Indeterminacy, Underground Activities and Tax Evasion

This paper shows that underground activities and tax evasion may be another possible source of local indeterminacy of the equilibrium path. We derive necessary and sufficient conditions for equilibrium path to be locally indeterminate under tax evasion and underground activities. Moreover, the explicit introduction of an (even small) underground sector into a one-sector general equilibrium model allow to reduce aggregate degree of increasing returns required for indeterminacy, and for having well behaved input demand schedules (in the sense that slope down). Finally, we show that under indeterminacy, an increase in corporate, labor or income tax rates has a non-Keynesian effect, i.e. the economy enters into an expansionary pattern. These effects are reversed when the steady state is saddle-path stable