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Tolerance of Informality and Occupational Choices in a Large Informal Sector Economy

Tolerance of Informality and Occupational Choices in a Large Informal Sector Economy AbstractWe study an equilibrium two-sector occupational choice model – agents can be (formal or informal) entrepreneurs or workers. An informal entrepreneur faces taxation determined by the combination of her capital choice and society’s tolerance of informality. Our model is consistent with many empirical findings regarding the informal sector in Brazil, a developing economy with a large informal sector. With a calibrated version of our model, we show that as society’s tolerance of informality decreases, the informal sector employs less capital and labor, and informality decreases. We conduct several counterfactual exercises. Informality is substantially lower in economies that are less tolerant of informal activities, formal entrepreneurs have more access to financial markets, and taxation of output and labor is lower. We extend the model to consider stochastic taxation of informal activities – a higher (average) informal output taxation and its variability reduce informality. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The B.E. Journal of Macroeconomics de Gruyter

Tolerance of Informality and Occupational Choices in a Large Informal Sector Economy

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Publisher
de Gruyter
Copyright
© 2022 Walter de Gruyter GmbH, Berlin/Boston
ISSN
1935-1690
eISSN
1935-1690
DOI
10.1515/bejm-2021-0076
Publisher site
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Abstract

AbstractWe study an equilibrium two-sector occupational choice model – agents can be (formal or informal) entrepreneurs or workers. An informal entrepreneur faces taxation determined by the combination of her capital choice and society’s tolerance of informality. Our model is consistent with many empirical findings regarding the informal sector in Brazil, a developing economy with a large informal sector. With a calibrated version of our model, we show that as society’s tolerance of informality decreases, the informal sector employs less capital and labor, and informality decreases. We conduct several counterfactual exercises. Informality is substantially lower in economies that are less tolerant of informal activities, formal entrepreneurs have more access to financial markets, and taxation of output and labor is lower. We extend the model to consider stochastic taxation of informal activities – a higher (average) informal output taxation and its variability reduce informality.

Journal

The B.E. Journal of Macroeconomics – de Gruyter

Published: Jan 1, 2023

Keywords: informal sector; social norms; credit constraints; limited enforcement; E6; E26; H26; O11; O17; Z13

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