This paper investigates the determinants of informal economic activity. We present two equilibrium models of informality and test their implications using a survey of 48,000+ small firms in Brazil. We define informality as tax avoidance; firms in the informal sector avoid tax payments but suffer other limitations. In the first model there is a single industry and informal firms face a higher cost of capital and a limitation on size. As a result informal firms are smaller and have a lower capital labor ratio. When education is an imperfect proxy for ability, we show that the interaction of the manager's education and formality has a positive correlation with firm size. These implications are supported by our empirical analysis. The second model highlights the role of value added taxes in transmitting informality. It predicts that the informality of a firm is correlated to the informality of firms from which it buys or sells. The model implies that higher tolerance for informal firms in one production stage increases tax avoidance in downstream and upstream sectors. Empirical analysis shows that, in fact, various measures of formality of suppliers and purchasers (and its enforcement) are correlated with the formality of a firm. Even more interestingly, when we look at sectors where Brazilian firms are not subject to the credit system of value added tax, this chain effect vanishes.

We present an equilibrium model of tax avoidance and test its implications using a survey of firms in Brazil. In the model, the credit method used to collect value-added tax (VAT) creates informality chains-clients or suppliers of informal firms are more likely to be informal. An increase in enforcement in a production stage increases formality downstream and upstream. Various empirical measures of formality of suppliers and buyers, and of enforcement downstream and upstream, are positively correlated with formality. When the VAT is applied in a single stage of production at a rate estimated by the authorities, these chain effects disappear. (JEL H25, H26, L14, L21, O14, O17)

This paper studies the inference of interaction effects in discrete simultaneous games with incomplete information. We propose a test for the signs of state‐dependent interaction effects that does not require parametric specifications of players' payoffs, the distributions of their private signals, or the equilibrium selection mechanism. The test relies on the commonly invoked assumption that players' private signals are independent conditional on observed states. The procedure is valid in (but does not rely on) the presence of multiple equilibria in the data‐generating process (DGP). As a by‐product, we propose a formal test for multiple equilibria in the DGP. We also implement the test using data on radio programming of commercial breaks in the United States, and infer stations' incentives to synchronize their commercial breaks. Our results support the earlier finding by Sweeting (2009) that stations have stronger incentives to coordinate and air commercials at the same time during rush hours and in smaller markets.

This paper studies the identification of a simultaneous equation model involving duration measures. It proposes a game theoretic model in which durations are determined by strategic agents. In the absence of strategic motives, the model delivers a version of the generalized accelerated failure time model. In its most general form, the system resembles a classical simultaneous equation model in which endogenous variables interact with observable and unobservable exogenous components to characterize an economic environment. In this paper, the endogenous variables are the individually chosen equilibrium durations. Even though a unique solution to the game is not always attainable in this context, the structural elements of the economic system are shown to be semi‐parametrically identified. We also present a brief discussion of estimation ideas and a set of simulation studies on the model.