The relationship between poverty and underground economy

Nowadays the problem of underground economy is widely encountered particularly in less-developed and it is at some extent problem for developing economies as well. It is a problem in the sense that it causes tax revenue loss for government and creates unfair competition with the firms operating in formal sector. Among the economic and demographic reasons causing underground economy that we may count are unfair tax rates, unfair income distribution, population increase, migration from rural area to urban area. Besides the other determinants of underground economy, poverty is one of the crucial determinants of underground economy. People who do not have a regular job or could not find a job in formal sector would prefer to work in underground economy in order to survive. In addition to that, underground economy is widely seen in the economies where economical and political uncertainty is high. In this study the impact of poverty on informal sector will be analyzed in a panel data framework. In this sense we test the hypothesis that increase in poverty level will boost underground economy in an economy. The estimation results from panel data analysis reveal that there is a statistically significant positive association between poverty and underground economy, namely a decrease in poverty level reduces underground economy.