This study looks at the relationship between the prevalence of state-level shadow economies and the extent of labor regulations specific to occupational licensing. Occupational licensing leads to higher prices in the formal sector and barriers to entry into formal sector employment, therefore incentivizing individuals to migrate their demand and supply to the underground sector. Using state-level panel data for the 50 U.S. states from 2001 to 2019 and two-stage least squares estimation, we find a positive relationship between occupational licensing in a state and the size of its shadow economy. These results are robust to various considerations.
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