The Informal Sector: An Equilibrium Model and Some Empirical Evidence from Brazil, Second Version
30 Pages Posted: 26 Jul 2010
Date Written: July 26, 2010
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. The model predicts that the interaction of an index of observable inputs to entrepreneurial ability and formality is positively correlated with firm size, which we verify in the data. Using the model, we estimate that informal firms in our data-set faced at least 1.3 times the cost of capital of formal firms.
Keywords: Informal Sector, Tax Avoidance, Brazil
JEL Classification: H2, H3, K4
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