"Fiscal Policy with an Informal Sector"
Macroeconomic models that omit the shadow economy systematically mis-forecast and mis-measure the effect of fiscal--in particular tax--policy on economic activity and tax revenue. We add an informal sector to the Bank of Greece DSGE model and use the actual package of fiscal consolidation implemented in Greece over the period 2010 - 2015 to evaluate the role of the black economy. In the data, official Greek GDP declined by about 26%, budget deficits proved larger and more persistent, tax rates increased by much more, and tax revenue by much less than predicted. The model replicates the official output decline but implies a true output decline that is less than two-thirds of that in recorded output. The discrepancy is even more pronounced for employment. Higher labour and capital income taxes and the reduction in the public wage bill contributed the lion's share in the decline in GDP. The model also implies that the size of fiscal adjustment and the drop in economic activity could have been considerably milder had the informal sector been curtailed (it instead increased by about 50%). The underground economy seems to have been a key factor in Greece's failure to achieve orderly debt consolidation while avoiding economic depression.
Harris Dellas is Professor and Chair of Macroeconomics at the University of Bern. He previously taught at the Catholic University of Louvain, University of Maryland, and Vanderbilt University, and was the Chairman of the Board of Trustees at the Athens University of Economic and Business (AUEB). His research centers on international macroeconomics and monetary theory. He received his BA from AUEB and PhD (1985) from the University of Rochester.
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