Informal Sector, Government Policy and Institutions

S. Boragan Aruoba

No 324, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: We document cross-country differences in informal activity, government policies and institutions using a data set covering 127 countries. Five key facts emerge from this data set. Better institutions are associated with lower inflation, higher income tax rates and less informal activity. Related to these, we also find that higher levels of informal activity is associated with lower income tax rates and higher inflation. We develop a general equilibrium model where households optimally choose the extent of informal activity and the government optimally chooses policies, both taking as given the institutions of the economy. The model is able to account for most of the cross-country differences in policies, and other key facts that emerge from the data. The performance of the model is significantly reduced for various subsets of countries, where some of the key assumptions that underlie our model are violated.

Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed010:324

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