Regional authority and the shadow economy

Abstract

Despite extensive institutional efforts to tackle the shadow economy, this sector remains prevalent globally. This study endeavors to examine how regional authority could influence the size of the shadow economy. Using a new index of regional authority (RAI) and 12 sub-indicators, we apply different panel estimates for a sample of 72 countries from 1996 to 2018, based on the available data. We find that: (i) increases in RAI appear to have a significant negative impact on the size of the shadow economy (as a percentage of official GDP); and (ii) most sub-indicators of RAI are consistent, except for the insignificant effects of the executive control sub-index and constitutional control sub-index. We propose two channels for the effects: control of corruption and tax burden. Increases in RAI appear to improve corruption control while reducing the overall tax burden, which then transmits to reducing the shadow economy. The robustness checks—utilizing various estimates, estimation strategies, and three distinct measures of the shadow economy—demonstrate consistent and reliable findings. The results suggest that central governments should consider enhancing regional authority as an additional policy measure to curb the informal economy.