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Law enforcement and the size of the informal sector

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  • Acosta-Henao, Miguel

Abstract

This study presents cross-country evidence indicating that the relationship between the size of the informal sector and tax rates is ambiguous. Motivated by this finding, a standard two-sector model is augmented with endogenous law enforcement, which depends on the size of the informal sector and government expenditure. Additionally, based on microdata from Colombia, taxes and law enforcement are necessary to match the observed size of the informal sector. Meanwhile, the dependence of law enforcement on government expenditure creates a non-linearity in the form of a Laffer curve. Therefore, lowering tax rates would not necessarily reduce the size of the informal sector.

Suggested Citation

  • Acosta-Henao, Miguel, 2023. "Law enforcement and the size of the informal sector," Economic Modelling, Elsevier, vol. 126(C).
    • Handle: RePEc:eee:ecmode:v:126:y:2023:i:c:s0264999323002122
    DOI: 10.1016/j.econmod.2023.106400
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    More about this item

    Keywords

    Informal sector; Law enforcement; Tax policy;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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