The Informal Sector: An Equilibrium Model and Some Empirical Evidence from Brazil

30 Pages Posted: 7 Dec 2009  

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)

Date Written: December 2, 2009

Abstract

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.

Keywords: Informal Sector, Tax Avoidance, Brazil

JEL Classification: H2, H3, K4

Suggested Citation

de Paula, Aureo and Scheinkman, Jose A., The Informal Sector: An Equilibrium Model and Some Empirical Evidence from Brazil (December 2, 2009). PIER Working Paper No. 09-044. Available at SSRN: https://ssrn.com/abstract=1517201 or http://dx.doi.org/10.2139/ssrn.1517201

Aureo De Paula (Contact Author)

University College London - Department of Economics ( email )

Gower Street
London WC1E 6BT, WC1E 6BT
United Kingdom

Getulio Vargas Foundation (FGV) - Sao Paulo School of Economics

Rua Itapeva 474 s.1202
São Paulo, São Paulo 01332-000
Brazil

Jose A. Scheinkman

Columbia University ( email )

420 W. 118th Street
New York, NY 10027
United States

HOME PAGE: http://www.princeton.edu/~joses

Princeton University - Department of Economics ( email )

26 Prospect Avenue
Princeton, NJ 08544
United States
609-258-4020 (Phone)
609-258-6419 (Fax)

HOME PAGE: http://www.princeton.edu/~joses

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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