Why does a Large Shadow Economy not show up in Administrative Inspections?1

This paper deals with the apparent gap that exists between very high estimates of the size of the shadow economy and the results of various tax and policy authorities' inspections. The analyses are based on Finnish data, with the benchmark values for the size of the shadow economy taken from a recent parliamentary investigation which arrived at very high values for all types of shadow economy activities. These estimates are compared with the Finnish Tax Administration's own data on tax audits. The data are also used in assessing the fiscal results from tax inspections and other administrative actions. These values suggest that it is pointless to spend enormous amounts of resources to curtail the shadow economy unless one can show that there are important economies of scale in tax audits and law enforcement. Our estimates do not support the idea of increasing returns in tax audits.