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Optimal redistribution with a shadow economy

Author

Listed:
  • Doligalski, Paweł

    (School of Economics, University of Bristol)

  • Rojas, Luis E.

    (Department of Economics and Economic History, Universitat Autònoma de Barcelona and Barcelona School of Economics)

Abstract

We extend the theory of optimal redistributive taxation to economies with an informal sector. In particular, in our model workers can supply labor simultaneously to the formal and the informal sectors, which we call moonlighting. The optimal tax formula contains two novel terms capturing informality responses on an intensive and an extensive margin. Both terms decrease the optimal tax rates. We estimate the model with Colombian data and find that informality strongly reduces tax rates at all income levels. The possibility to migrate to entirely informal employment restricts tax rates at low and medium income levels, while the possibility of moonlighting is relevant at higher earnings.

Suggested Citation

  • Doligalski, Paweł & Rojas, Luis E., 2023. "Optimal redistribution with a shadow economy," Theoretical Economics, Econometric Society, vol. 18(2), May.
  • Handle: RePEc:the:publsh:4569
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    References listed on IDEAS

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    More about this item

    Keywords

    Income Taxation; Redistribution; Informal Sector; Moonlighting;
    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
    • J46 - Labor and Demographic Economics - - Particular Labor Markets - - - Informal Labor Market

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