International Monetary Fund. Communications Department
This issue of Finance & Development focuses on dark web of secret transactions that enable tax evasion and avoidance, money laundering, illicit financial flows, and corruption. Demands on government resources are building—to boost growth in some advanced economies, build infrastructure in emerging markets, and improve health and education in the developing world. IMF research shows that countries with lower levels of perceived corruption have significantly less waste in public projects. Among low-income countries, the share of the budget dedicated to education and health is one-third lower in more corrupt countries. The rise of digital finance, crypto assets, and cybercrime adds to the challenges. Consider the so-called dark web, a hidden marketplace for everything from stolen identities to arms and narcotics. Improving governance is not easy; it requires sustained effort over the long term.
This paper develops a dynamic computable general equilibrium model in which optimizing agents evade taxes by operating in the underground economy. The cost to firms of evading taxes is that they find themselves subject to credit rationing from banks. Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base. Aggregate investment in the economy is lowered because of credit rationing. Taxes that are too low eliminate the underground economy, but result in unsustainable budget and trade deficits. Thus, the optimal rate of taxation, from a macroeconomic point of view, may lead to some underground activity.