EXPLORING THE LINK BETWEEN TAX EVASION AND THE UNDERGROUND ECONOMY

Often, the size of the underground economy is treated as equivalent to the amount of tax evaded. This may be misleading. It is possible to have income unreported to the tax authority, thus creating a serious tax evasion problem, while the official national product is not understated. This paper shows that the underground economy and tax evasion are related but they are not identical. To do so, a simple framework is developed to distinguish between tax evasion in the aboveground economy and the underground economy. Implications are drawn in the context of mitigating the size of the evaded tax and the underground economy.