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Taxes, inequality and the size of the informal sector

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  • Dessy, Sylvain
  • Pallage, Stephane

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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Suggested Citation

  • Dessy, Sylvain & Pallage, Stephane, 2003. "Taxes, inequality and the size of the informal sector," Journal of Development Economics, Elsevier, vol. 70(1), pages 225-233, February.
  • Handle: RePEc:eee:deveco:v:70:y:2003:i:1:p:225-233
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    References listed on IDEAS

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    1. Dessy, Sylvain E. & Pallage, Stephane, 2001. "Child labor and coordination failures," Journal of Development Economics, Elsevier, pages 469-476.
    2. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, pages 293-312.
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    More about this item

    JEL classification:

    • O14 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Industrialization; Manufacturing and Service Industries; Choice of Technology
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures

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