This paper examines the impact of innovation on the underground economy, focusing on differences between informal entrepreneurship and the overall shadow economy. Using cross-national data and measuring innovative activity alternately by patent grants and patent applications, results show that increases in innovative activity spur informal entrepreneurship. The effects of innovation on the overall shadow economy are insignificant. Further, general improvements in government effectiveness seem more effective in checking the underground sector than specific initiatives related to minimum wages or taxes. Transition countries, ceteris paribus, have lower informal entrepreneurship, but higher overall underground economy.