Religion and the Shadow Economy

Religion is increasingly acknowledged to be a cultural dimension which affects economic outcomes in different regards. This contribution focuses on religion’s possible impact on the size of the shadow economy. Different dimensions of the religious markets are taken into account. These dimensions refer to the overall degree of religiosity, the specific impact of different religions, religious competition or the proximity between religion and the state. For example, we would expect that the shadow economy is smaller in religious countries and in countries with a close link between religion and the state. The former is to be expected because the ethical teaching of religions imposes additional non-pecuniary costs on believers performing unlawful informal transactions. And the latter should hold because religion as an ally of the secular state should have self-interest to defend the secular partner’s financial basis The empirical test makes use of the largest available country cross-section on the size of the shadow economy and matches this dataset with numerous religious indicators. The starting point is a baseline specification with standard economic determinants of shadow activities which then is augmented by religious indicators. We complement the analysis by a battery of robustness checks. Overall, our findings support the view that religion influences the level of informal transactions, albeit with several qualifications. The analysis did not support the view that countries with religious citizens have smaller shadow economies per se. However, there is a significant divergence across main religions: Countries dominated by Islam or Eastern religions are associated with smaller shadow economies compared to Christian countries for comparable levels of economic development and government effectiveness. Furthermore, the proximity between state and religion is relevant whereas the degree of religious competition has no measurable impact. Close ties between the dominant religion and the state are typical for countries with a lower share of economic activity in the informal sector. Obviously, religion uses its normative influence on believers as a “supernatural police” to protect state interests if state and religion are in a reciprocal relationship. The relatively low shares of the shadow economy for Islamic countries is remarkable, given that Islamic ethics appear to be relatively skeptical on several forms of modern taxation. Obviously, the particularly close ties between religion and state in Islamic countries compensate for this. All these significant findings only hold for countries with low or middle income so that the existence of a state religion in industrial countries does not appear to be of empirical relevance in the context of the shadow economy.

Heinemann, Friedrich and Friedrich Schneider (2011), Religion and the Shadow Economy, ZEW Discussion Paper No. 11-038, Mannheim.