Taxation and the Shadow Economy : How the Tax System Can Stimulate and Enforce the Formalization of Business Activities

Cash transactions for goods and services in which no receipts are issued greatly increase the risk of tax evasion. Despite the availability of banking services and alternative payment, key sectors of the economy remain largely cash-based in almost all developing countries. This paper shows the apparent strong negative correlation between the use of electronic or formal payments and the size of the shadow economy and reviews the approaches used by tax policy makers and administrators to achieve better control of cash transactions. It argues that the many new and sometimes innovative approaches developed to support the formalization of cash transactions will have little impact on the shadow economy if applied in isolation. A successful strategy to tax cash economy businesses and transactions requires a holistic approach to compliance management in which traditional monitoring and enforcement tools, such as enabling tax administrations to access taxpayer data and match information from various public and private sources, play a key role