Bardey, David and Mejía, Daniel (2019) Informality and Optimal Public Policy. Economía: the Journal of LACEA, vol. 19 (n° 2). pp. 1-19.

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Identification Number : 10.1353/eco.2019.0000


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: Article
Language: English
Date: April 2019
Refereed: Yes
Place of Publication: Washington
Uncontrolled Keywords: Informality, public good and enforcement
JEL Classification: 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
Divisions: TSE-R (Toulouse)
Site: UT1
Date Deposited: 20 Nov 2018 11:11
Last Modified: 06 Sep 2021 14:12
OAI Identifier:

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