Distributional implications of informal economy in the EU countries: Accounting for the spread of tax evasion benefits and cultural characteristics

This study provides evidence about the impact of informal economy on income inequality by using annual cross-country panel data from 28 European Union countries observed during the period 2005–2017. Particular attention is dedicated to the cultural setting which is expected to impact taxpayers’ behaviour and thereby income distribution. The study reveals a relationship between the size of the underground economy and income inequality, which is negative when approaching domestic informality and positive when international tax evasion by individuals is related to the top-bottom income disparity. Moreover, a delay of one-year is needed for these effects to occur, sustaining the hypothesis of secondary consequences of the informality. The study also shows that a set of cultural peculiarities are relevant for the nexus of international tax evasion by individuals and income polarisation. The inequality enhancing effect of the offshore activities is larger in countries with high degree of uncertainty avoidance and power distance, and low level of indulgence and long-term orientation respectively.