The Hidden Costs of Tax Evasion: Collaborative Tax Evasion in Markets for Expert Services

We experimentally examine the impact of tax evasion attempts on the performance of credence goods markets, where contractual incompleteness results from asymmetric information on the welfare maximizing quality of the good. Our results suggest that tax evasion attempts – independently of whether they are successful or not – lead to efficiency losses in the form of too low quality and less frequent trade. Thus, shadow economies may reduce welfare not only by inducing agents to incur costs to hide or to uncover taxable transactions, by imposing risk on risk-averse tax evaders and by distorting competition, but also by creating an additional efficiency loss in the underlying market by forfeiting possible gains from trade and by inducing insufficient quality provision. We call this the hidden costs of tax evasion.