Handbook on the Shadow Economy
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Handbook on the Shadow Economy

Edited by Friedrich Schneider

The shadow economy (also known as the black or underground economy) covers a vast array of trade, goods and services that are not part of the official economy of a country. This original and comprehensive Handbook presents the latest research on the size and development of the shadow economy, which remains an integral component of the economies of most developing and many developed countries.
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Chapter 12: Deterrence Policy and the Size of the Shadow Economy in Germany: An Institutional and Empirical Analysis

Lars P. Feld, Andreas J. Schmidt and Friedrich Schneider


Lars P. Feld, Andreas J. Schmidt and Friedrich Schneider 12.1 INTRODUCTION As recently spotlighted by the cases of tax evasion by German taxpayers at Liechtenstein banks, the most important policy practice to fight tax evasion and undeclared work in OECD countries is to increase fines or investigation efforts of tax authorities. In these recent cases, investigation efforts and hence expectations of detection were emphasized. The German tax authorities (even more mysteriously, actually the German Secret Service) paid 5 million euros to an informant in order to get their hands on confidential bank customer data. In economic theory, such deterrence measures as remedy against tax evasion and undeclared work are founded in the economics of crime pioneered by Becker (1968). He argued theoretically that costs and benefits determine criminal behaviour. According to this theory, expected punishment is the cost each criminal faces for committing a crime or, as Gneezy and Rusticchini (2000) coined it, a fine is a price. The higher the expectations of detection, the higher the real detection efforts and the higher the fine, the more it deters from committing a crime. In contrast, on the benefit side, the incentives to commit a crime are stronger the higher the expected gains from crime. Allingham and Sandmo (1972) applied this approach to tax evasion, and enhanced it by taking individual risk preferences and risk aversion into account. In this frame, it turns out to be theoretically ambiguous how the (true) personal income and the marginal tax rate as the most...

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