Dodging the Grabbing Hand: Determinants of Unofficial Activity in 69 Countries Author(s):
Eric Friedman, Simon Johnson, Daniel Kaufman, and Pablo Zoido-Lobaton
Journal of Public Economics 76(3): 459–93, 2000
Across 69 countries, higher tax rates are associated with less unofficial activity as a percent of GDP but corruption is associated with more unofficial activity. Entrepreneurs go underground not to avoid official taxes but to reduce the burden of bureaucracy and corruption. Dodging the ‘grabbing hand’ in this way reduces tax revenues as a percent of both official and total GDP. As a result, corrupt governments become small governments and only relatively uncorrupt governments can sustain high tax rates.
Start-Up Costs, Limited Enforcement and the Hidden Economy* Author(s):
Antonio Antunes and Tiago Cavalcanti
European Economic Review 51 (1): 203–24, 2007
This paper examines how much of the difference in the size of the informal sector and in per capita income across countries can be accounted by regulation costs and enforcement of financial contracts. It constructs and solves numerically a general equilibrium model with credit constrained heterogeneous agents, occupational choices over formal and informal businesses, financial frictions and a government sector which imposes taxes and regulations on formal firms. The benefit from formalization is better access to outside finance. The quantitative exercises suggest that: (i) regulation costs and not the level of enforcement account for differences in the size of the informal sector between United States and Mediterranean Europe; (ii) for a developing country like Peru, however, contract enforcement and regulation costs are equally important in accounting for the size of the informal sector; and (iii) regulation costs and contract enforcement do not account for most of the income differences observed among countries.
What Causes Firms to Hide Output? The Determinants of Informality* Author(s):
Era Dabla-Norris, Mark Gradstein and Gabriela Inchauste
Journal of Development Economics 85 (1): 1–27, 2008
In many developing countries, a significant part of economic activity takes place in the informal sector. Earlier work has examined the determinants of the size of the informal sector, focusing separately on factors such as tax and regulation burden, financial market development, and the quality of the legal system. We revisit this issue by using an integrated data set which contains information on all these aspects. Building on a simple analytical framework, we test the channels affecting the degree of informality. We find that the quality of the legal framework is crucially important in determining the size of the informal sector, whereas the significance of taxes, regulations, and financial constraints is reduced in the context of a well functioning legal system, consistent with the presented model. Additionally, firm size is negatively correlated with the propensity to go informal; finance constraints tend to induce informality among smaller firms but not among large firms, whereas legal obstacles induce informality among larger firms.