On the Economic Rationale of Estimating the Hidden Economy
The estimation of the hidden economy may be considered as a human passion for knowing the unknown. Although a large literature on the hidden economy exists, the subject is still controversial at a very basic level. There are disagreements about: (1) the definition of the hidden activities; (2) the terms used to describe these activities; (3) the estimation or measurement procedures; and finally, (4) on the use of these estimates in economic analysis. In this paper we will only consider the issues related to estimation, economic and econometric analysis of the hidden economy. Thus we implicitly accept the term hidden economy and explicitly state the definition before entering into the main discussions. For a comprehensive study of past literature readers are referred to Feige (1989), Gaertner and Wenig (1985) and Tanzi (1982) and the large number of references in these books. The use of the hidden economy estimates for economic and econometric analysis can be classified into three potentially distinct but interrelated categories: (a) the derivation of economic theory and/or its implication for the existing theories; (b) the formulation of economic policies; and (c) econometric modelling. If we consider that the tax evaded income is the only constituent of the hidden economy then the issues are almost obvious for all three categories. However, as we will see later, such a simple interpretation of the hidden economy estimates is generally not possible. For example, in this paper we define the hidden economy as the unrecorded national income. The unrecorded national income is calculated as the difference between the 'potential' national income for the given currency in circulation and the recorded national income. This definition of the hidden economy suggests that, in principle, it is larger than the tax evaded income. The empirical illustrations are taken from the studies conducted in the United Kingdom and India where this is a workable definition. However, for many other countries such an approach is totally inadequate as a measure of unrecorded national income, since the method of estimating the hidden economy is constrained by the structure of the economy. In this paper we shall present a brief description of a general method of estimating the hidden economy and appraise the applicability and limitation of the method. Due to space constraint we shall discuss very briefly the importance of the hidden economy on economic theory and on the empirical