Evaluating competing public policy approaches towards the informal economy

What is it about?

Conventionally, participation in the informal economy has been explained by viewing citizens as rational economic actors participating when the pay-off is greater than the expected cost of being caught and punished, and thus tackled by raising the sanctions and risks of detection. Given that many citizens do not engage even when the benefits outweigh the costs, a new social actor approach has begun to emerge which explains the informal economy as arising when tax morality is low and seeks to foster commitment to compliance. The aim of this paper is to provide an evidence-based evaluation of these competing policy approaches.

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Why is it important?

The finding is that raising the sanctions and risks of detection has no significant impact on the likelihood of participation in the informal sector. However, participation in the informal economy is significantly associated with tax morality. Indeed, the only time that increasing the sanctions and risks of detection reduces the level of participation in the informal economy is amongst citizens with very low tax morality.

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