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Marginal Cost of Public Funds under the Presence of Informality

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Listed:
  • Ceyhun Elgin

    (Bogazici University)

  • Orhan Torul

    (Bogazici University)

  • Tugce Turk

    (University of Chicago)

Abstract

In this paper, we investigate the behavior of the marginal cost of public funds (MCF) for different taxes under the presence of informality. We build a dynamic general equilibrium model with formal and informal sectors and allow the government to use consumption, capital, and labor income taxes to raise revenue. Using country-level data on taxes, we calibrate and measure MCF for a cross-section of economies. Our results show that different taxes have distinct cost responses to changes in the informal sector size in each country: while MCF of the consumption tax decreases with the increase in the informal sector size, the MCF of the income taxes, capital and labor, display an opposite behavior. Moreover, omitting the informal sector results in an underestimation in the MCF of capital income tax and overestimation in that of the consumption tax

Suggested Citation

  • Ceyhun Elgin & Orhan Torul & Tugce Turk, 2022. "Marginal Cost of Public Funds under the Presence of Informality," Hacienda Pública Española / Review of Public Economics, IEF, vol. 241(2), pages 79-103, June.
    • Handle: RePEc:hpe:journl:y:2022:v:241:i:2:p:79-103
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Informal economy; Taxation; Marginal cost of the public funds; Dynamic general equilibrium model;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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