Evaluating competing public policy approaches towards the informal economy

Purpose – Conventionally, participation in the informal economy has been explained by viewing citizens as rational economic actors participating when the pay-off is greater than the expected cost of being caught and punished, and thus tackled by raising the sanctions and risks of detection. Given that many citizens do not engage even when the benefits outweigh the costs, a new social actor approach has begun to emerge which explains the informal economy as arising when tax morality is low and seeks to foster commitment to compliance. The purpose of this paper is to provide an evidence-based evaluation of these competing policy approaches. Design/methodology/approach – To do so, the results are reported of 1,306 face-to-face interviews undertaken during 2013 in the UK. Findings – The finding is that raising the sanctions and risks of detection has no significant impact on the likelihood of participation in the informal sector. However, participation in the informal economy is significantly associated with tax morality. Indeed, the only time that increasing the sanctions and risks of detection reduces the level of participation in the informal economy is amongst citizens with very low tax morality. Practical implications – Rather than continue with the current rational economic actor approach of increasing the penalties and risks of detection, this case study of the UK reveals that a new policy approach is required that seeks to improve tax morality by introducing measures to reduce the acceptability of participating in the informal economy. Whether this is more widely applicable now needs to be tested, given the dominance throughout the world of this punitive rational economic actor approach. Originality/value – This paper provides evidence supporting a new social actor approach towards explaining and tackling participation in the informal economy.