A Dynamic Model of the Black Economy
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A dynamic equilibrium model of an economy with underground trade is developed in which agents devote effort to search, building up networks of underground contacts. The model is used to illustrate dynamic responses to tax increases. The model is shown to be consistent with the stylized fact that the underground economies have continued to grow in many countries after taxes have stopped increasing. The model is also used to explore how optimal policy depends on the dynamic properties of underground networks.