## Financial Frictions and Firm Informality: A General Equilibrium Perspective

_IMF Working Papers, September 25, 2020_

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## Bibliographic details
- Authors: Luis Franjo, Nathalie Pouokam, Francesco Turino
- Published: September 25, 2020
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513557809.001

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### Summary and approach
- Builds a model of occupational choice with informal production and progressive income taxation.
- Calibrates the model to the Brazilian economy to evaluate the impact of removing financial frictions on informality.
- Tests model predictions with cross-country data to examine non-linear responses across levels of financial development.
- Investigates changes in income tax progressivity as an alternative policy.

### Main quantitative findings (Brazil calibration)
- Size of the informal sector: from 37 percent to 22 percent of official GDP (drop following financial deepening).
- Measured TFP: increase by 4 percent.
- Official GDP: increase by 27 percent.
- Tax evasion: decrease by 17 percent.
- Fiscal revenues: increase by 15 percent.

### Non-linear effects and cross-country evidence
- Finds a non-linear relationship between the credit-to-GDP ratio and:
  - The size of the informal economy.
  - GDP per capita.
- Cross-country tests find evidence in favor of both types of non-linearity.

### Policy comparison: financial deepening vs. income tax progressivity
- Financial deepening yields large reductions in informality, increases in measured TFP and official GDP, reductions in tax evasion, and higher fiscal revenues (see quantitative findings above).
- Increasing income tax progressivity:
  - Evaluated as an alternative policy.
  - Found to be more effective in countries with a medium to high level of financial markets development.

### Key themes and keywords
- Credit; entrepreneurship; financial frictions; firms informality; ghost firm; Informal economy; informal firm; informality; misallocation; parasite firm; productivity; Self-employment; survival firm; Tax evasion; taxation; WP

*IMF Working Paper: Financial Frictions and Firm Informality: A General Equilibrium Perspective (Luis Franjo, Nathalie Pouokam, Francesco Turino, September 25, 2020).*

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_Source: https://www.imf.org/en/publications/wp/issues/2020/09/25/financial-frictions-and-firm-informality-a-general-equilibrium-perspective-49764_