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Cross-subsidies, and the elasticity of informality to social expenditures

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  • Alonso-Ortiz, Jorge
  • Leal Ordonez, Julio

Abstract

In the quest to alleviate the lack of protection of an important group in the population, social programs directed to informal workers are being introduced in developing countries. How is the size of the informal sector affected when the distribution across formal and informal workers and/or the generosity of social transfers change? The nature of many tax and transfer systems imply a cross subsidy from high-income to low-income workers. Thus, depending on the wage of the worker, the transfers tied to formal jobs could be bigger, equal, or smaller than the taxes paid. The effects of changes in taxes and transfers greatly depend on which of the three situations above is the one prevailing for the marginal worker. In this paper, we use a search frictions model with an informal sector, heterogeneous workers, and conditional taxes and transfers to address this question. In the model formal sector jobs are tied to larger benefits, and are less risky, but harder to get. We calibrate the model to the Mexican economy and perform a number of counter-factuals. We find that the size of the informal sector is quite inelastic to marginal changes in the generosity of transfers due to the presence of two opposing forces on the marginal worker: more taxes vs. more transfers. In comparison, the informal sector is more elastic to changes in the distribution of transfers because only one force is present in this case. Our results are consistent with the novel empirical evidence found in Almeida and Carneiro (2012) for Brazil, and with the evidence found in Azuara and Marinescu (2013) on the effects of Seguro Popular in Mexico.

Suggested Citation

  • Alonso-Ortiz, Jorge & Leal Ordonez, Julio, 2014. "Cross-subsidies, and the elasticity of informality to social expenditures," MPRA Paper 59613, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:59613
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    References listed on IDEAS

    as
    1. Bosch, Mariano & Esteban-Pretel, Julen, 2012. "Job creation and job destruction in the presence of informal markets," Journal of Development Economics, Elsevier, vol. 98(2), pages 270-286.
    2. Costas Meghir & Renata Narita & Jean-Marc Robin, 2015. "Wages and Informality in Developing Countries," American Economic Review, American Economic Association, vol. 105(4), pages 1509-1546, April.
    3. Azuara, Oliver & Marinescu, Ioana, 2013. "Informality and the expansion of social protection programs: Evidence from Mexico," Journal of Health Economics, Elsevier, vol. 32(5), pages 938-950.
    4. repec:dau:papers:123456789/1888 is not listed on IDEAS
    5. Rita Almeida & Pedro Carneiro, 2012. "Enforcement of Labor Regulation and Informality," American Economic Journal: Applied Economics, American Economic Association, vol. 4(3), pages 64-89, July.
    6. Adriana Kugler & Maurice Kugler, 2009. "Labor Market Effects of Payroll Taxes in Developing Countries: Evidence from Colombia," Economic Development and Cultural Change, University of Chicago Press, vol. 57(2), pages 335-358, January.
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    Cited by:

    1. Gustavo Leyva & Carlos Urrutia, 2018. "Informality, Labor Regulation, and the Business Cycle," 2018 Meeting Papers 587, Society for Economic Dynamics.

    More about this item

    Keywords

    Informal Sector; Taxes and Transfers; Seguro Popular; Search;

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy

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