We propose a consumer demand system approach to estimating the size of the black economy where alternative hypotheses affecting the empirical results can be tested in a nested framework. This approach allows for the estimation of the under‐reporting of household income from various sources, dispensing with the need to use arbitrary criteria to classify households by their main source of income. It also avoids potential bias in black economy estimates arising from mistaking preference heterogeneity (substitution) as income effects. We illustrate these arguments by estimating the extent to which self‐employment income in the UK is under‐reported using parametric and nonparametric techniques.

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This paper estimates adult equivalence scales in the context of a nonlinear demand system using cross‐section individual household data. It then evaluates the treatment of children under the tax allowance and child benefit systems on the basis of the estimated equivalence scales. The results suggest that a child benefit system allowing for economies of scale in the family is consistent with the cost of children implied by the notion of adult equivalence scale.

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