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Optimal Policies and the Informal Sector

Listed author(s):
  • Katherine Cuff
  • Nicolas Marceau
  • Steeve Mongrain
  • Joanne Roberts

This paper characterizes optimal policies in the presence of tax evasion and undocumented workers. Equilibrium can be characterized as segmented or non-segmented, depending on whether domestic workers work exclusively in the formal sector (segmented) or also in the informal sector (non-segmented). Surprisingly, in equilibrium, wages are always equalized between domestic and undocumented workers, even if they do not work in the same sectors of the economy. This is driven by the interaction of firm level decisions with optimal government policy. We also find that enforcement may not always be decreasing in its cost, and that governments will optimally enforce segmentation if enforcement costs are not too high.

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File URL: http://socserv.mcmaster.ca/econ/rsrch/papers/archive/2009-14.pdf
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Paper provided by McMaster University in its series Department of Economics Working Papers with number 2009-14.

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Length: 37 pages
Date of creation: Sep 2009
Handle: RePEc:mcm:deptwp:2009-14
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  1. Áureo de Paula & José A. Scheinkman, 2007. "The Informal Sector," NBER Working Papers 13486, National Bureau of Economic Research, Inc.
  2. A. Mitchell Polinsky & Steven Shavell, 2005. "The Theory of Public Enforcement of Law," Discussion Papers 05-004, Stanford Institute for Economic Policy Research.
  3. Fugazza, Marco & Jacques, Jean-Francois, 2004. "Labor market institutions, taxation and the underground economy," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 395-418, January.
  4. George J. Borjas & Jeffrey Grogger & Gordon H. Hanson, 2008. "Imperfect Substitution between Immigrants and Natives: A Reappraisal," NBER Working Papers 13887, National Bureau of Economic Research, Inc.
  5. Gary S. Becker, 1968. "Crime and Punishment: An Economic Approach," Journal of Political Economy, University of Chicago Press, vol. 76, pages 169-169.
  6. 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.
  7. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  8. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
  9. Borjas, George J., 1999. "The economic analysis of immigration," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 28, pages 1697-1760 Elsevier.
  10. Cremer, Helmuth & Gahvari, Firouz, 2000. "Tax evasion, fiscal competition and economic integration," European Economic Review, Elsevier, vol. 44(9), pages 1633-1657, October.
  11. Louis Kaplow, 1989. "Optimal Taxation with Costly Enforcement and Evasion," NBER Working Papers 2996, National Bureau of Economic Research, Inc.
  12. Epstein, Gil S. & Heizler (Cohen), Odelia, 2007. "Illegal Migration, Enforcement and Minimum Wage," IZA Discussion Papers 2830, Institute for the Study of Labor (IZA).
  13. Patricia Cortes, 2008. "The Effect of Low-Skilled Immigration on U.S. Prices: Evidence from CPI Data," Journal of Political Economy, University of Chicago Press, vol. 116(3), pages 381-422, 06.
  14. Ethier, Wilfred J, 1986. "Illegal Immigration: The Host-Country Problem," American Economic Review, American Economic Association, vol. 76(1), pages 56-71, March.
  15. Slemrod, Joel & Yitzhaki, Shlomo, 2002. "Tax avoidance, evasion, and administration," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 22, pages 1423-1470 Elsevier.
  16. Djajic, Slobodan, 1997. "Illegal Immigration and Resource Allocation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(1), pages 97-117, February.
  17. Allingham, Michael G. & Sandmo, Agnar, 1972. "Income tax evasion: a theoretical analysis," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 323-338, November.
  18. Freeman, Scott & Grogger, Jeffrey & Sonstelie, Jon, 1996. "The Spatial Concentration of Crime," Journal of Urban Economics, Elsevier, vol. 40(2), pages 216-231, September.
  19. Bond, Eric W. & Chen, Tain-Jy, 1987. "The welfare effects of illegal immigration," Journal of International Economics, Elsevier, vol. 23(3-4), pages 315-328, November.
  20. Reinganum, Jennifer F. & Wilde, Louis L., 1985. "Income tax compliance in a principal-agent framework," Journal of Public Economics, Elsevier, vol. 26(1), pages 1-18, February.
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