Optimal investment with transparency costs and tax evasion

This paper discusses relations among firms size, "transparency costs" and tax evasion. Tax evasion is here performed by allocating resources into an underground sector. We address these issues within the context of theory of investment, explicitly incorporating tax evasion, transparency costs and the relationship with credit markets. The theoretical model is calibrated for two countries: Italy, as a proxy for full developed countries with a significant underground sector, and Turkey, as a proxy for transition countries, still with a large underground share of the economy. In this context, we discuss the consequences of selected economic policies acting over transparency costs, credit market constraints and anti-evasion policies. We obtain the following results: the growing of transparency costs disincentivate capital accumulation inducing a reduction in firms size. The relative weight of underground activities increases over produced output. Vice-versa, a reduction in transparency costs supports an increase in firms size and a reduction of the weight of underground activities. A tighter credit market reduces the average firm size but increases the share of regular economy. An easier access to the credit market, on the other hand, increases the average size of firms but incentivates the companies to hide more revenues from the Tax Offices.