Tax, investment, institutional and social channels of economic shadowing: Challenges for macro-financial stability and good governance

Abstract

A significant size of the shadow economy is a threat to the sustainable functioning of a country’s economy, its ability to finance economic and social programs. The paper studies the influence of the shadow economy on the macro-financial stability of the EU countries. The dependence between macro-financial stability and the size of the shadow economy was estimated using the quadrocentric (considering the four channels of the shadow economy) recursive (takes into account direct and inverse relationships between them) model. Dependence between indicators was analyzed using Euler’s methods, Calvo’s and Dixit Stiglitz’s principles, Taylor’s and Smets-Wouters’ function. It has been proved that shadow economy channels affect the macro-financial stability almost equally (an increase in the size of the shadow economy in Slovenia by 1% leads to a decrease in macro-financial stability by 0.562% for tax, 0.56% for investment, 0.572 for institutional, and 0.444 for social channels). At the same time, the growth in the volume of shadow transactions through one channel forms an impetus for the increasing intensity of use of the remaining channels to hide income. With the help of the payment matrix, the optimal level of drivers of shadow economy by which the targeted value of the level of macro-financial stability is achieved was determined. It was concluded that ensuring good governance in the direction of preventing shadow schemes of capital withdrawal should be carried out in terms of institutional, tax, social, and investment channels of the shadow economy. AcknowledgmentThis work was supported by the Slovak Research and Development Agency under the contract No. APVV-16-0602.