Subsidizing electronic payments to decrease the informal economy

The informal economy affects almost every economy around the world. The policies to control informality usually overburden the existing formal sector of the economy, hence creating an informality trap. The government can increase electronic payments among the consumers to decrease informality, so that the businesses can not conceal their information. If the government subsidizes electronic payments, then the consumers will be willing to search for an electronic payment facility, if the sellers do not offer one. Using Game Theory, the thesis establishes that the consumers are willing to search for electronic payment facility, if the cost of searching is less than the product of reimbursed amount and the firms providing electronic payments. The Game Theory analysis further establishes, that for sellers, it is profitable to offer electronic payment facilities, if the tax rate is below the consumer’s probability of searching for another seller. Analysing the data from EU member states, a regression analysis of tax gap on electronic payments is performed, while analysing data as individual years and as a panel data. The results of regression analysis, for cross sectional and panel data, verifies the hypothesis derived from the game theory. The electronic payments are negatively correlated with the tax gap.