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Tax Policies and Informality in South Africa

Eliane El Badaoui and Riccardo Magnani

No 2015-22, EconomiX Working Papers from University of Paris Nanterre, EconomiX

Abstract: We use a micro-macro simulation model to evaluate the effects of labor income tax policies in South Africa. The country is characterized by a high unemployment rate while employment in the informal sector is relatively low. Our approach is based on the aggregation of the preferences of individuals who choose among (i) working in the formal sector,(ii) working in the informal sector, and (iii) not working. We quantify the effects of different tax policies on the individual's labor supply choices (formal/informal employment, work/leisure) and at the macro level (GDP, equilibrium wages, size of the informal sector, and unemployment rate). We further analyze the effects in terms of income distribution, poverty and inequality. We find that the introduction of a negative income tax system reduces inequality and poverty but, at the same time, discourages people from participating in the labor market and working in the formal sector and, consequently worsens the equitye efficiency trade-off. We find however that the equity-efficiency trade-off can be improved by introducing (i) a (revenue-neutral) tax system which combines a sufficiently high at rate (25%) and lump-sum transfer paid only to formal workers; (ii) an expansionary policy (a reduction in total taxes or an increase in public expenditures). Interestingly, even though they increase the informal sector, these reforms reduce inequality and poverty through a reduction in the level of unemployment.

Keywords: Tax Reform; Informal Sector; Labor Supply; CGE Model; Microsimulation; South Africa. (search for similar items in EconPapers)
JEL-codes: J22 H24 O17 C68 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-iue and nep-pub
Date: 2015
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Working Paper: Tax Policies and Informality in South Africa (2019)
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