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Tax enforcement, technology, and the informal sector

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  • Elgin, Ceyhun
  • Solis-Garcia, Mario

Abstract

Theoretical models of the informal sector mostly assume—or end up with—a positive correlation between a measure of taxes and the size of the informal sector. However, some recent empirical studies associate higher taxes with a smaller informal sector size. In this paper, we build a theoretical framework—an extension to a two-sector growth model—which allows us to unravel the negative correlation between informal sector size and taxes. We find that (a) a higher degree of tax enforcement, (b) a higher productivity of formal sector households, and (c) a lower physical capital depreciation rate make for a negative relation between these variables. Our results suggest that enforcement and technological factors are likely candidates to account for this relationship.

Suggested Citation

  • Elgin, Ceyhun & Solis-Garcia, Mario, 2015. "Tax enforcement, technology, and the informal sector," Economic Systems, Elsevier, vol. 39(1), pages 97-120.
    • Handle: RePEc:eee:ecosys:v:39:y:2015:i:1:p:97-120
    DOI: 10.1016/j.ecosys.2014.05.007
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    3. Mitra, Shalini, 2014. "Tax Evasion, Tax Policies and the Role Played by Financial Markets," MPRA Paper 58977, University Library of Munich, Germany.
    4. Acosta-Henao, Miguel, 2023. "Law enforcement and the size of the informal sector," Economic Modelling, Elsevier, vol. 126(C).

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    More about this item

    Keywords

    Informal sector; Tax enforcement; Productivity;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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