Estimating the size of the underground economy in South Africa using the Multiple Indicators Multiple Cause Model (MIMIC) and the Currency Demand Approach (CDA).

Abstract

The underground economy is a major challenge across the world affecting both developed and developing economies. South Africa is no exception to this phenomenon and has lost billions of rands due to the underground economy. Tax revenue loss due to illicit trade was estimated to be approximately R36.5 billion in 2019, with illicit cigarettes and tobacco and undervalued clothing and textiles perceived to be the main contributors to this economy. The objective of this research is to estimate the size of the underground economy in South Africa using the Currency Demand Approach (CDA) and the Multiple Indicators Multiple Cause (MIMIC) models. To accomplish this, secondary economic data was obtained from Statistics South Africa (STATSSA), World Bank, South African Reserve Bank (SARB) and the International Monetary Fund (IMF) for the period 2000 to 2020. The results from the MIMIC model showed that the underground economy in South Africa was growing with estimates ranging from 25.4% to 32.3% of GDP for 2003 to 2020.The model further indicated that mining employment rate, tax burden and government expenditure are the causes of the underground economy and Nominal Gross Domestic Product (NGDP) and labour force participation rate are the indicators of the underground economy. Similarly, the CDA model showed a steadily increasing underground economy estimated at 28.8% of GDP on average for 2003 to 2020. Furthermore, the CDA model showed that NGDP, tax burden, interest rate, unemployment rate, self-employment rate and social benefits granted by the government are determinants of the underground economy. This study makes a significant contribution to the body of knowledge in this research area and will provide much needed insights on the relative magnitude of the underground economy, drivers of the underground economy and the extent of tax evasion in South Africa, ultimately contributing towards an improved tax base and compliance. It will further serve as a basis for future research in this topic by academia, private sector, government, multilateral bodies and all other interest groups.