Estimating the Underground Economy from the Tax Gap: The Case of Malaysia

Abstract

The Underground Economy (UE) in Malaysia is estimated using ratio technique on tax and criminal annual time series enforcement data. For the period of 1980 to 2009, UE rose between 9 and 27 per cent of GDP. UE grows in the opposite direction of GDP during good and bad times, and has shrunk due to slower growth in the last decade. The size of the direct tax gap is about 10 per cent of direct tax revenue, 15 per cent of federal revenue or 33 per cent of federal deficit. There is a shift in the tax non-compliance mix in the irregular economy and a rise in‘fraud’ activities in the illegal economy. The change in tax non-compliance mix is likely due to taxation reforms.The rise in fraud activities highlights the urgency of more efficient and effective enforcement.