Effect of the Shadow Economy on Tax Revenue in Sub-Saharan African Countries: A Dynamic Panel Data Analysis

Abstract

The shadow economy in Sub-Saharan African (SSA) countries has become a persistent challenge that undermines government tax revenues. This study investigates the shadow economy’s adverse effect on tax revenue in SSA, addressing a critical gap in the region’s fiscal research. The analysis covers 15 SSA countries over the period of 15 years, using the Arellano-Bover/Blundell-Bond GMM estimation method. Model validity was confirmed through Arellano-Bond autocorrelation tests and a significant Wald chi-squared statistic, ensuring robust results. Descriptive analysis reveals that SSA countries exhibit relatively low tax revenue (15.7 % of GDP, on average) alongside a sizable shadow economy (36.2 % of GDP). The shadow economy was found to exert a significant negative effect on tax revenue (â = -0.249, p = 0.010). Tax revenues also display persistence, with prior tax revenue significantly influencing current levels. Among the control variables, unemployment (â = 0.315, p = 0.002) and trade openness (â = 0.057, p = 0.006) positively affect tax revenue. Conversely, foreign direct investment (â = – 0.022, p = 0.071) and oil revenue (â = -0.087, p = 0.002) have negative impacts, reflecting tax incentives and resource dependency. Control of corruption exerts a marginally positive influence (â = 2.950, p = 0.096). GDP per capita, inflation, the role of agriculture, the number of taxes paid by businesses, and regulatory quality show no significant effects. This study highlights the shadow economy’s detrimental impact on tax revenue in SSA and underscores the need for policies aimed at formalizing informal activities and strengthening tax compliance. The findings contribute to public finance research and provide practical guidance for designing sustainable fiscal policies. Avenues for future research could include expanding the analysis to a broader set of countries.