nep-iue New Economics Papers
on Informal and Underground Economics
Issue of 2016‒11‒20
four papers chosen by
Catalina Granda Carvajal
Universidad de Antioquia

  1. Entrepreneurship in the Shadows: Wealth Constraints and Government Policy By Tumen, Semih
  2. Informality, Public Employment and Employment Protection in Developing Countries By Fran çois Langot; Shaimaa Yassin
  3. Dynamic Tax Evasion with Habit Formation By Michele Bernasconi; Rosella Levaggi; Francesco Menoncin
  4. The Bomb-Crater Effect of Tax Audits: Beyond Misperception of Chance By Luigi Mittone; Fabrizio Panebianco; Alessandro Santoro

  1. By: Tumen, Semih (Central Bank of Turkey)
    Abstract: I develop a dynamic model of forward-looking entrepreneurs, who decide whether to operate in the formal economy or informal economy and choose how much to invest in their businesses, taking government policy as given. The government has access to two policy tools: taxes on formal business activity and enforcement (or policing) discouraging informality. The main focus of the paper is on transitional dynamics under different initial wealth levels. Whether an initially small business will be trapped in the informal economy and remain small forever or grow quickly and become a large formal business depends on tax and enforcement policies. High tax rates accompanied by loose enforcement – which is mostly the case in less-developed countries (LDCs) – induce tax avoidance, discourage investment in formal businesses, and drive the entrepreneurial activity toward the informal sector even though the initial wealth level is high. Lowering taxes on formal activity joined with strict enforcement can help reducing the magnitude of poverty traps in LDCs.
    Keywords: investment, government policy, informal economy, entrepreneurship, wealth constraints
    JEL: E21 E26 L26 O17
    Date: 2016–10
  2. By: Fran çois Langot (University of Le Mans (GAINS-TEPP & IRA), Paris School of Economics, CEPREMAP and IZA.); Shaimaa Yassin (University of Neuchâtel (IRENE), University of Paris 1 Panthéon-Sorbonne (CES and Paris School of Economics) and University of Le Mans (GAINS-TEPP).)
    Abstract: This paper proposes an equilibrium matching labor market model for developing countries where the interaction between public, formal and informal sectors is considered. Theoretical analysis shows that labor markets' liberalization reforms can be evicted by shifts in public employment. Since the public sector accounts for a substantial share of employment in developing countries, this approach is crucial to understand their labor market outcomes. Wage offers to public sector employees increase the outside option value of workers during their bargaining processes in the formal and informal sectors. It becomes more profitable for workers to search on-the-job to access more attractive and stable jobs. The public sector therefore acts as an additional tax imposed on private firms. Using workers flows data from Egypt, we show that labor markets' liberalization plays against informal employment by increasing formal jobs' profitability, but is evicted by the increase of public sector wages observed at the same time.
    Keywords: Job search, Informality, Public Sector, Egypt, Unemployment, Wages, Policy Interventions.
    JEL: E24 E26 J60 J64 O17
    Date: 2016–11
  3. By: Michele Bernasconi; Rosella Levaggi; Francesco Menoncin
    Abstract: Although tax evasion and auditing are dynamic processes, they have been approached in a dynamic framework only recently. We argue that the decision to avoid taxes is dynamically embedded with consumption decisions, which in turn are driven by consumption habits. The model is cast in a dynamic context with an infinite horizon. Our paper makes several contributions to the existing literature on tax evasion: 1) habit formation has a dampening effect on tax evasion; 2) as the representative consumer grows older, the gap between habit and consumption decreases and his tax evasion decreases; 3) the effect of an increase in tax evasion depends on the ration of habit to capital, i.e. the presence of the Yitzhaki (1974) paradox depends on such a ratio; 4) we show that in the long run the ratio increases while the relationship between evasion and the tax rate changes from being positive to being negative; 5) the model has policy implications: other things being equal, it is better to induce people to reduce their level of tax evasion with controls rather than fines.
    Keywords: dynamic tax evasion, habit
    JEL: H26 H30
    Date: 2016
  4. By: Luigi Mittone; Fabrizio Panebianco; Alessandro Santoro
    Abstract: In this paper, we run a laboratory experiment where the information set is relatively rich, and, in particular, it includes audits on other taxpayers. At the same time, the implementation of the Bayesian updating process for the subjective probability to be audited is fairly simple. By doing so, we are able to elicit a range of consistent but heterogeneous probability beliefs and to distinguish between Bayesian and non-Bayesian subjects. We obtain two major results concerning Bayesian subjects. First, they exhibit strong and robust short-run BoCE. Second, they are seemingly not affected by audits on other taxpayers in their compliance decision. These results are robust to different definitions of Bayesianity and to different specifications. They confl ict with the evidence that Bayesian agents do perceive correctly the chance to be audited. In turn, this suggests that existing explanations of the BoCE are not entirely satisfactory and that alternative theories, possibly based on the Duality approach, are needed. KEYWORDS: Bomb-crater effect, Bayesian Updating, Behavioral Duality. JEL CODES: C91,D81,H26
    Date: 2016

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