Evaluation of the Underground Economy in Quebec:A Microeconomic Approach

The main purpose of this paper is to estimate the size and the growth of Quebec’sunderground economy, and the corresponding loss of taxes for the government. Ourapproach is based on a method developed by Pissarides and Weber (1989) and extended byLyssiotou et al. (2004). The basic hypothesis is that individuals can under-report theirearnings from self-employment but not from paid work, from which taxes are directlydeducted. We estimate a consumer demand system in which the marginal propensity toconsume is allowed to vary with the two types of earnings. We next estimate the amount ofself-employment earnings that are under-reported. From this estimate, we calculate therelative size of the underground economy in Quebec. We use data from Statistics Canada’sSurvey of Household Spending. According to our results, Quebec’s underground economyamounted to 4.6% of GDP in 1997 and increased slightly to 5.7% in 2002. For thegovernment, this represents approximately $ 3.3 billion in forgone taxes for the year 2002.This estimate is very close to those reported by Gervais (1994) and Fortin and Lacroix (2009)using very different estimation methods and data...