Informal economy is present in all countries; however it is in low and middle income countries that it has its deepest roots with some measurements estimating it to average at above 40% of national GDP. This represents a large part of the economy and poses serious problems for economic development and the relationship between state and society. It also means a significant loss in tax revenue, that poor countries need for the provision of public goods, resulting in the undermining of state capacity (Fukuyama, 2004). This leads to a vicious cycle, since without the efficient provision of public goods the incentive for tax compliance further decreases.
As tax structure and bureaucratic burden haven been identified as primary causes for informal economy, in the following we want to analyze whether lower costs of compliance actually lead to lower levels of informal economy. Given that in recent years some countries have implemented flat tax as tool for tax simplification, the authors explore the question of whether flat taxes have actually lived up to their promise and increased tax revenue or lowered levels of informal economy.
Pedro Obando and Johannes Wahner are both Master’s of Public Policy candidates at the Hertie School of Governance in Berlin.