Indeterminacy, Underground Activities and Tax Evasion

This paper introduces underground activities and tax evasion into a one sector dynamic general equilibrium model with external effects. The model presents a novel mechanism driving the self-fulfilling prophecies, which is triggered by the reallocation of resources to the underground sector to avoid the excess tax burden. This mechanism differs from the customary one, and it is complementary to it. In addition, the explicit introduction of an (even tiny) underground sector allows to reduce the aggregate degree of increasing returns required for indeterminacy, and for having well behaved input demand schedules (in the sense they slope down).