TAX EVASION AND CURRENCY RATIO: PANEL EVIDENCE FROM DEVELOPING COUNTRIES

We examine the link between tax evasion and the currency ratio for non-OECD countries for the period 1996-2013. Unlike previous studies, we use non-parametric methods of estimation because economic theory doesn’t prescribe a specific functional form for the relationship between currency ratio and its determinants. We find that higher tax rate and lower enforcement strength leads to a higher tax evasion and higher currency ratio. Furthermore, we find that the level of development, the rate of interest, the rate of inflation, and the degree of urbanization across countries tend to explain currency ratio. The study highlights a new link through which fiscal policy can have an effect on the composition of monetary aggregates and hence monetary policy.