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Department of Economics, Copenhagen Business School Working Paper Series, Department of Economics, Copenhagen Business School

No 11-2003:
Wages, unemployment, and the underground economy

Anne-Sofie Kolm and Birthe Larsen

Abstract: While examining the macroeconomic effects of increased government control of the informal sector, this paper develops a two-sector general equilibrium model featuring matching frictions and worker-firm wage bargaining. Workers search for jobs in both the formal and the informal sector. We analyse the impact of higher punishment rates and a higher audit rate on labour market performance. We find that a higher punishment rate reduces the size of the informal sector and reduces unemployment. A higher audit rate has an ambiguous impact on unemployment, and may actually increase the size of the underground economy.

Keywords: Tax evasion; underground economy; matching; bargaining; unemployment; (follow links to similar papers)

JEL-Codes: H26; (follow links to similar papers)

32 pages, October 20, 2003

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