Informality and Optimal Public Policy

Bardey, David and Mejía, Daniel (2016) Informality and Optimal Public Policy. TSE Working Paper, n. 16-720

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Official URL: http://tse-fr.eu/pub/31126

Abstract

This article tackles the feature of optimal public policy such as the level of enforcement and the supply of public goods in an economy characterized by a huge informal sector. We consider informality as the group of productive activities which,before hand, do not comply (totally or partially) with government regulations. The Government intervenes as a Stackelberg leader and has to decide how to allocate public expenditures, collected through the tax system, between the provision of a public good, which can only be used for formal activties, and enforcement effort, aimed at detecting informal firms that evade taxes. Taking the public policy as given, a representative family, owner of a representative ?rm, decides how to split a ?x amount of labour supply between formal and informal activities. Our results show that the greater are the distortions in the process of tax collection, the larger is the size of the informal sector. Finally, we derive the properties of the optimal public policy. In particular, we show that the shadow cost of public fund represent the rationale of enforcement spending. We also point out that the size of the tax distortion (e.g. the shadow cost of public funds) is inversely related to total income, the tax rate and the provision of the public good. Our calibration results reveal that higher values of the shadow cost of public funds call for more stick (more enforcement) and less carrot (public goods).

Item Type: Monograph (Working Paper)
Language: English
Date: October 2016
Uncontrolled Keywords: Informality, public good and enforcement
JEL codes: K10 - General
K20 - General
K42 - Illegal Behavior and the Enforcement of Law
O17 - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements - Legal, Social, Economic, and Political
Subjects: B- ECONOMIE ET FINANCE
Divisions: Toulouse School of Economics - TSE
Institution: Universite Toulouse 1 Capitole
Site: UT1
Date Deposited: 27 Oct 2016 08:30
Last Modified: 18 Oct 2017 15:11
OAI ID: oai:tse-fr.eu:31126
URI: http://publications.ut-capitole.fr/id/eprint/22460

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