Program and Development Research

Program and Development Research

The Role of Operational and Capital Budget Deficit in the Relationship Between the Size of Government and Underground Economy in Iran: An Application of the NARDL Approach

Document Type : Original Article

Authors
Mohammad Boushehri 1
Ahmadreza Ahmadi 2
1 Ph.D. Student in Econometrics,, Faculty of Economics, University of Tehran, Tehran, Iran.
2 Ph.D. Student in Econometrics, Faculty of Economics, Allameh Tabatabai University, Tehran, Iran,
10.22034/pbr.2025.539033.1564
Abstract
This study investigates the role of the government's operational and capital budget deficits in shaping the asymmetric impact of government size on the underground economy in Iran. To this end, the relative size of the underground economy was first estimated using the Multiple Indicators Multiple Causes (MIMIC) method, revealing an average of 18.3 percent of GDP over the study period. Subsequently, two econometric models were developed using the nonlinear Autoregressive Distributed Lag (NARDL) approach to examine the effects of operational and capital budget deficits on the relationship between government size and the underground economy during the period 1980 to 2021. The long-run estimation results indicate, first, that an increase in the capital budget deficit intensifies both the negative impact of government size expansions and the positive impact of government size contractions on the underground economy. Second, the operational budget deficit exhibits a dual behavior: when the deficit exceeds 4.12 percent during expansions in government size, the previously negative effect on the underground economy becomes unfavorable; conversely, when the deficit exceeds 5.47 percent during contractions in government size, the previously positive effect becomes favorable. These findings suggest that the operational deficit can reverse the direction of impact depending on its magnitude and the nature of fiscal shocks. Additional results show that trade openness and unemployment—used as control variables in the model—have a statistically significant and positive effect on the underground economy.
Keywords
Underground economy
government size
budget deficit components
MIMIC
Nonlinear Autoregressive Distributed Lag (NARDL)
Iran
Subjects
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