Moonlighting Production, Tax Rates and Capital Subsidies

Abstract

Informal firms play a crucial role in both developing and developed countries, and there is evidence of a larger presence of moonlighting firms over ghost firms. The former are firms that operate simultaneously in the official and unofficial sectors, whereas the ghost firms undertake their production only underground. In order to deal with this evidence, through an ad-hoc assumption we represent a specific technological advantage of moonlighting firms over ghost firms, modelled through an aggregate-capital externality. In this setting we examine the steady state effect of fiscal policies aimed to support firms, in particular investment subsidies and tax allowances, on firm size and underground production. Among the main results, a tax cut (rise), induces the moonlighting firm to engage in more (less) official production. Contrary to the presumption that subsidies may also be useful for pushing firms to operate over ground, in the presence of moonlighting technology, the incentives to improve capital stock turn out to be counterproductive in that they increase the unofficial economy overall.formal and informal sectors, capital investment, tax exemptions