ENHANCING THE ROLE OF TAXATION IN REDUCING THE SHADOW ECONOMY

Abstract

This article examines the role of taxation policy in reducing the scale of the shadow economy and proposes effective mechanisms to strengthen its regulatory and incentivizing functions. The shadow economy remains one of the most pressing socio-economic challenges in developing and transition countries, as it undermines fiscal stability, distorts fair competition, reduces public trust in state institutions, and limits sustainable economic growth. In this context, taxation serves not only as a source of budget revenues but also as a strategic instrument for formalizing economic activity. The study analyzes theoretical approaches to understanding the relationship between tax burden, tax administration quality, and the expansion or contraction of informal economic activities. It emphasizes that excessively high tax rates, complex reporting systems, and weak institutional capacity often encourage businesses and individuals to operate outside the formal sector. Conversely, transparent tax systems, moderate and fair tax rates, digitalized tax administration, and simplified procedures for small and medium-sized enterprises significantly contribute to voluntary compliance and formalization. Particular attention is given to modern reforms such as the digital transformation of tax services, the introduction of electronic invoicing, risk-based tax audits, and the integration of databases across government agencies. These measures increase transparency, reduce opportunities for corruption, and improve monitoring without imposing excessive pressure on compliant taxpayers. The article also highlights the importance of tax incentives, differentiated tax regimes, and social awareness campaigns in fostering a culture of tax compliance. Furthermore, the research explores the socio-psychological dimensions of tax compliance, including trust in government, perception of fairness, and the visibility of public service delivery funded by taxes. It argues that strengthening the link between tax payments and the quality of public goods—such as education, healthcare, infrastructure, and social protection—can significantly reduce motivations to participate in the shadow economy. The article concludes that reducing the shadow economy requires a balanced and comprehensive tax policy that combines reasonable tax rates, administrative efficiency, institutional transparency, digital innovation, and public engagement. By enhancing the strategic role of taxation, governments can promote economic formalization, increase fiscal capacity, and support long-term sustainable development.