Entrepreneurship in the Shadows: Wealth Constraints and Government Policy

Arbeitspapier

I develop a dynamic model of forward-looking entrepreneurs, who decide whether to operate in the formal economy or informal economy and choose how much to invest in their businesses, taking government policy as given. The government has access to two policy tools: taxes on formal business activity and enforcement (or policing) discouraging informality. The main focus of the paper is on transitional dynamics under different initial wealth levels. Whether an initially small business will be trapped in the informal economy and remain small forever or grow quickly and become a large formal business depends on tax and enforcement policies. High tax rates accompanied by loose enforcement – which is mostly the case in less-developed countries (LDCs) – induce tax avoidance, discourage investment in formal businesses, and drive the entrepreneurial activity toward the informal sector even though the initial wealth level is high. Lowering taxes on formal activity joined with strict enforcement can help reducing the magnitude of poverty traps in LDCs.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: IZA Discussion Papers ; No. 10324

Classification and Topics

• Classification: Wirtschaft ; Macroeconomics: Consumption; Saving; Wealth ; Informal Economy; Underground Economy ; Entrepreneurship ; Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
• Subject: investment ; government policy ; informal economy ; entrepreneurship ; wealth constraints

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Tumen, Semih
• Event: Veröffentlichung
• (who): Institute for the Study of Labor (IZA)
• (where): Bonn
• (when): 2016

Further information

• Handle: http://hdl.handle.net/10419/149183
• Last update: 10.03.2025, 11:41 AM CET