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The purpose of this paper is to investigate the nonlinear relationship between shadow economy and income inequality and determine whether the size of shadow economy can influence the level of income inequality.

Both parametric (panel OLS) and nonparametric/semiparametric regression suggested by Robinson (1988) will be used to capture the dynamic nonlinear relationship between these variables using unbalanced panel data of 154 countries from 2000 to 2007. Additionally, the relationship between income inequality and shadow economy on both developed and developing countries will be analyzed and compared.

First, semiparametric analysis and nonparametric analysis are significantly different than parametric analysis and better in nonlinear analysis between income inequality and shadow economy. Second, income inequality and shadow economy …