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An Empirical Model of Labor Supply in the Underground Economy

  • Bernard Fortin
  • Thomas Lemieux
  • Pierre Frechette

This paper uses micro data from a random survey carried out in the region of Quebec City, Canada, to estimate a model of labor supply in the underground economy. The model assumes that the individual's gross wage rate in the regular sector is parametric while his gross labor earnings in the underground sector are a concave function of hours of work. This distinction between the two sectors is used to generate a simple separation result between preferences and the magnitude of underground labor market activities. This result implies that the individual's labor supply in the underground economy is generally a negative function of his net wage rate in the regular sector. The separation result also implies a set of restrictions on the parameters of the reduced form of the model, which are imposed using minimum distance methods of estimation. Various generalized method of moments specification tests allow us to verify the validity of these restrictions. According to our results, the marginal tax rates embodied in the Quebec tax-transfer system are an important determinant of the decision to participate in the underground sector.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3392.

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Date of creation: Jun 1990
Date of revision:
Publication status: published as American Economic Review , vol.84, no.1, pp.231-254, March 1994.
Handle: RePEc:nbr:nberwo:3392
Note: LS
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  2. Hausman, Jerry A., 1985. "Taxes and labor supply," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 1, chapter 4, pages 213-263 Elsevier.
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  15. Amemiya, Takeshi, 1979. "The Estimation of a Simultaneous-Equation Tobit Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(1), pages 169-81, February.
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