Informality, tax policy and the business cycle: Exploring the links

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Informality, tax policy and the business cycle: Exploring the links

Despite the worldwide prevalence of informality, consensus on a reliable and consistent set of drivers and consequences of this phenomenon has been elusive to both researchers and policymakers. This study partly addresses this shortcoming by exploring the interactions between the informal economy and tax policy and how these are shaped by business cycle uctuations. To this end, we identify robust determinants of both informality and taxation by means of an econometric analysis that accounts for bi-directional causality. Focusing on two diferent dimensions of informal activity and three tax policy instruments and employing numerous determinants over dozens of model combinations, we find that the significance of the relationship between informality and taxation depends on the specific tax instrument under consideration. Thus, the informal economy may particularly afect the design of direct taxes. Also, the business cycle may have distinctive in uences on informality and tax policy, so direct taxes appear to be acyclical or countercyclical while indirect taxes are strongly procyclical. We conclude by noting that how the business cycle afects the informal economy and taxation allows to substantiate evidence on the role of informality in the adoption of potentially destabilizing fiscal policies.

Fecha de publicación

26 noviembre, 2020

Palabras clave

tax policy interactions business cycle
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