Estimation of the size of Indonesia’s Shadow Economy

This paper estimates and analyzes the size of Indonesia’s shadow economy over the period 1969-2004 by the application of the currency demand approach, following the Schneider model. In order to check the robustness of the result, the household electricity approach is also applied based on the Lacko model. However, it should be noted, that the Lacko model could not produce the figure of the shadow economy’s size, unless the elasticity of the growth of the shadow economy’s electricity demand to GDP growth is known. Our concern is on the trend of yearly changes of Indonesia shadow economy during the estimation period resulted from both the currency demand approach and household electricity approach. Comparison between these two estimation results shows that there is a large size and increasing trend of the shadow economy in Indonesia. I found that at least on average the size of Indonesia shadow economy is 40% of reported GDP. Direct tax burden, indirect tax burden, complexity of the tax system, and the Government sector’s size are factors which influence significantly the size of the shadow economy. Other economic shocks and tax reform are also found as significant factors influencing the shadow economy’s size change during several periods