nep-iue New Economics Papers
on Informal and Underground Economics
Issue of 2021‒05‒03
six papers chosen by
Catalina Granda Carvajal
Universidad de Antioquia

  1. Trade and Informality in the Presence of Labor Market Frictions and Regulations By Rafael Dix-Carneiro; Pinelopi Koujianou Goldberg; Costas Meghir; Gabriel Ulyssea
  2. Public financing with financial frictions and underground economy By Martinez, Tomás R.; Fuster Pérez, Luisa; Erosa Etchebehere, Andrés
  3. What sustains informality?: A study of the interactions between formal- and informal-sector firms By Ajit Mishra
  4. Complexity and Distributive Fairness Interact in Affecting Compliance Behavior By Bellemare, Charles; Deversi, Marvin; Englmaier, Florian
  5. Taxing Multinationals: The Scope for Enforcement Cooperation By Hindriks, Jean; Nishimura, Yukihiro
  6. The Double Dividend of a Joint Tariff and VAT Reform: Evidence from Iran By Yousefi, Kowsar; Vesal, Mohammad

  1. By: Rafael Dix-Carneiro (Duke University and NBER); Pinelopi Koujianou Goldberg (Yale University); Costas Meghir (Yale University); Gabriel Ulyssea (University College of London)
    Abstract: We build an equilibrium model of a small open economy with labor market frictions and imperfectly enforced regulations. Heterogeneous firms sort into the formal or informal sector. We estimate the model using data from Brazil, and use counterfactual simulations to understand how trade affects economic outcomes in the presence of informality. We show the following: 1) Trade openness unambiguously decreases informality in the tradable sector but has ambiguous effects on aggregate informality. 2) The productivity gains from trade are understated when the informal sector is omitted. 3) Trade openness results in large welfare gains even when informality is repressed. 4) Repressing informality increases productivity but at the expense of employment and welfare. 5) The effects of trade on wage inequality are reversed when the informal sector is incorporated in the analysis. 6) The informal sector works as an “unemployment buffer” but not a “welfare buffer” in the event of negative economic shocks.
    Keywords: Labor market effects of trade, Informality, Unemployment
    JEL: F14 F16 J46 O17
    Date: 2021–04
  2. By: Martinez, Tomás R.; Fuster Pérez, Luisa; Erosa Etchebehere, Andrés
    Abstract: What are the aggregate effects of informality in a financially constrained economy? We develop and calibrate an entrepreneurship model to data on matched employer-employee from both formal and informal sectors in Brazil. The model distinguishes between informality on the business side (extensive margin) and the informal hiring by formal firms (intensive margin). We find that when informality is eliminated along both margins, aggregate output increases 9.3%, capital 14.7%, TFP 5.4%, and tax revenue37%. The output and TFP increases would be much larger if informality were only eliminated on the extensive margin, a result that supports the view that the informal economy can play a positive role in an economy with financial frictions. Finally, we find that the output cost of financing social security in our baseline model is about twice as large as the one in an economy with no frictions.
    Keywords: Tax Revenue; Social Security; Financial Frictions; Informality; Occupational Choice
    JEL: O16 L26 H55 H20 E26 E22
    Date: 2021–04–27
  3. By: Ajit Mishra
    Abstract: We consider two vertical links between informal- and formal-sector firms and study their implications. In one case, the final products produced by the formal- and informal-sector firms are vertically differentiated in terms of quality, and the size of the informal sector demand is related to the income distribution. Our paper studies the implications of this quality choice for the size of the informal sector. In the other case, the informal-sector firm produces an intermediate good as an input for the formal-sector firm.
    Keywords: Informal sector, Income distribution, Supply and demand, Quality of products, Output, Choice
    Date: 2021
  4. By: Bellemare, Charles (Université Laval); Deversi, Marvin (LMU Munich); Englmaier, Florian (LMU Munich)
    Abstract: Filing income tax returns or insurance claims often requires that individuals comply with complex rules to meet their obligations. We present evidence from a laboratory tax experiment suggesting that the effects of complexity on compliance are intrinsically linked to distributive fairness. We find that compliance remains largely unaffected by complexity when income taxes are distributed to a morally justified charity. Conversely, complexity significantly amplifies non-compliance when income taxes appear wasted as they are distributed to a morally dubious charity. Our data further suggest that this non-compliance pattern is facilitated through the ambiguity that evolves from mostly unstrategic filing mistakes.
    Keywords: complexity; compliance; distributive fairness; experiment;
    JEL: C91 D01 D91 H26
    Date: 2019–10–16
  5. By: Hindriks, Jean (Université catholique de Louvain, LIDAM/CORE, Belgium); Nishimura, Yukihiro
    Abstract: Policymakers seeking to raise more tax revenues from multinational enterprises have two alternatives: to raise tax rates or to devote more resources to improve tax compliance. Tougher tax enforcement increases the cost of profit shifting, and thus mitigates tax competition. We present a tax-competition model with two policy instruments (the corporate tax rate and the tightness of tax enforcement). In line with the OECD’s BEPS project, we analyze the scope for enforcement cooperation among asymmetric countries, considering that taxes are set noncooperatively. We show that the low-tax country may fail to cooperate if asymmetry is large enough and that tax havens would never agree to cooperate. Then we identify two drivers for enforcement cooperation. The first driver of cooperation is the complementarity of enforcement actions across countries. This is because the efficiency loss from enforcement dispersion is greater under complementarity. The second driver of cooperation is tax leadership by the high-tax country, which acts as a level-playing field in the tax competition and reduces the extent of disagreement on enforcement.
    Keywords: Profit shifting; Tax competition; Tax enforcement; Weakestlink; Tax leadership; Tax Haven
    JEL: C72 F23 F68 H25 H87
    Date: 2020–12–15
  6. By: Yousefi, Kowsar; Vesal, Mohammad
    Abstract: Abstract A rich theoretical literature discusses whether replacing tariffs with value added tax (VAT) improves efficiency. We provide empirical evidence on a novel complementarity between VAT and trade taxes. Downstream domestic firms require VAT receipts from importers to claim purchases VAT increasing incentives for honest reporting of imports. We use the trade gap, the difference between mirror and domestic trade reports in Iran at 6-digit HS disaggregation, to measure this complementarity. Iran introduced VAT in 2008 and increased its rate from 3 to 9 percent since then. Difference-in-differences estimations show that a 1 percentage point increase in the VAT rate reduces the trade gap by 6.7 percent. Consistent with the compliance mechanisms of VAT, we observe a smaller effect for the consumer products that have a shorter value chain. Our results suggest that replacing tariffs with VAT results in a double dividend. Tax revenue could increase due to better tariff compliance and a broader VAT base.
    Keywords: Value Added Tax; Trade Liberalization; Tariffs; Chains Effect; Tax Compliance;
    JEL: F13 F14 H25
    Date: 2021–04–16

This nep-iue issue is ©2021 by Catalina Granda Carvajal. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.