Envelope Wages, Hidden Production and Labor Productivity

Abstract

We evaluate the relative importance of aggregate labor productivity versus income taxes and social contributions for tax compliance in an economy with a large degree of informality. Empirical evidence points out that tax evasion in Europe happens through partially concealing wages and profits in formally registered enterprises. To this end, we build a model in which employer-employee pairs of heterogeneous productive capacities make joint decisions on the degree of tax evasion. The quantitative model is used to analyze the case of Bulgaria which has the largest informal economy in Europe and underwent a number of important tax reforms over the period 2000-2014, including the introduction of a flat income tax in 2008. The estimation strategy relies on matching the empirical series for the size of the informal economy and other aggregate outcomes for 2000-2014. Our counterfactual experiments show that the most important factor for the changing size of the informal economy is labor productivity, which accounts for more than 75% of the change. The variation in corporate income tax accounts for the rest. We find that the 2008 flat tax reform did not play any visible role in coping with informality.

How quantitatively important is public investment for both business cycle fluctuations and output growth in Bulgaria (1999–2018)?

“…5 For a survey of different fiscal (mainly tax-) reforms in Bulgaria and their effect on the business cycle, the reader is referred to Vasilev (2017a), Vasilev (2015b), Di Nola et al (2019, as well as the references therein. There are not many studies on Eastern European economies that use dynamic general equilibrium setups with micro-foundations.…”

Underground activities and labour market performance

“…Taking a Latin American perspective, Albrecht et al (2009) account for worker heterogeneity in a search framework, while considering the impact of payroll taxes and severance pay on unemployment in the presence of an informal sector. 9 The study by Meghir et al (2015) takes a slightly different modelling approach in its focus on underground activities in Brazil as their paper considers on-the-job-search and firm heterogeneity. Workers may search for jobs both in the formal and the informal sector, and search frictions make it profitable for firms to start both types of jobs.…”

“…See for exampleSandmo (1981) for an early contribution of endogenous labour supply and underreporting of income. Also equilibrium models with tax evasion have been developed, as, for example, the early study byCremer and Gahvari (1993) and the studies byTonin (2011) andPrado (2011) 9. See also Bosch and Esteban-Pretel (2012) for a model based on a similar set-up calibrated by use of flow data from Brazil.…”