In this paper, results of the research on measurement of shadow economy in Poland in the period 1995 - 2007 are presented. This research is motivated by controversial existing estimates. First, some definitions of shadow economy are reviewed. Then, on the basis of monetary methods, an econometric model for currency demand is built. Using estimation results, the size of shadow economy is assessed. According to these estimates shadow economy declined in the period 1995 – 2007 starting from 40% of GDP in 1995 and reaching about 10% of GDP in 2007. The paper also analyses relations between shadow economy, state budget and tax system. Measures for these relations are discussed and a Vector Autoregressive model is estimated. Impulse Reaction Functions are drawn, showing that an increase in indirect tax burden enlarges shadow economy. A contrary effect arises due to an increase in a) direct tax burden, b) budget balance.