The not so dark side of trust: Does trust increase the size of the shadow economy?

This paper reports a negative relationship between the size of the shadow economy and generalized trust, in a sample of countries, both developed and developing. That relationship is robust to controlling for a large set of economic, policy, and institutional variables, to changing the estimate of the shadow economy and the estimation period, and to controlling for endogeneity. It is independent from trust in institutions and from income inequality, and is mainly present in the sample of developing countries. Those findings suggest that the tax compliance effect of trust dominates its role as a substitute for the formal legal system.

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► We observe a negative relationship between the size of the shadow economy and generalized trust.
► Causality runs from trust to the shadow economy.
► The relationship is robust, and independent from trust in institutions.
► The relationship is mainly present in the sample of developing countries.
► The tax compliance effect of trust dominates its role as a substitute for the formal legal system.