Discussion Paper

No. 2019-67 | November 20, 2019
Does the tax undermine the effect of remittances on shadow economy?

Abstract

There are considerable studies regarding the contribution of international migrants’ remittances to economic growth while there is a lack of studies which investigate the effect of remittances on shadow economy. The authors explore empirically the effect of remittances and its interaction effect with tax on shadow economy by using panel data covering the period 2004–2015 and applying the GMM method for 141 countries. Their empirical model, in which a remittance-recipient government, operating in tax environment of some regimes (imposition of different levels and kinds of taxes), predicts a negative effect of remittances on shadow economy, is mitigated by a higher tax regime. In other words, the paper argues that a well-established negative correlation between remittances and shadow economy has been weakened by tax rule. The study contributes to the current literature on public policy that gives importance to know the causes of shadow economy and boost remittances effect. The authors´ baseline results are robust to various computations of macroeconomics variables, institutions variables and freedom variables.

Data Set

JEL Classification:

O17, H24, H71, F24

Assessment

  • Downloads: 378

Links

Cite As

Friedrich Schneider, Shabeer Khan, Baharom Abdul Hamid, and Abidullah Khan (2019). Does the tax undermine the effect of remittances on shadow economy? Economics Discussion Papers, No 2019-67, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2019-67


Comments and Questions


Anonymous - Referee report 1
December 11, 2019 - 07:53

This paper has explored the linkages of remittances with shadow economy by incorporating the role of taxes in 141 countries. The flow of remittances plays a vital role for the economic growth but at the same time it may inflate the size of shadow economy. The tax evasion is one ...[more]

... of the key factors in expanding the size of shadow economy. So the policy maker must consider these linkages before devising an effective tax policy. Overall, this paper has a valid contribution both in literature and policy. The subject matter is very well defined throughout the manuscript but it would have been much better if the authors would further highlight the problem statement in the introduction section. The literature and theory part in its current state is enough for the readers to grasp the understanding. An appropriate methodology has been opted, it would be better if the authors would provide the list of the countries selected for this research. There are some minor spelling and grammar mistakes in the manuscript; it is advised to carefully proofread the article before final submission. I would recommend the publication of this paper.


Anonymous - Response to reviewer one
February 08, 2020 - 09:50

comment 1: the problem statement has been further highlighted in the introduction section.
comment 2: countries list has been provided.
comment 3: spelling and grammar mistakes will be incorporated in final version of manuscript.


Abidullah Khan - pdf file
February 11, 2020 - 13:30

the file has been uploaded in pdf format.


Anonymous - Referee report 2
January 21, 2020 - 10:14

1- No need to include the first para in the introduction, I think the information’s already discussed in the later exercises.

2- The study found a significant number of careless errors like spelling mistakes (for instance connexion page2 first para,) inappropriate words. For instance, avoid words like he, ...[more]

... him. Boost up, connect Correct the entire document.

3- The study link remittances with shadow economy using the Dutch diseases phenomena. However, it doesn’t always happen in the remittances recipient countries.

4- In a literature review, be specific to the objective of the study, avoid the irrelevant details. If there are limited numbers of studies on the topic, the study requires to do an in-depth analysis of the available studies. It would be pertinent to construct a narrative that why the studies are important, and briefly explain in what ways the present study contributes to the empirical literature.

5- What are the channels of remittances through which shadow economy are interlinked? The argument partially discussed in the introduction as well in the theoretical underpinning section but needs a very strong narrative.

6- Include tax burden in equation 1, and also use same variable name (Equ.2) as reported earlier.

7- The study used GMM estimation to control for endogenity without sorting out the endogenous and exogenous variables. It seems that all variables in the model are taken as endogenous variable instrumenting by their respective lags. I would recommend to run an endogenity Hausam- Wu test before adjusting for endogenity problem. Similarly, how’s the interaction term deals in the instrumentation? Please, send the do file of the analysis.

8- The considerable volume of remittances is transferred through informal channels. I think the cost of remitting playing a role somewhere between remittances and shadow economy. The negative relationship between formal remittances and shadow economy can be due to regulations and the costs of remitting. Moreover, cost of remitting and regulation can be used as instrument in equation 1. Read for instance Junaid Ahmed and Inmaculada Martínez-Zarzoso (2016). Do Transfer Costs Matter for Foreign Remittances? A Gravity Model Approach. Economics: The Open-Access, Open-Assessment E-Journal, 10 (2016-4): 1–36. http://dx.doi.org/10.5018/economics-ejournal.ja.2016-4

9- Provide the descriptive statistics of the variables used in the study.

