Employing similar regression methods used by chong et

Employing similar regression methods used by Chong et al. (2004) of OLS and IV in same
nation Mexico, Winkelried (2005) investigated the role of income distribution as the
determinant of informal sector size for the period 1992 to 2002. He found that higher Gross
Domestic Product (GDP) per capita leads significantly to a smaller informal sector whereas a
higher share of services in the local GDP increases informality. In addition, higher inequality
leads to a larger informal sector and the higher middle class implies a low extent of
informality that is the redistribution towards a large middle class reduces the size of
informality.
Alanon et al. (2005) estimated the informal sector in Spain for the period 1976-2002 using
the similar method used by Loayza (1997) and Guillermo (2008) of MIMIC approach and
maximum likelihood in estimating the size and causes of informality in Spain. This research
found that labour costs, tax burden, disposable income and regulation burden have a positive
influence on informal sector size. The regression shows that a unit increase in the standard
deviation will produce an increase of 0.60 standard deviations in the shadow economy while
a unitary increases in the tax burden cause increase of 0.34 standard deviations. The informal
sector was found to be negatively related to unemployment.
Another study by Michael et al. (2007) looked at the causes of firm’s decision to locate into
the informal sector. The research was based on Kenya, South Africa, Senegal, Tanzania,
Uganda and Zambia data for the period covering 2003 to 2006. The researchers used the
probit model where the dependent variable was set to 1 if the firm is formal, 0 otherwise.

The results showed that formal firms report more of their sales for tax purposes,
approximately 75 percent of sales compared to 35 percent in informal firms. Thus the
research found that the taxes, labour restrictions and corruption are significant variables and
they have a positive relationship to informal economy. The researchers indicated that labour
regulations restrictions make firms to react quickly to seasonal fluctuations and changes in
market activity by increasing or decreasing the workforce. However, in Kenya the duration
for licensing was considered as the driver of corruption hence leads to an increase in the size
of informal economy.
Chiumya (2007) analysed the contribution of tax to the existence of parallel economy in
Malawi for the period covering 1965 to 2000. He used the currency demand approach and the
results of currency demand equation was estimated using OLS method. This study found that
income taxes contributed greatly to both the parallel economy and to tax revenue. The results
indicate that income taxes contribute 51.3 percent to parallel economy followed by import tax
with 28.2 percent and lastly by consumption tax with 20.3 percent. According to the research
all categories of taxes are significant determinants and they have positive influence to the
informal economy and also there is a positive relation between tax revenue and parallel
economy.