Do Environmental Taxes Expand the Shadow Economy? Evidence from 61 Countries
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A new HAPRI-affiliated study in Annals of Public and Cooperative Economics finds that environmental taxes significantly enlarge the shadow economy, and traces why: they push up unemployment and the overall tax burden. For governments building carbon and energy tax regimes, the design of the tax matters as much as the tax itself.
Context
Environmental taxes have become one of the most widely adopted instruments for steering economies toward lower emissions and less resource depletion. The intuition is straightforward — price the damage, and firms and households will do less of it. But taxes that raise the cost of energy, pollution, and resource use also raise the cost of operating formally, and much less is known about what happens on that margin.
The shadow economy — production that is legal in nature but hidden from the state — is where that pressure can surface. When formal operation becomes more expensive, some activity does not disappear; it relocates outside the tax net. That matters for environmental policy twice over: informal activity is neither taxed nor regulated, so it erodes both the revenue and the environmental effect the tax was designed to deliver.
Methods
The study assembles a global panel of 61 countries with data from 2002 to 2018, split into a high-income group and a low- and middle-income group so that the effect can be compared across levels of development. Beyond estimating the overall relationship, the authors use a simultaneous equations model to test the channels through which environmental taxes travel, and disaggregate the tax itself into four forms — energy, pollution, resource, and transport taxes — rather than treating environmental taxation as a single lever.
Key findings
Environmental taxes significantly increase the size of the shadow economy — globally and in both the high-income and the low- and middle-income subsamples.
The magnitude is economically meaningful: a one percentage point rise in environmental taxes relative to GDP is associated with a rise of about 0.201 percentage points in the shadow economy's share of GDP.
Two channels carry the effect. Higher environmental taxes raise unemployment and increase the tax burden, and both push activity into informal channels.
The form of the tax matters. Energy taxes expand the shadow economy consistently across samples and appear to work through unemployment, while pollution, resource, and transport taxes operate mainly through a heavier tax burden — with pollution and resource taxes showing a positive effect primarily in high-income countries.
Keywords:
Environmental Taxes
Shadow Economy
Energy Tax
Tax Burden
Unemployment
Green Fiscal Policy
Link:
Citation:
Nguyen, C. P., Doan, N., Doan, H., Nguyen, C. T., & Nguyen, B. Q. (2026). Environmental taxes and the economy: New evidence of the shadow economy. Annals of Public and Cooperative Economics, 97(3), 731-756.
