The Learning Path of the Hidden Economy: The Tax Burden and Tax Evasion in New Zealand

This paper considers the "learning curve" relationship between the aggregate tax rate and the relative size of the hidden economy in New Zealand. Some simple non-linear models are estimated so that the effects of changes in the effective tax rate on the underground economy can be simulated. We find that about half of the hidden activity in New Zealand is a learned response to changing opportunities and constraints in fiscal policy, but this amount varies over the business cycle. Simulating a zero tax rate permits us to discover the "natural rate" of underground and criminal activity. Some partial lessons are drawn for taxation policy in that country.