A Comprehensive Assessment Of Fiscal And Regulatory Mechanisms For Formalizing The Shadow Economy

Abstract

The informal sector, commonly referred to as the "shadow economy," constitutes a pervasive and complex challenge to global economic development, fiscal stability, and social equity. This study provides a comprehensive evaluation of the efficacy of financial mechanisms designed to incentivize the legalization of informal economic activities. Employing a mixed-methods approach, we combined a systematic policy review with rigorous econometric analysis using a panel dataset of 30 OECD countries over the period 2000-2020. Our model specifically investigates the impact of simplified tax regimes, tax holidays, and capital legalization amnesties on the relative size of the shadow economy, while controlling for overall tax burden and institutional quality. The regression results demonstrate that these financial mechanisms have a statistically significant and negative correlation with the share of the informal sector. Crucially, our analysis reveals a powerful interaction effect: the success of these financial incentives is critically dependent on the prevailing level of government effectiveness. We conclude that while financial mechanisms are potent tools for formalization, they are not standalone solutions. Their optimal efficacy is realized only when implemented in concert with broader institutional reforms aimed at enhancing transparency, reducing corruption, and building state capacity. This research underscores the necessity of an integrated, context-sensitive policy framework for effectively transitioning economic activities from the informal to the formal sector.