Informality and Optimal Public Policy

This article tackles the feature of optimal public policy such as the level of enforcement and the supply of public goods in an economy characterized by a huge informal sector. We consider informality as the group of productive activities which,before hand, do not comply (totally or partially) with government regulations. The Government intervenes as a Stackelberg leader and has to decide how to allocate public expenditures, collected through the tax system, between the provision of a public good, which can only be used for formal activties, and enforcement effort, aimed at detecting informal firms that evade taxes. Taking the public policy as given, a representative family, owner of a representative ?rm, decides how to split a ?x amount of labour supply between formal and informal activities. Our results show that the greater are the distortions in the process of tax collection, the larger is the size of the informal sector. Finally, we derive the properties of the optimal public policy. In particular, we show that the shadow cost of public fund represent the rationale of enforcement spending. We also point out that the size of the tax distortion (e.g. the shadow cost of public funds) is inversely related to total income, the tax rate and the provision of the public good. Our calibration results reveal that higher values of the shadow cost of public funds call for more stick (more enforcement) and less carrot (public goods)

Informality and Optimal Public Policy

This article tackles the feature of optimal public policy such as the level of enforcement and the supply of public goods in an economy characterized by a huge informal sector. We consider informality as the group of productive activities which,before hand, do not comply (totally or partially) with government regulations. The Government intervenes as a Stackelberg leader and has to decide how to allocate public expenditures, collected through the tax system, between the provision of a public good, which can only be used for formal activties, and enforcement effort, aimed at detecting informal firms that evade taxes. Taking the public policy as given, a representative family, owner of a representative ?rm, decides how to split a ?x amount of labour supply between formal and informal activities. Our results show that the greater are the distortions in the process of tax collection, the larger is the size of the informal sector. Finally, we derive the properties of the optimal public policy. In particular, we show that the shadow cost of public fund represent the rationale of enforcement spending. We also point out that the size of the tax distortion (e.g. the shadow cost of public funds) is inversely related to total income, the tax rate and the provision of the public good. Our calibration results reveal that higher values of the shadow cost of public funds call for more stick (more enforcement) and less carrot (public goods)

Growth, Fiscal Policy and the Informal Sector in a Small Open Economy

We discuss the implications of informality on growth and fiscal policy by considering an informal sector based on low tech firms, in an open economy model of endogenous growth, where labour supply is elastic and increasing returns arise from public spending. We allow for both labour and capital to allocate between sectors and examine the dynamic and policy issues that arise in an economy, where long run outcomes are still dominated by formal activities, but long macroeconomic transitions arise as a result of informal microeconomic activities, which take advantage of both government taxation and limited fiscalization.Endogenous Growth Theory; Optimal Fiscal Policy; Informal Sector; Public Capital.

Growth, Fiscal Policy and the Informal Sector in a Small Open Economy

We discuss the implications of informality on growth and fiscal policy by considering an informal sector based on low tech firms, in an open economy model of endogenous growth, where labour supply is elastic and increasing returns arise from public spending. We allow for both labour and capital to allocate between sectors and examine the dynamic and policy issues that arise in an economy, where long run outcomes are still dominated by formal activities, but long macroeconomic transitions arise as a result of informal microeconomic activities, which take advantage of both government taxation and limited fiscalization.Endogenous Growth Theory; Optimal Fiscal Policy; Informal Sector; Public Capital

Essays in development economics and public finance

This dissertation studies a range of topics in development economics and public finance. The first two chapters contain empirical studies on India addressing the impact of financial development on poverty and informality. Using time and state-level variation across Indian states, the first study examines the effect of financial liberalization in 1991on poverty and investigates the underlying mechanisms. The second study examines the effect of financial deepening and bank outreach on informality using micro data of Indian manufacturing sector. The next two chapters investigate the optimal government policy to reduce tax evasion in a value-added tax (VAT) system. Chapter three addresses the problem of misreporting by registered traders in the VAT. The last chapter models the role of inter-sectoral linkages on tax evasion of informal firms in an input-output framework and justifies the results using Indian data

