Taxes, Inequality and the Size of the Informal Sector

Sylvain Dessy () and Stephane Pallage ()

Cahiers de recherche from Université Laval - Département d'économique

Abstract:

In this note we develop a simple heterogeneous-agent model with incomplete markets to explain the prevalence of a large, low-productivity, informal sector in developing countries. In our models, taxes levied on formal sector agents are used to finance the provision of a productive public infrastructure, which creates a productivity premium from formalization. Our model offers endogenous differentiation of rich and poor countries. Complete formalization is an equilibrium only in countries with the appropriate initial conditions. We discuss existence of this equilibrium and highlight the ambiguous effect of taxes.

Keywords: Informal sector; Technology adoption; Infrastructure; Inequality; Taxation; Development (search for similar items in EconPapers)
JEL-codes: O14 O17 H54 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dev and nep-pbe
Date: 2001
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Journal Article: Taxes, inequality and the size of the informal sector (2003)
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Persistent link: http://EconPapers.repec.org/RePEc:lvl:laeccr:0112

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