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FISCAL ADJUSTMENTS AND THE SHADOW ECONOMY IN AN EMERGING MARKET

Published online by Cambridge University Press:  05 February 2020

Celso J. Costa Junior ,
Alejandro C. Garcia-Cintado  and
Carlos Usabiaga
Celso J. Costa Junior
Affiliation:
State University of Ponta Grossa
Alejandro C. Garcia-Cintado*
Affiliation:
Pablo de Olavide University
Carlos Usabiaga
Affiliation:
Pablo de Olavide University
*
Address correspondence to: Alejandro C. Garcia-Cintado, Pablo de Olavide University. Carretera de Utrera, Km. 1, 41013 Seville, Spain. e-mail: agcintado@upo.es. Phone: +34 954348994. Fax: +34 954349339.
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Abstract

We build an open-economy dynamic stochastic general equilibrium (DSGE) model that allows us to: (i) derive a time series for labor informality in Brazil spanning the period 2004–2018, whose evolution is consistent with the behavior of the main series provided by Pesquisa Nacional por Amostra de Domicílios (PNAD); (ii) run dynamic simulations showing that, in the presence of a large informal labor market (around 50% of the total labor force), expenditure-cutting measures lead, at worst, to mild short-run recessions in the formal sector and are likely to foster public debt sustainability. Likewise, adjustments through some kinds of distortionary taxation, mainly the corporate tax, and to a lesser extent, the consumption tax, also seem to improve both public debt dynamics and fiscal collection without a significant cost in terms of output. Thus, in countries with large informal economies experiencing fiscal woes, expenditure-based consolidations, as well as some sorts of tax-based adjustments, should be relied upon.

Keywords

DSGE ModelsShadow EconomyFiscal PolicyEmerging Economies
Type
Articles
Information
Macroeconomic Dynamics , Volume 25 , Issue 7 , October 2021 , pp. 1666 - 1700
Copyright
© Cambridge University Press 2020

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Footnotes

We would like to thank, without implicating, two anonymous referees and the Editors of Macroeconomic Dynamics, Luis de Araujo, Ali Bayar, Javier Ferri, Bernardo Guimaraes, Tim Kehoe, Miguel Leon-Ledesma, Alessandro Maravalle, Diego Martinez-Lopez, Daniel Oto-Peralias, Stephen L. Parente, Diego Romero-Ávila, Manuel Toledo, as well as participants at the VI Regional Modelling Workshop, European Commission, October 25–26, 2018, at the XLIII International Conference on Regional Science, November, 15–17, 2017, Seville, at the 17th SAET Conference on Current Trends in Economics, Faro, June 25–30, 2017, at the seminar entitled “Usando a teoria para medir a atividade informal”, FGV-EESP, September 9, 2016, São Paulo, and at the EcoMod2016 International Conference on Economic Modeling, July 6–8, 2016, Lisbon, for the helpful comments made on an earlier version of this paper. We are also grateful to the Research Groups PAIDI SEJ-513 and ECO2017-86780-R for the funding provided. All the remaining errors are our sole responsibility.

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