BRING ON THE LIGHT: REDUCTION OF THE CORPORATE SHADOW ECONOMY BY TAX REFORM

Abstract

Background: Our preliminary research shows that tax reform can have a meaningful impact in reducing the corporate shadow economy of a society. Countries are constantly applying lower tax rates to attract large businesses to their territory. They are also trying to improve tax collection efficiency in their jurisdiction area. We study the relationship between the Baltic countries' tax systems and the shadow economy level within their respective economies. Our research examines how economic growth can reduce the corporate shadow economy due to changes in tax collections. Methods: Based on quarterly data from 2002-2022, a panel regression was chosen for the analysis, which allows for determining the impact of each specific tax on the level of the shadow economy separately, considering all three samples as one synergistic system. Results and Conclusions: Thus far, we find that for all types of taxes, the models have the same structure, which allows for comparing the impact of gross domestic product on tax collections both in the short and long term. Our analysis showed that the effective income tax rate growth increases the shadow economy; that is, the country's citizens attempt to move into the shadows. At the same time, the growth of the effective corporate income tax rate, on the contrary, reduces the level of the shadow economy. A positive increase in the effective VAT rate also contributes to the growth of the shadow economy. The long-term effect for general taxes is almost 19% higher than the growth of the tax base. Thus, as to the Lithuanian economy, for example, it has a tendency for a reduction of the shadow economy, which means that there are significant opportunities for further improvement.