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Fiscal consolidation plans with underground economy

Author

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  • Maria Ferrara
  • Cristiana Fiorelli
  • Elisabetta Marzano
  • Monica Varlese

Abstract

Fiscal consolidation literature often neglects that there are economies characterized by sizable underground sectors, with their mechanisms of response to fiscal policy shocks. Therefore, reliable analyses of fiscal consolidation plans call for the decomposition of Gross Domestic Product in its regular and hidden components. We investigate fiscal consolidation effects in the context of tax evasion for the Italian economy. Results show that a temporary cut in public spending associated with a permanent drop in tax rate yet entails tax evasion reduction. The main underlying mechanism is the strong responsiveness of the underground sector, implying a reallocation of resources toward the regular sector.

Suggested Citation

  • Maria Ferrara & Cristiana Fiorelli & Elisabetta Marzano & Monica Varlese, 2025. "Fiscal consolidation plans with underground economy," Economic Inquiry, Western Economic Association International, vol. 63(1), pages 144-159, January.
    • Handle: RePEc:bla:ecinqu:v:63:y:2025:i:1:p:144-159
    DOI: 10.1111/ecin.13263
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