Threshold Effect of the Digital Economy on the Shadow Economy in Iran

Purpose: The shadow economy is one of the substantial economic phenomena that leads to the inefficient use of society's resources, reduces tax revenues, increases interest rates, and raises inflation and unemployment in the economy through the increase in government debt. Therefore, examining the factors affecting the shadow economy is very important. Along with the development and expansion of information and communication technology (ICT), during the past decade, the digital economy has been considered by policymakers in the field of ICT as an efficient mechanism and tool to control and reduce the volume of transactions in the informal sector of the economy. The literature review indicates that the digital economy plays a considerable role in increasing the efficiency of innovation and industrial transformation, causes an increase in production efficiency, and promotes economic development. Therefore, the digital economy has an important impact on the size of the shadow economy. Some studies emphasize that the components of the digital economy, including ICT, lead to a decrease in the size of the shadow economy due to the reduction of cash transactions and the increase in the production factors productivity; on the contrary, some studies show that ICT increases the size of the shadow economy by increasing tax evasion and raising the demand for goods and services of the informal sector. Therefore, there is no consensus on the positive or negative impact of the digital economy on the shadow economy. Accordingly, the present research aims to answer the question of what effect the digital economy has on the shadow economy in Iran.

Method: The paper aims to investigate the nonlinear impact of the digital economy on the shadow economy in Iran from 1990 to 2021. For this purpose, first, the digital economy index was extracted based on the principal components analysis method and using the variables of mobile phone subscription, fixed phone subscription, and the quantity of internet usage. Then, the threshold regression approach was used to measure the estimated effect of the digital economy index and other explanatory variables, i.e., direct tax burden, unemployment, inflation, degree of trade openness, and human capital on the size of the shadow economy.

Findings: The findings indicated that the size of the digital economy threshold is 6.7 percent; before reaching the threshold level, the digital economy leads to a rise in the size of the shadow economy, but after surpassing the threshold level, the digital economy conducts a decrease in the volume of the shadow economy. Also, findings showed that human capital has a negative and significant impact on the shadow economy. On the contrary, variables of direct taxes, unemployment, inflation, and trade openness have a positive and significant effect on the shadow economy.



Conclusion

The nonlinear behavior of the digital economy shows that in the low regime of the digital economy, the digital economy by taking advantage of technological development directs to reduce the cost of transactions and facilitate the supply of goods and services, which leads to an increase in the production capacity and volume of transactions in the shadow economy sector. However, in the high regime of the digital economy, the rapid development of the digital economy by providing new technologies, and improving the method of producing goods and services leads to a rise in the expertness to use technology, and enhancing people's access to information that accompanied to an increase in the production of goods and services. Because the ability of companies active in the formal sector to use technology in the production process is more than the active companies in the informal sector of the economy, the digital economy increases the volume of activity in the formal sector and reduces the size of the shadow economy through increasing the productivity of production in the formal sector and improving the government's supervision of the exchanges of the informal sector. Considering the negative impact of the shadow economy on the underground sector of Iran, it is suggested that the government, by developing ICT and improving the efficiency in providing public services reduces the access cost of economic firms to digital technologies, prevents tax evasion, increases the production efficiency of the formal sector of the economy and reduces the size of the shadow economy.