Tax rates, governance, and the informal economy in high-income countries

This paper studies the mechanisms behind the informal economy in high-income countries. About 16.3% of output in high-income OECD countries was produced informally in 2001-02. In a recent paper Davis and Henrekson [2004] show that there exists a positive relationship between tax rates and the informal economy for high-income OECD countries. Existing models of the informal economy mostly focus on developing countries. To account for the informal economy in high-income countries, build a model economy, following Lucas [1978], in which agents of different managerial abilities decide to become workers, managers of informal firms, or managers of formal firms. In contrast to formal managers, managers of informal firms do not pay taxes but run the risk of getting caught, taxed, and fined. A calibrated version of the model economy is able to generate the observed differences in informal economy of 21 high-income countries. Although tax rates are crucial for explaining the observed differences in informal economy, the quality of governance, the extent to which these tax rates are enforced, also plays an important role. Policy experiments show that by improving the enforcement of their tax policies countries can reduce informality. A smaller informal economy is accompanied by larger firms and higher productivity

Political Competition in Dual Economies: Clientelism in Latin America

Resumen:Este artículo presenta el proyecto de investigación que intenta iluminar los mecanismos que vinculan el clientelismo con la informalidad. En particular la investigación se concentra en las interacciones que tienen lugar durante la competencia electoral e intenta proporcionar un marco analítico para comprender los mecanismos económicos subyacentes en la competencia electoral en América Latina. Esta competencia está caracterizada por asimetrías entre los políticos (credibilidad y habilidad para movilizar votantes) y asimetrías entre los votantes (ingreso y participación en cierto segmento de la economía) ambos inmersos en un ambiente de baja calidad institucional (débil imperio de la ley). El artículo expone la evidencia empírica que motivó la investigación, discute los conceptos y literatura centrales y presenta un ejercicio exploratorio basado en el modelo de votación probabilística como un punto de partida en la formalización del problema. En esta primera aproximación se muestra que el político clientelista en el poder puede proveer más bienes públicos cuando su maquinaria política es suficientemente rentable y la sociedad es altamente inequitativa. En la medida en que el político entrante tiene su nicho en los votantes ricos quienes demandan bajos impuestos, el político clientelista redistribuye más ingreso aunque a costa de una mayor informalidad.maquinaria política, clientelismo, política redistributiva, dualidad, informalidad, modernización económica, América Latina

Tax Evasion, Minimum Wage Non-Compliance and Informality

We study the impact of tax and minimum wage reforms on the incidence of informality. To gauge the incidence of informality, we use measures of the extent of tax evasion, the extent of minimum wage non-compliance, and the size of the informal workforce. Our approach allows us to examine (i) the distinction between determinants of firm-level reported wage distribution and actual wage distribution, (ii) the complementarity of tax and minimum wage enforcement, (iii) the impact that a minimum wage reform has on tax and minimum wage compliance, and (iv) the impact that a tax policy reform has on tax and minimum wage compliance. We conclude with the design of optimal minimum wage and tax policies (even in the complete absence of minimum wage enforcement). We do so based on two objectives derived from popular concerns associated with an unchecked expansion of informality: tax revenue maximization, and poverty alleviation among workers.poverty, flat tax reform, minimum wage reform, tax evasion, informality

Taxation, public services, and the informal sector in a model of endogenous growth

Large informal sectors are an important characteristic of developing countries. The authors build a dynamic model in which the informal sector exists when overregulation (high tax rates and high cost for entering the formal sector) is coupled with an inefficient and corrupt system of compliance control. They consider a production technology in which public services are essential and subject to congestion. The public services are financed by taxes collected from the formal sector. Informal producers evade taxes and, because of their illegal status, can use only some public services, cannot use capital or insurance markets, and are subject to stochastic penalties. The authors find that the relative size of the informal sector is negatively related to the severity of the penalties and positively related to tax rates and the extent of informal use of public services. They also find that economies with larger informal sectors have lower capital return and growth rates because the contribution of public services to productivity decreases with informality. They argue that self-interested bureaucracies create an economic environment that makes informality attractive or simply unavoidable because they profit from the presence of the informal sector.Economic Theory&Research,Banks&Banking Reform,Poverty Assessment,Environmental Economics&Policies,National Governance