Tax Policies and Informality in South Africa

Using a micro–macro simulation approach, we evaluate the effects of different tax policies in South Africa. The country is characterised by a high unemployment rate, while the informal sector remains relatively small. The effects of the simulated tax policies are quantified at the macro level, on the individual's labour supply choices, and on income distribution, inequality and poverty. We find that the equity‐efficiency trade‐off can be improved by introducing a system combining a sufficiently high flat rate and a lump‐sum transfer paid only to formal workers. Interestingly, even though it increases the informal sector, this reform reduces inequality and poverty through a reduction in unemployment. © 2019 John Wiley & Sons, Ltd.