Ethnic divisions, trust, and the size of the informal sector

This paper investigates the relationship between ethnic fractionalization and the size of the informal, or hidden, economy. Recent experimental and empirical research links, in turn, ethnicity and trust, and trust and tax compliance. In addition, recent empirical studies have identified an unwillingness to contribute to public goods benefiting other ethnic groups. Combining these insights, we argue that increasing ethnic fractionalization decreases voluntary tax compliance, and we present empirical evidence at the macro level in a cross-section of more than 50 countries that more ethnically fractionalized societies have significantly larger informal sectors.