Simulating the Relationship Between the Hidden Economy and the Tax Level and Tax Mix in New Zealand

In this paper we consider a simple Logistic relationship between the relative size of the Hidden Economy in New Zealand, and the effective tax rates for the major tax components. The model that we estimate from annual time-series data is used to simulate the effects of changes in both the overall tax "burden", and in the tax "mix", on the size of the Hidden Economy as a percentage of measured GDP in that country. At recent taxation levels, we find that for every percentage point reduction in the tax/GDP ratio, the Hidden Economy/GDP ratio drops by about 0.2 percentage points. We also find that the latter ratio is very responsive to changes in the tax "mix" in favour of relatively more indirect taxation; and that at an effective tax rate of about 21% of GDP, the impact of tax changes on underground activity begins to decelerate. The latter results suggests a tax evasion-efficient frontier for the tax/GDP ratio in New Zealand.