Cross-subsidies, and the elasticity of informality to social expenditures

Jorge Alonso-Ortiz () and Leal-Ordoñez Julio C.
Authors registered in the RePEc Author Service: Julio César Leal Ordóñez

No 2014-26, Working Papers from Banco de México

Abstract: How is the size of the informal sector affected when the distribution of social expenditures across formal and informal workers changes? Given this distribution, how is it affected when the generosity of these transfers changes? We use a search frictions model with informality, (ex post) heterogeneous workers, and conditional taxes and transfers. In the model, formal jobs are "better" than informal jobs, but harder to get. Taxes are proportional to the wage, while transfers are lump sum, implying a cross-subsidy from high-income to low-income workers. As a result, the marginal worker weighs two opposing forces: changes in taxes vs. changes in transfers. We calibrate the model to Mexico and perform counterfactuals. We find that informality is quite inelastic due to frictions, and due to the opposing forces of taxes and transfers.

Keywords: Informality; elasticity of informality; social expenditures; cross-subsidies; taxes and transfers; search frictions (search for similar items in EconPapers)
JEL-codes: E2 E26 J46 J6 (search for similar items in EconPapers)
Date: 2014-12
New Economics Papers: this item is included in nep-dge, nep-iue and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Working Paper: Cross-subsidies, and the elasticity of informality to social expenditures (2014)
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