The Relation of between Fiscal Illusion and Shadow Economy in Iran

There is a close relationship between fiscal illusion and shadow economy, as the existence of shadow economy provides the possibility of creating the fiscal illusion for the government. In the fiscal illusion, due to taxpayer's misperception of tax burden, public goods and services demand raise which finally leads to the positive growth of government spending. In this paper, the relationship between fiscal illusion and shadow economy has been studied within the framework of Linear Structural Relationship pattern (LISREL) for Iran in the period of 1357 to 1391. The results of the LISREL model estimation show first, shadow economy has a significant and positive effect on fiscal illusion in Iran; this finding indicates that the existence of expanded shadow economy in Iran creates the positive growth in fiscal illusion, which increases government’s debt. Second, the tax burden is the most important explanatory variable of fiscal illusion size in Iran that is used by the government in order to create misperception of the taxpayer.