A Model of the Informal Economy in the Transition Setting

19 Pages Posted: 7 Feb 1999

See all articles by Simon John Commander

Simon John Commander

London Business School; IZA Institute of Labor Economics

Andrei Tolstopiatenko

World Bank

Date Written: July 1998


The informal economy has burgeoned in many transition economies but particularly in the Former Soviet Union. While the variation in the size of the informal economy has been related to differences in tax regimes and the degree of transparency in the legal and commercial system the causality is far from obvious and other factors -- such as the importance of non-monetary compensation or social benefits -- seem to be important. This paper sets up a model of a formal and informal sector where multiple job-holding is feasible. The informal sector can choose to employ part time labour or full time workers; the latter will be subject to payroll taxation. The informal sector in this model makes its decisions contingent on the behaviour of the formal sector and parameters, such as tax rates and the probability of being caught evading taxes. The model allows us to retrieve the ratio of the types of employment in each sector and their associated levels. With the closed form, a set of simulations are run that indicate the effect of shocks to demand and/or financing of social benefits on labour allocation. The distribution of employment across full and part time employment is very sensitive to the scale of subsidy given to benefits, as well as the tax regime and incidence.

JEL Classification: J23, J32, P31, 011

Suggested Citation

Commander, Simon John and Tolstopiatenko, Andrei, A Model of the Informal Economy in the Transition Setting (July 1998). Available at SSRN: https://ssrn.com/abstract=148915 or http://dx.doi.org/10.2139/ssrn.148915

Simon John Commander (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072

Andrei Tolstopiatenko

World Bank ( email )

1818 H Street
Washington, DC 20433
United States
202-473-0349 (Phone)
202-676-0965 (Fax)

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