nep-iue New Economics Papers
on Informal and Underground Economics
Issue of 2014‒07‒28
eight papers chosen by
Catalina Granda Carvajal
Universidad de Antioquia

  1. Informality and Development By LaPorta, Rafael; Shleifer, Andrei
  2. A theory of compliance with minimum wage law By Asongu, Simplice; Jellal, Mohamed
  3. Applying “Benford’s law” to the Crosswise Model: Findings from an online survey on tax evasion By Kundt, Thorben
  4. Financial Contracting with Tax Evaders By Philipp Meyer-Brauns
  5. Optimal Auditing with Heterogeneous Audit Perceptions By Philipp Meyer-Brauns
  6. Audits as Signals By Kotowski, Maciej Henryk; Weisbach, David A.; Zeckhauser, Richard Jay
  7. Knowledge Economy and Financial Sector Competition in African Countries By Asongu, Simplice A
  8. Costs and Benefits to Phasing Out Paper Currency By Rogoff, Kenneth S.

  1. By: LaPorta, Rafael; Shleifer, Andrei
    Abstract: We establish five facts about the informal economy in developing countries. First, it is huge, reaching about half of the total in the poorest countries. Second, it has extremely low productivity compared to the formal economy: informal firms are typically small, inefficient, and run by poorly educated entrepreneurs. Third, although avoidance of taxes and regulations is an important reason for informality, the productivity of informal firms is too low for them to thrive in the formal sector. Lowering registration costs neither brings many informal firms into the formal sector, nor unleashes economic growth. Fourth, the informal economy is largely disconnected from the formal economy. Informal firms rarely transition to formality, and continue their existence, often for years or even decades, without much growth or improvement. Fifth, as countries grow and develop, the informal economy eventually shrinks, and the formal economy comes to dominate economic life. These five facts are most consistent with dual models of informality and economic development.
    Date: 2014
  2. By: Asongu, Simplice; Jellal, Mohamed
    Abstract: In this paper, we introduce firm heterogeneity in the context of a model of non-compliance with minimum wage legislation. The introduction of heterogeneity in the ease with which firms can be monitored for non compliance allows us to show that non-compliance will persist in sectors which are relatively difficult to monitor, despite the government implementing non stochastic monitoring. Moreover, we show that the incentive not to comply is an increasing function of the level of the minimum wage and increasing function of the gap between the minimum wage and the competitive wage rate.
    Keywords: Minimum wage legislation, Compliance , Incentives , Informal sector
    JEL: J3 K31 K42 L51 M54 O17
    Date: 2014–07–15
  3. By: Kundt, Thorben (Helmut Schmidt University, Hamburg)
    Abstract: Many surveys on sensitive topics such as tax evasion suffer from the reluctance of respondents to provide truthful answers which can cause downward-biased estimates. This paper addresses this problem by making use of a recent survey method (Crosswise Model) designed to provide positive incentives for respondents to answer sensitive questions more truthful. We extend the Crosswise Model by applying the so-called “Benford Illusion” which allows us to increase the precision of the Crosswise Model that is less statistically efficient than other methods. To test the effectiveness of the model in providing privacy protection, we carried out an online survey in which the respondents were randomly allocated into two splits differing only by the questioning technique applied. Our results suggest that the Crosswise Model can help to increase privacy protection compared to a simple direct questioning approach. As a consequence, survey estimates of tax evasion using the Crosswise Model are likely to become more valid. At the same time, we show that were able to obtain an efficient estimator without substantially decreasing privacy protection, even for a relatively small sample size.
    Keywords: tax evasion; survey methodology; Crosswise Model; Benford’s law
    JEL: C83 H26
    Date: 2014–07–10
  4. By: Philipp Meyer-Brauns
    Abstract: This paper derives the optimal financial contract when an entrepreneur can evade taxes in a model of costly state verification. In contrast to the previous literature, we find that standard debt contracts are not optimal when tax evasion is possible. Instead, the optimal contract is debt-like only for very low and very high profit realizations, and features a constant repayment and verification of returns in an intermediate range. This occurs because the entrepreneur has to be given a positive rent even under verification in order to not abuse her limited liability protection for excessive tax evasion activities.
