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The B.E. Journal of Macroeconomics

Editor-in-Chief: Cavalcanti, Tiago / Kambourov, Gueorgui

Ed. by Abraham, Arpad / Carceles-Poveda , Eva / Debortoli, Davide / Schwartzman, Felipe / Wang, Pengfei

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Envelope wages, hidden production and labor productivity

Alessandro Di Nola / Georgi Kocharkov / Aleksandar Vasilev
Published Online: 2019-04-09 | DOI: https://doi.org/10.1515/bejm-2018-0252


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.

This article offers supplementary material which is provided at the end of the article.

Keywords: envelope wages; flat tax reform; hidden production; informal economy

JEL Classification: H24; H25; H26; C63; E62; E65


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About the article

Published Online: 2019-04-09

Funding Source: Global Development Network

Award identifier / Grant number: RRC1437

This research is supported by research grant RRC1437 from the CERGE-EI Foundation under a program of the Global Development Network.

Citation Information: The B.E. Journal of Macroeconomics, 20180252, ISSN (Online) 1935-1690, DOI: https://doi.org/10.1515/bejm-2018-0252.

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