Entrepreneurship in the Shadows: Wealth Constraints and Government Policy

Semih Tumen

No 10324, IZA Discussion Papers from Institute of Labor Economics (IZA)

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: wealth constraints; entrepreneurship; informal economy; government policy; investment (search for similar items in EconPapers)
JEL-codes: E21 E26 L26 O17 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2016-10
New Economics Papers: this item is included in nep-ent, nep-iue, nep-mac and nep-sbm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Published - published in: Economics of Transition, 2017, 25(2), 239-270

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Related works:
Journal Article: Entrepreneurship in the shadows (2017)
Working Paper: Entrepreneurship in the Shadows: Wealth Constraints and Government Policy (2016)
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