    Keywords: financial contracting, security design, corporate tax evasion, costly state verification
    JEL: D82 D86 G3 H25 H26
    Date: 2014–01
  5. By: Philipp Meyer-Brauns
    Abstract: This paper derives a government's optimal tax audit policy when taxpayers hold different beliefs about the likelihood of a tax audit. When audits are inexpensive, differences in perceived audit risk lead to stricter optimal auditing in equilibrium. If audits are relatively costly, heterogeneity in audit perceptions lowers the equilibrium audit intensity. Except when beliefs are near-identical throughout the population, both tax evasion and honest reporting occur in equilibrium. A welfare analysis shows a non-monotonic, U-shaped relationship between perception heterogeneity and social welfare. High levels of social welfare are associated with very homogeneous or very heterogeneous populations. Moderately heterogeneous taxpayer populations are associated with lower levels of social welfare.
    Keywords: optimal auditing, heterogeneity, tax evasion
    JEL: D82 H26
    Date: 2014–06
  6. By: Kotowski, Maciej Henryk; Weisbach, David A.; Zeckhauser, Richard Jay
    Abstract: A broad array of law enforcement strategies, from income tax to bank regulation, involve self-reporting by regulated agents and auditing of some fraction of the reports by the regulating bureau. Standard models of self-reporting strategies assume that although bureaus only have estimates of the of an agent’s type, agents know the ability of bureaus to detect their misreports. We relax this assumption, and posit that agents only have an estimate of the auditing capabilities of bureaus. Enriching the model to allow two-sided private information changes the behavior of bureaus. A bureau that is weak at auditing, may wish to mimic a bureau that is strong. Strong bureaus may be able to signal their capabilities, but at a cost. We explore the pooling, separating, and semi-separating equilibria that result, and the policy implications. Important possible outcomes are that a cap on penalties increases compliance, audit hit rates are not informative of the quality of bureau behavior, and by mimicking strong bureaus even weak bureaus can induce compliance.
    Date: 2014
  7. By: Asongu, Simplice A
    Abstract: The goal of this paper is to assess how knowledge economy (KE) plays out in financial sector competition. It suggests a practicable way to disentangle the effects of different components of KE on various financial sectors. The variables identified under the World Bank’s four knowledge economy index (KEI) are employed. An endogeneity robust panel instrumental variable fixed-effects estimation strategy is employed on data from 53 African countries for the period 1996-2010. The following findings are established. First, education and innovation in terms of scientific and technical publications broadly bear an inverse nexus with financial development. Second, the incidence of information and communication technologies is positive on all financial sectors but increases the non-formal sectors to the detriment of the formal sector. Third, economic incentives have positive implications for all sectors though the formal financial sector benefits most. Fourth, institutional regime is positive (negative) for the semi-formal (informal) financial sector. The findings contribute at the same time to the macroeconomic literature on measuring financial development and respond to the growing fields of informal sector importance, microfinance and mobile banking by means of KE promotion. Policy implications and future research directions are discussed.
    Keywords: Financial development; Knowledge Economy; Africa
    JEL: G21 O10 O34 P00 P48
    Date: 2014–07–10
  8. By: Rogoff, Kenneth S.
    Abstract: Despite advances in transactions technologies, paper currency still constitutes a notable percentage of the money supply in most countries. For example, it constitutes roughly 10% of the US Federal Reserve’s main monetary aggregate, M2. Yet, it has important drawbacks. First, it can help facilitate activity in the underground (tax-evading) and illegal economy. Second, its existence creates the artifact of the zero bound on the nominal interest rate. On the other hand, the enduring popularity of paper currency generates many benefits, including substantial seigniorage revenue. This paper explores some of the issues associated with phasing out paper currency, especially large-denomination notes.
    Date: 2014

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