10- The study provided plenty of results, however its pertinent to explain the results in the discussion section to previous estimates and economics theory. Furthermore, what relevant policy would be suggested given the outcome of the study.


Abidullah Khan - Response to 2nd Reviewer comments
February 17, 2020 - 09:03

1- No need to include the first para in the introduction, I think the information’s already discussed in the later exercises.
response: Removed

2- The study found a significant number of careless errors like spelling mistakes (for instance connexion page2 first para,) inappropriate words. For instance, avoid words ...[more]

... like he, him. Boost up, connect Correct the entire document.
response: Addressed

3- The study link remittances with shadow economy using the Dutch diseases phenomena. However, it doesn’t always happen in the remittances recipient countries.
response: While discussing different channels through which remittances have a linkage with shadow economy, Dutch diseases is one of them as explored by Chatterjee and Turnovsky (2018). By going with the logic that remittances create demand for local currency and thus appreciate recipient country local currency. This appreciation leads to shrink growth of official economy and compel businesses to move to informal economy and as a result shadow economy rises.

4- In a literature review, be specific to the objective of the study, avoid the irrelevant details. If there are limited numbers of studies on the topic, the study requires to do an in-depth analysis of the available studies. It would be pertinent to construct a narrative that why the studies are important, and briefly explain in what ways the present study contributes to the empirical literature.
response: In Literature review section irrelevant details has been avoided. A narrative has been constructed where important and contribution of the present study has been mentioned.

5- What are the channels of remittances through which shadow economy are interlinked? The argument partially discussed in the introduction as well in the theoretical underpinning section but needs a very strong narrative.
response: Complementary theory of shadow economy states that official economy and shadow economy are complementary to each other, they both have interconnection, and because of their interdependency, they decline and grow simultaneously (Williams, 2007 and Williams and Round, 2006). According to Mondal et al. (2018), the remittance receiving households use foreign remittances for both durable and non-durable goods consumption, in both ways it increases the remittance receiving households’ income and consumption. Following complementary theory of shadow economy i.e. official economy and shadow economy decline and grow simultaneously. In other words, foreign remittances boost receiving households’ income and consumption not only in official economy but in shadow economy too.
Secondly, The Structuralist or Dependency School of shadow economy says that shadow economy consists of small firms and businesses (Castells and Porters, 1989). According to Yang (2008), positive migrant shocks cause greater human capital accumulation and private enterprise in recipient households. Because accumulated migrant earnings boost investments in recipient economy that would not have otherwise been made due to credit restraints and startup costs. As shadow economy is a part of official economy, therefore, portion of migrant remittances can also be allocated to start small businesses in shadow economy.
Finally, according to Chatterjee and Turnovsky (2018) there is positive association between remittances and shadow economy because increase in remittances lead to increase demand for local currency and thus negatively impact official economy and positively impact shadow economy.

6- Include tax burden in equation 1, and also use same variable name (Equ.2) as reported earlier.
response: Tax burden has been included in equation 1 and used the same variable name in equation 2.

7- The study used GMM estimation to control for endogenity without sorting out the endogenous and exogenous variables. It seems that all variables in the model are taken as endogenous variable instrumenting by their respective lags. I would recommend to run an endogenity Hausam- Wu test before adjusting for endogenity problem. Similarly, how’s the interaction term deals in the instrumentation? Please, send the do file of the analysis.
response: All variables in the model are not taken as endogenous variable and not instrumenting by their respective lags. Details do file has been sent.

8- The considerable volume of remittances is transferred through informal channels. I think the cost of remitting playing a role somewhere between remittances and shadow economy. The negative relationship between formal remittances and shadow economy can be due to regulations and the costs of remitting. Moreover, cost of remitting and regulation can be used as instrument in equation 1. Read for instance Junaid Ahmed and Inmaculada Martínez-Zarzoso (2016). Do Transfer Costs Matter for Foreign Remittances? A Gravity Model Approach. Economics: The Open-Access, Open-Assessment E-Journal, 10 (2016-4): 1–36. http://dx.doi.org/10.5018/economics-ejournal.ja.2016-4
response: This scope of this study is to investigate the remittances coming only through official channel. The article has been read which cover remittances coming to Pakistan while this article scope is 141 countries.

9- Provide the descriptive statistics of the variables used in the study.
response: Provided

10- The study provided plenty of results, however it’s pertinent to explain the results in the discussion section to previous estimates and economics theory. Furthermore, what relevant policy would be suggested given the outcome of the study.
response: The results in the discussion section have been link to previous estimates and economics theory. Policy recommendation is also provided.