Optimal policies with an informal sector

K Cuff, N Marceau, S Mongrain, J Roberts - Journal of Public Economics, 2011 - Elsevier
Journal of Public Economics, 2011Elsevier
This paper characterizes optimal policies in the presence of tax evasion and undocumented
workers. In equilibrium, domestic workers may work exclusively in the formal sector or also
in the informal sector. Surprisingly, in equilibrium, wages are always equalized between
domestic and undocumented workers, even if they do not work in the same sectors of the
economy. This is driven by the interaction of firm level decisions with optimal government
policy. We also find that enforcement may not always be decreasing in its cost, and that …
This paper characterizes optimal policies in the presence of tax evasion and undocumented workers. In equilibrium, domestic workers may work exclusively in the formal sector or also in the informal sector. Surprisingly, in equilibrium, wages are always equalized between domestic and undocumented workers, even if they do not work in the same sectors of the economy. This is driven by the interaction of firm level decisions with optimal government policy. We also find that enforcement may not always be decreasing in its cost, and that governments will optimally enforce labour market segmentation if enforcement costs are not too high.
Elsevier
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