“This paper provides a theoretical discussion on the relationship between buoyancy/elasticity and the existence of the underground economy and postulates an inverse relationship between the two. Such relationship is argued because the growth of the underground economy erodes the tax base and consequently reduces receipts, which in turn affects revenue productivity. In addition, the paper estimates the size of the underground economy in Tanzania for the period 1967-1990 in order to determine the magnitude of tax evasion. The resulting estimates show that the size of the underground economy is significant and grew from about 10% of official GDP in 1967 to 31% in 1990. These estimates suggest that tax evasion in 1990 was equal to more than one-third of total tax receipts in that year. The paper also provides an explanatory link between measured revenue productivity (buoyancy/elasticity) and tax policies. Finally, the paper discusses what type of reforms could penetrate the underground economy. The paper concludes with important policy implications for tax reform. “
