The Underground Economy: Minimizing the Size of Government

In this paper we outline the results of some extensive econometric modelling that has been undertaken to establish a time-series of the size of the New Zealand Hidden Economy from 1968 to 1994. The derivation of these data has facilitated a good deal of associated research, and here we draw on those findings to comment, in particular, on the relationship between taxation policy and the effects taxes - in terms of both the overall tax burden and also the nature of the "tax mix", as between direct and indirect taxes, etc.. Our research in this area has revealed a clear and statistically significant link between high taxes and the size of the underground economy. Moreover, we have been able to establish the extent to which reductions in the tax burden, and changes to its "mix", can lower illicit activity in the economy. Interestingly, and very importantly, this in turn enables us to establish an "optimal" aggregate tax rate, if the objective is maximize the impact on the Hidden Economy. Many of the broad lessons that emerge from this research have applicability in the Canadian context, and more specific work of this type with Canadian data is currently being undertaken by the author and colleagues.