Pecunia olet. Cash usage and the underground economy.

• Role of cash for underground economy is analyzed with a unique dataset for Italy. • An increase in cash use translates into a higher share of shadow value added. • Rising the maximum threshold for cash transactions shifts the same share upwards. • Stricter limits on cash use are an effective instrument to tackle tax evasion. This paper explores the role of cash usage in feeding the underground economy by using a unique dataset that combines, at province level, official estimates of Italian firms' underreporting with data on cash transactions drawn from the aggregate anti-money laundering reports filed to the Italian Financial Intelligence Unit (UIF) by banks. In order to derive causal evidence, we apply two different econometric strategies: an instrumental variable approach and a difference-in-difference approach, which exploits the change in the maximum threshold for cash transactions introduced in 2016, thereby providing a measure of the effect of such policy on tax evasion. We find that an increase in cash usage translates, other things being equal, into a higher level of underreporting by firms, and that raising the cash threshold in 2016 – a measure motivated by the objective of boosting spending – had the side effect of leading to a larger underground economy. [ABSTRACT FROM AUTHOR]