304–311.CrossRefGoogle Scholar
  25. Jacobsson, U. (1976): “On the Measurement of the Degree of Progression.” Journal of Public Economics 5: 161–168.CrossRefGoogle Scholar
  26. Kolm, S.-C. (1973): “A Note on Optimum Tax Evasion.” Journal of Public Economics 2: 265–270.CrossRefGoogle Scholar
  27. Koskela, E. (1983): “On the Shape of Tax Schedules, the Probability of Detection, and the Penalty Schemes as Deterrents to Tax Evasion.” Public Finance 38: 70–80.Google Scholar
  28. Koskela, E. (1983a): “A Note on Progression, Penalty Schemes and Tax Evasion.” Journal of Public Economics 22: 127–133.CrossRefGoogle Scholar
  29. Lewis, A. (1979): “An Empirical Assessment of Tax Mentality.” Public Finance 34: 245–257.Google Scholar
  30. McCaleb, T.S. (1976): “Tax Evasion and the Differential Taxation of Labor and Capital Income.” Public Finance 31: 287–294.Google Scholar
  31. Mork, K.A. (1975): “Income Tax Evasion: Some Empirical Evidence.” Public Finance 30: 70–76.Google Scholar
  32. Nayak, P.B. (1978): “Optimal Income Tax Evasion and Regressive Taxes.” Public Finance 33: 358–366.Google Scholar
  33. Nitzan, S., and Tzur, J. (1987): “Taxpayers, Auditors and the Government — An Extended Tax Evasion Game.” Discussion Paper No. A-105, Sonderforschungsbereich 303, University of Bonn.Google Scholar
  34. Pencavel, J.H. (1979): “A Note on Income Tax Evasion, Labor Supply and Nonlinear Tax Schedules.” Journal of Public Economics 12: 115–124.CrossRefGoogle Scholar
  35. Poterba, J.M. (1987): “Tax Evasion and Capital Gains Taxation.” American Economic Review, Papers and Proceedings 77: 234–239.Google Scholar
  36. Reinganum, J.F., and Wilde, L.L. (1985): “Income Tax Compliance in a Principal- Agent Framework.” Journal of Public Economics 26: 1–18.CrossRefGoogle Scholar
  37. Reinganum, J.F., and Wilde, L.L. (1986): “Equilibrium Verification and Reporting Policies in a Model of Tax Compliance.” International Economic Review 27: 739–760.CrossRefGoogle Scholar
  38. Sandmo, A. (1981): “Income Tax Evasion, Labour Supply, and the Equity-Efficiency Tradeoff.” Journal of Public Economics 16: 265–288.CrossRefGoogle Scholar
  39. Sandmo, A. (1983): “Progressive Taxation, Redistribution, and Labor Supply.” Scandinavian Journal of Economics 85: 311–323.CrossRefGoogle Scholar
  40. Schneider, F., and Hofreither, M.F. (1987): “The Effects of a Changing Shadow Economy on the Official Economy: First Results with a Small Econometric Model.” Discussion Paper, University of Linz.Google Scholar
  41. Shoven, J.B., and Whalley, J. (1984): “Applied General-Equilibrium Models of Taxation and International Trade: An Introduction and Survey.” Journal of Economic Literature 22: 1007–1051.Google Scholar
  42. Singh, B. (1973): “Making Honesty the Best Policy.” Journal of Public Economics 2: 257–263.CrossRefGoogle Scholar
  43. Slemrod, J., and Yitzhaki, S. (1987): “The Optimal Size of a Tax Collection Agency.” Scandinavian Journal of Economics 89: 183–192.CrossRefGoogle Scholar
  44. Spicer, M.W., and Hero, R.E. (1985): “Tax Evasion and Heuristics. A Research Note.” Journal of Public Economics 26: 263–267.CrossRefGoogle Scholar
  45. Spicer, M.W., and Lundstedt, S.B. (1976): “Understanding Tax Evasion.” Public Finance 31: 295–305.Google Scholar
  46. Sproule, H.A. (1985): “Tax Evasion and Labor Supply under Imperfect Information about Individual Parameters of the Tax System.” Public Finance 40: 441–456.Google Scholar
  47. Sproule, R.A., Komus, D., and Tsang, E. (1980): “Optimal Tax Evasion: Risk- Neutral Behaviour under a Negative Income Tax.” Public Finance 35: 309–317.Google Scholar
  48. Srinivasan, T.N. (1973): “Tax Evasion: A Model.” Journal of Public Economics 2: 339–346.CrossRefGoogle Scholar
  49. Watson, H. (1985): “Tax Evasion and Labor Markets.” Journal of Public Economics 27: 231–246.CrossRefGoogle Scholar
  50. Weck, H., Pommerehne, W.W., and Frey, B.S. (1984): Schattenwirtschaft. München: Franz Vahlen-Verlag.Google Scholar
  51. Weiss, L. (1976): “The Desirability of Cheating Incentives and Randomness in the Optimal Income Tax.” Journal of Political Economy 84: 1343–1352.CrossRefGoogle Scholar
  52. Wiegard, W. (1984): “Schwarzarbeit und Besteuerung.” In Schattenökonomie, edited by W. Schäfer. Göttingen: Vandenhoeck & Ruprecht.Google Scholar
  53. Yitzhaki, S. (1974): “A Note on: Income Tax Evasion: A Theoretical Analysis.” Journal of Public Economics 3: 201–202.CrossRefGoogle Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 1989

Authors and Affiliations

  • Reinhard Neck
    • 1
  • Friedrich Schneider
    • 1
  • Markus F. Hofreither
    • 1
  1. 1.Vienna, LinzAustria

Personalised recommendations