Scandinavian Working Papers in Economics

Working Papers,
Copenhagen Business School, Department of Economics

No 04-2002: Social norm, the informal sector and unemployment

Ann-Sofie Kolm and Birthe Larsen
Additional contact information
Ann-Sofie Kolm: Uppsala University, Postal: Department of Economics,, Uppsala University,, Box 513, S-751 20 Uppsala
Birthe Larsen: Department of Economics, Copenhagen Business School, Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark

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 on the labour market and a social norm. Conducting informal work, or employing a worker infor- mally, is associated with expected punishment fees and payments of a moral cost, given that there is a social norm against tax evasion. This framework facilitates an analysis of how wage setting, unemployment and the size of the informal sector are affected by punishment policies, which has been ignored in the previous literature. Furthermore, the inclusion of an endogenously determined norm against tax evasion may explain differences in-between regions or countries in relative sizes of the formal and the informal sectors for similar tax- and punishment policies.

Keywords: Tax evasion; informal sector; matching; bargaining; unem- ployment.

JEL-codes: H26; J64

24 pages, May 1, 2002

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