The Informal Sector: An Equilibrium Model and Some Empirical Evidence from Brazil
Aureo De Paula
University College London - Department of Economics; Getulio Vargas Foundation (FGV) - Sao Paulo School of Economics
Jose A. Scheinkman
Columbia University; Princeton University - Department of Economics; National Bureau of Economic Research (NBER)
December 2, 2009
PIER Working Paper No. 09-044
We test implications of a simple equilibrium model of informality using a survey of 48,000 small firms in Brazil. In the model, agent's ability to manage production differ and informal firms face a higher cost of capital and limitation on size, although these informal firms avoid tax payments. As a result, informal firms are managed by less able entrepreneurs, are smaller and employ a lower capital-labor ratio. When education is an imperfect proxy for ability, the model predicts that the interaction of the manager's education and formality is positively correlated with firm size. Using the model, we estimate that informal firms in our dataset faced at least 1.3 times the cost of capital of formal firms.
Number of Pages in PDF File: 30
Keywords: Informal Sector, Tax Avoidance, Brazil
JEL Classification: H2, H3, K4working papers series
Date posted: December 7, 2009
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