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Taxes, Inequality and the Size of the Informal Sector

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  • Dessy, Sylvain
  • Pallage, Stéphane

Abstract

In this note we develop a simple heterogeneous-agent model with incomplete markets to explain the prevalence of a large, low-productivity, informal sector in developing countries. In our models, taxes levied on formal sector agents are used to finance the provision of a productive public infrastructure, which creates a productivity premium from formalization. Our model offers endogenous differentiation of rich and poor countries. Complete formalization is an equilibrium only in countries with the appropriate initial conditions. We discuss existence of this equilibrium and highlight the ambiguous effect of taxes.

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File URL: http://www.ecn.ulaval.ca/w3/recherche/cahiers/2001/0112.pdf
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Bibliographic Info

Paper provided by Université Laval - Département d'économique in its series Cahiers de recherche with number 0112.

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Date of creation: 2001
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Handle: RePEc:lvl:laeccr:0112

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Keywords: Informal sector; Technology adoption; Infrastructure; Inequality; Taxation; Development;

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  1. Stephen L. Parente & Edward C. Prescott, 1997. "Monopoly rights: a barrier to riches," Staff Report 236, Federal Reserve Bank of Minneapolis.
  2. Saint-Paul, G. & Verdier, T., 1991. "Education, Democracy and growth," DELTA Working Papers 91-27, DELTA (Ecole normale supérieure).
  3. Sarte, Pierre-Daniel G., 2000. "Informality and rent-seeking bureaucracies in a model of long-run growth," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 173-197, August.
  4. Basu, Kaushik & Van, Pham Hoang, 1998. "The Economics of Child Labor," American Economic Review, American Economic Association, vol. 88(3), pages 412-27, June.
  5. Jane Ihrig & Karine S. Moe, 2000. "The dynamics of informal employment," International Finance Discussion Papers 664, Board of Governors of the Federal Reserve System (U.S.).
  6. Sylvain Dessy & Stephane Pallage, 2000. "Child Labor and Coordination Failures," Cahiers de recherche CREFE / CREFE Working Papers 109, CREFE, Université du Québec à Montréal.
  7. Matsuyama, Kiminori, 1996. "Why Are There Rich and Poor Countries? Symmetry-Breaking in the World Economy," Journal of the Japanese and International Economies, Elsevier, vol. 10(4), pages 419-439, December.
  8. Parente, Stephen L & Prescott, Edward C, 1994. "Barriers to Technology Adoption and Development," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 298-321, April.
  9. Murphy, Kevin M & Shleifer, Andrei & Vishny, Robert W, 1989. "Industrialization and the Big Push," Journal of Political Economy, University of Chicago Press, vol. 97(5), pages 1003-26, October.
  10. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, vol. 66(2), pages 293-312, November.
  11. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
  12. Krugman, Paul, 1991. "History versus Expectations," The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 651-67, May.
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