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American Economic Journal: Economic Policy: Vol. 1 No. 1 (February 2009)

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Optimal Tax Design and Enforcement with an Informal Sector

Article Citation

Boadway, Robin, and Motohiro Sato. 2009. "Optimal Tax Design and Enforcement with an Informal Sector." American Economic Journal: Economic Policy, 1(1): 1-27.

DOI: 10.1257/pol.1.1.1

Abstract

An optimal commodity tax approach is taken to compare trade taxes and VATs when some commodities are produced informally. Trade taxes apply to all imports and exports, including intermediate goods, while the VAT applies only to sales by the formal sector and imports. The VAT achieves production efficiency within the formal sector, but, unlike trade taxes, cannot indirectly tax profits. Making the size of the informal sector endogenous in each regime is potentially decisive. The ability of the government to change the size of the informal sector through costly enforcement may also tip the balance in favor of the VAT. (JEL E26, H21, H25)

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Authors

Boadway, Robin (Queen's U, Kingston)
Sato, Motohiro (Hitotsubashi U)

JEL Classifications

E26: Informal Economy; Underground Economy
H21: Taxation and Subsidies: Efficiency; Optimal Taxation
H25: Business Taxes and Subsidies including sales and value-added (VAT)

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