An estimation of the underground economy and tax evasion. Empirical analysis from an emerging economy

Published date07 October 2019
DOIhttps://doi.org/10.1108/JMLC-01-2019-0002
Date07 October 2019
Pages626-645
AuthorJohn Kwaku Amoh,Babonyire Adafula
An estimation of the underground
economy and tax evasion
Empirical analysis from an emerging economy
John Kwaku Amoh
Department of Accounting, Faculty of Accounting and Finance,
University of Professional Studies, Accra, Ghana, and
Babonyire Adafula
Department of Accounting, University of Ghana, Accra, Ghana
Abstract
Purpose This paper aims to use an econometric model to estimate tax evasion from the size of the
undergroundeconomy and examined the factors that trigger it.
Design/methodology/approach The study used time series data sourced from world development
indicators and Bank of Ghana coveringthe period 1990-2015 to estimate tax evasion from the underground
economyusing an autoregressive distributed lag modeldrawing on the currency demand approach.
Findings The results conrmedthe existence of a large underground economy and a high incidenceof tax
evasion in Ghana. The Ghanaian situation has been aggravated by an underground economy-triggering
factor of mobile money activities,which increased by 83.1 per cent in 2015. Tax evasion averaged 20.78 per
cent of GDP over the period.The study, thus, concludes that the increased numberof mobile money activities,
high tax burden and unemploymentcontribute to the worsening of the tax evasion problem in Ghana.
Originality/value The study is one of the premier attempts to introduceelectricity power consumption
variables in the currency demand modelto estimate tax evasion from the size of the undergroundeconomy.
The authors hypothesize that the emergence of mobile money activities in its current form triggers
underground and tax-evading activities. The study, thus, calls for the formalization and regulation of the
operations of mobile money activities in emerging economies as a way of managing the underground
economy,which incubates tax evasion.
Keywords Ghana, Mobile money, Underground economy, Tax evasion, ARDL cointegration
Paper type Research paper
1. Introduction
The challenges of tax administrationhave been variously researched and chronicled.Otieku
(1992) posited that the major problems of tax administration in Ghana are the poor level of
voluntary compliance with tax laws by taxpayers, complex and fragmented tax laws,
predominance ofcash transactions and tax evasion.
Tax evasion is widespread,always has been and probably always will be Slemrod (2007).
Alleyne and Harris (2017) concluded that tax evasion is a major challenge for governments
the world over, with innovative and ever-changing schemes, which makes it increasingly
difcult to regulate. Tax evasion has been dened as an illegal act or practice of failing to
pay taxes, which are owed to the state(Benk et al.,2015).
The authors take this opportunity to thank the editor, Dr Chris Brennan and the anonymous
reviewers for their time and energy to review our work and to oer valuable comments to enrich our
work.
JMLC
22,4
626
Journalof Money Laundering
Control
Vol.22 No. 4, 2019
pp. 626-645
© Emerald Publishing Limited
1368-5201
DOI 10.1108/JMLC-01-2019-0002
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1368-5201.htm
In 2010, the Global Financial Integrity (GFI, 2010) estimated thatAfrican countries have
lost US$854bn in cumulative capital ight[1] over the 1970-2008 period. The more the
incidence of tax evasion, the greater the share of the tax burden that falls on the few law-
abiding and tax compliant citizens. Therefore, policymakers need to address the issue to
avoid a breakdown of thetax system as taxpayers burdened by the high tax ratescaused by
tax evasion may deserttheir tax obligations and become tax evaders.
In a time when the governments debt levels are high[2] and the budget decits are
worsening, the size of the tax evasion should be a key variable in the tax policy equation.
Where the level of tax evasion is low, the government has high potential to mobilize tax
revenues for developmentalprojects. Hence, addressing tax evasion is vital if public services
are to be well preserved while providingsupport to businesses and taxpayers.
The inability of the formal private sector to generate jobs in their required numbers has
forced many Ghanaians into the informal sector.The unemployment rate as a percentage of
labour force stood at 1.8 per cent in 2013 but shot up to 2.4 per cent in 2014 (WDI,2015). This
is because, in the absence of appropriate social protection mechanisms, informal activities
have become survival strategiesfor many Ghanaians both old and young. The origin of the
informal sector in Ghanaseconomy can be traced to the pre-independence period. Though it
was heterogeneous in nature, it accommodated varieties of peasant proprietors and
agricultural labourers,distribution agents, buyers, transport owners and employees, porters
and repairers.
Over the years, instead of fading as modern economies grew, the informal sector has
actually grown in the rural and urban areas of Ghana. Ghanas structural adjustment
programme of the early 1980s with its attendant signicant retrenchment of labour and the
inability of governmentto provide employment for the growing labour force wasenough for
a large pool of unemployed persons to gravitate towards the informal sector. Osei-Boateng
and Ampratwum (2011) reported that in 2011, about 88 per cent of theGhanaian workforce
was in the informal sector.
Consequently, economistsand policymakers have become intrigued by the activities, size
and possible economic impact of the informal sector, also referred to as the underground,
second, parallel, subterranean, hidden, black or shadow economy (Organization for
Economic Cooperationand Development (OECD, 2002). To date, there is no consensus on the
denition of the undergroundeconomy (Schneider and Hametner, 2014).
The activities of most of theseeconomic agents in the informal sector escape the attention
of tax ofcials and are difcult to detect because the participants make private gains by
keeping the activities concealed. These gains may take the form of evaded taxes, non-
compliance with tax laws, income from prohibited and criminal activities or fraudulent
receipt of various governmentbenets (Tanzi, 1983).
Additionally, the extentof tax evasion in an economy and the size of the hidden economy
are difcult to observe and investigatebecause of their covert nature. Prior literature (Tanzi,
1983;Savasan, 2003;DellAnno, 2007;Bayer and Sutter, 2008;Bayer, 2006;Cebula and
Saadatmand, 2005;Fishlow and Friedman, 1994;Caballe and Panade, 2004;Aigner,
Schenider and Ghosh, 1988;Kasipillai, Aripin and Amran, 2003;Jain, 1987;Joulfaian and
Rider, 1996;Martinez-Vazquez and Rider, 2005;Crane and Norzad, 1986;Koyame, 1996;
Alleyne and Harris, 2017) have attributed the size of hidden economy and tax evasion to
several factors. These tax evading triggering factors include high tax burden,
unemployment, complicatedtax structure and dishonest staff.
As a result, various methodshave been developed since the 1950s by various researchers
to calculate the size of the hidden economy and the extent of tax evasion in several tax
jurisdictions. Theseinclude Cagan (1958),Allingham and Sandmo (1972) and Tanzi (1980) in
Underground
economy and
tax evasion
627

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