The prevalence of hidden activities in countries at different levels of development and the implicit welfare losses
related to them have induced researchers and policy makers to reiterate two basic questions of this theme: (1) what
are the major factors that make economic agents hide their activities, and (2) how could public policy make
participation in the official economy more attractive as opposed to working in the hidden economy? The early
literature of this subject emphasized the role of tax rates influencing economic agents to hide their activities.
Recent studies, however, brought new and, to some extent, controversial results, particularly by putting a strong
emphasis on such factors as the extent of corruption and the rule of law.
The proposed research attempts to reconcile earlier and most recent results by introducing a new concept in the
analysis: the subjective tax rate. The subjective tax rate suggests that in different countries with different corruption
levels the same tax rate leads to different levels of tax burden as perceived by the economic agents: given tax rate
combined with a higher corruption level is felt as a higher tax burden than the same tax rate combined with a lower
level of corruption. Treating corruption and the level of taxes in a common framework promises new results in
various interrelated fields such as (i) the determinants of the size of the hidden economy, (ii) the relation of tax
rates and tax revenues of the budget, (iii) the impact of taxes on the development of various segments of the labor
market, and (iv) developing and testing a new method to estimate the size of the hidden economy in countries at
various stages of economic development.
The research analyses behavioral relationships in 28 OECD countries over the period 1995-2000 with the help of
econometric methods. The analysis can be extended to the post-socialist countries (other than the four such
countries that are already OECD members). This extension is all the more important because the problems of tax
collection, corruption and the hidden economy are particularly crucial in the countries in transition by impeding the
development of a healthy public finance, a smooth working of the labor market and the recovery of economic
growth.